WASHINGTON -- Advisors helping clients plan for retirement have a new option that could help carve out a middle ground between taking a lump-sum payout from a 401(k) and throwing their entire plan into an annuity.

On Tuesday, the Treasury Department and IRS finalized rules governing so-called longevity annuities, a deferred income vehicle that begins paying out when the retiree reaches an advanced age -- say 80 or 85 -- and continues through the individual's life.

J. Mark Iwry, a deputy assistant secretary at Treasury and senior advisor to the secretary, announced the new rules at a policy conference organized by the Insured Retirement Institute.

Iwry argues that the retirement challenge, already made acute by insufficient savings rates and an aging population, is exacerbated by the fact that life expectancies are on the rise, making it harder to plan for a retirement that could last 30 years or longer.

"People are increasingly confronting the longevity risk problem," Iwry says. "Americans are increasingly recognizing that it's hard for an individual who doesn't know his or her future lifespan to deal with and manage the risk of running out of assets while they're in retirement."

In setting out rules for longevity annuities, the Treasury Department is hoping that more Americans will choose not to cash out their 401(k) or IRA plan in a lump sum once they retire. Irwy notes that participants in 401(k) plans that offer a conversion to annuities tend overwhelmingly to opt for the lump sum payout. Smitten at the prospect of instantly receiving more money than they've ever seen in their lives, Iwry calls this the "wealth illusion."

The longevity annuities, sometimes described as "deeply deferred" annuities, offer a sort of hybrid model that would carve out a portion of an investor's retirement plan -- capped at 25% -- for lifetime payouts to begin at a much later date, leaving the balance of the plan available for a cash-out, rollover or some other action.

"This may be able to help among other strategies to overcome some of the behavioral inhibitions," Iwry says. "The longevity annuity has the advantage of overcoming the all-or-nothing character of the choice architecture, if you will, confronting the individual when they're making the decision, especially in a 401(k) plan, how to take your benefits."

The Treasury Dept.'s announcement was welcome news for the IRI, which has been lobbying for a wider array of retirement products that advisors can offer clients.

"We think it helps lifetime income in a new way that we haven't seen before," says IRI President and CEO Cathy Weatherford.

Treasury says that the final rule is generally consistent with its earlier draft, though several changes were incorporated in response to comments from the public. One is the purchase cap at 25% of the individual's retirement plan, or $125,000, whichever is lesser. That raised the threshold from the $100,000 mark Treasury had initially floated.

The Treasury Department also considered incentives that could make the longevity annuities an easier sell for advisors and other financial professionals. In particular, comments on the draft proposal urged the department to address the question of how benefits would be paid out if the individual died before reaching the age when the annuity was scheduled to begin paying out.

A psychology similar to what can make lump-sum payouts so appealing -- "What if I get hit by a bus tomorrow?" -- could tamp down interest in deferring payments until an age that many retirees won't reach. The final rules provide for returning the premiums that an investor paid, but never collected annuities on, to the account so they would pass to the heirs.

"If people aren't going to buy it, it's not going to be much good," Iwry says. "It will be easier to sell this to people if we can deal with the get-hit-by-the-bus problem."

The Treasury Department is looking to other regulatory changes to make more choices available for retiring workers, including a set of rules that is nearing finalization that aims to clarify the options for taking partial annuities from defined-benefit plans. To be sure, the partial annuitization of a DB plan is permissible today, Iwry says, but retirees are commonly presented with the binary choice of taking a lump sum payment or going all-in with an annuity, and most opt to cash out.

"All too seldom is the choice architecture here framed as how much of your benefit do you want as an annuity and how much do you want as a lump sum," Iwry says. "You can have a mix. You can have a combination."

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