Letter from the US: From small beginnings

The US private retirement annuity market is quite small. But it is likely to grow dramatically thanks to the convergence of various factors, including new rules on taxation and new attitudes by both employers and employees. The former are increasingly focused on de-risking their defined-benefit pension plans through deferred annuity contracts; the latter are more concerned about longevity risks and also stock market risks.

Annuity reserves are only $2.1trn (€1.9trn) or 8.5% of total US retirement assets of around $25trn. One reason for this is that fewer than one-in-five defined contribution plans offer annuities, according to a factsheet the White House issued for its July 2015 conference on ageing.

Historically, sponsors, managers and participants have been more focused on the accumulation phase of assets and on investment options. “Solving the ageing risk and providing lifetime income is the biggest missing piece of our industry,” Chip Castille, chief retirement strategist at BlackRock, said recently. 

To raise awareness about “retirement debt” – the money that a person “owes” themself when they retire – BlackRock has created the CoRi Retirement indices, which were launched two years ago in the US and last summer in the UK.

They seek to estimate the fair value of a dollar of annual lifetime retirement income beginning at age 65, although in practice they follow the price of annuities. Last year, BlackRock also launched funds that track the CoRi indices and  which primarily invest in fixed income.

A more radical way to solve the problem is to offer annuities as investment options in 401(k) plans. This strategy is likely to become more popular in the wake of US Treasury regulations issued in July 2014. Previously, plan participants could not defer their income start-date beyond age 70.5 without incurring a significant tax penalty, because they were required to take yearly required minimum distributions (RMDs) out of their qualified savings at that point and RMDs are subject to income taxes. 

Now there is the alternative of the new qualifying longevity annuity contracts (QLACs). These are deferred income annuities (DIAs) that can be purchased in 401(k)s and individual retirement accounts (IRAs) and which allow owners to defer their annuity income payments up to age 85. Owners of QLAC contracts can also exclude the premiums from RMD calculations, meaning they will pay less tax. In other words, QLACs mean that a DC participant or IRA member can take out real longevity insurance to help meet later life expenses. When the member retires they can immediately withdraw money from their retirement account and receive a guaranteed income for the rest of their life once the QLAC begins payment.

The Employee Benefit Research Institute (EBRI) has undertaken a study to assess the ability of QLACs as an effective longevity hedge for Baby Boomers and members of Generation X (the generation that follows). The results are positive. According to the EBRI, the use of QLACs inside of 401(k)s produces a “significant increase” in retirement readiness – the likelihood of not running out of money late in life – for people with the longest life expectancy based on family status, gender and age.

It is too early for data on QLACs but sales of other annuities are going strong, notwithstanding low interest rates that force insurers to offer low guaranteed paycheques. 

Total US annuity sales in 2014 rose 3% to $235.8bn, according to the Secure Retirement Institute, while pension annuity contracts brought insurers $8.5bn in revenue, up from $3.8bn in 2013. This followed the annual record of $35.9bn in 2012 due to GM’s and Verizon’s jumbo deals.