The IRS has issued guidance in Notice 2014-66 designed to allow expanded use of income annuities in Section 401(k) plans.

The IRS said the guidance is meant to help retirees manage their savings and ensure they have a stream of regular income throughout retirement. The guidance makes clear that plan sponsors can include deferred income annuities in a range of target date funds, even if only some of the target date funds are available only to older participants in a manner that complies with the nondiscrimination requirements applicable to qualified plans. This option is voluntary for plan sponsors and participants.

Many Section 401(k) plans offer so-called target date funds as a default investment for participants who do not affirmatively elect a different investment. Target date funds get their name from the fact that their allocation of investments shifts gradually from equities to fixed income as participants approach an intended target retirement year. A deferred income annuity provides an income stream that generally continues throughout an individual's life but is not intended to begin until sometime after it is purchased. According to the IRS, this can provide a cost-effective solution for retirees willing to use part of their savings to protect against their outliving the rest of their assets, and can also help them avoid overcompensating by unnecessarily limiting their spending in retirement.

Under Notice 2014-66, a target date fund may include annuities allowing payments, beginning either immediately after retirement or at a later time, as part of its fixed income investments, even if the fund containing the annuities is limited to employees over a specified age. The guidance makes clear that plans have the option to offer target date funds that include these annuity contracts either as a default or as a regular investment alternative.

Notice 2014-66 also describes how the fiduciary standards under the Employee Retirement Income Security Act (ERISA) can be satisfied when a plan sponsor appoints an investment manager to select the annuity contracts and annuity provider to pay the lifetime income.

The U.S. Department of Labor has separately confirmed that target date funds serving as default investment alternatives may include annuities among their fixed income investments.

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