As we discussed in our August retirement policy update, defined contribution plan sponsors will in 2022 have to begin providing participants with lifetime income illustrations showing the single life and 100% joint and survivor annuities their account balance would “buy.”
In this article we provide some examples of what these new lifetime income numbers might be like for participants at different ages and consider the implications of providing these numbers for participant communications. We start with some background.
The new lifetime income disclosure requirement was added by the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act). In August 2020, the Department of Labor released an interim final rule (IFR) describing how this “lifetime income disclosure” was to be calculated. Generally, the IFR requires sponsors to:
Assume that the lifetime income begins as of the last day of the statement period.
Assume that the participant is age 67 (or her actual age if older) on the statement date.
Assume the participant is married, and his spouse is the same age, for purposes of calculating the (required) 100% survivor lifetime income alternative.
Use an interest rate equal to the 10-year constant maturity Treasury securities yield rate.
Use unisex mortality assumptions under Internal Revenue Code section 417.
The most controversial of these rules is the requirement that the participant be assumed to be age 67 – in effect, for younger participants, the calculation assumes no earnings from the participant’s current age to age 67. Let’s call this the “pre-retirement earnings issue.”
This element of the IFR has been widely criticized, including by the SECURE Act’s main sponsor, Congressman Neal (D-MA), Chairman of the House Ways and Means Committee, who in a letter to DOL urged its correction.
In its recent FAQs on lifetime income disclosure, DOL stated that it “intends to issue a final rule [finalizing the “Interim Final Rule”] as soon as practicable based on feedback from comments received during the public comment period on the IFR.” We expect DOL to make some (modest) accommodation to the concerns (noted above) about the pre-retirement earning issue before issuing that final rule.
In this context – and given the imminent requirement that sponsors issue participant statements that include a lifetime income disclosure – we thought it would be useful review the impact this will have on participant understanding of the value of their DC/401(k) benefit.
The table below shows the amount of the 100% joint and survivor lifetime income – at different ages – that $100,000 will buy under (i) the rules of the IFR and (ii) an amended final rule that credits a modest, real (that is, net of inflation) earnings rate of 1% per year.
|Monthly Income, 100% Joint & Survivor Annuity|
|Age||Account Balance||DOL Interim Final Rule||1% Real Return Pre-Retirement|
We have published several articles discussing the effect of declining interest rates on DC lifetime income. Last January, in our article Retirement savings finance at the end of 2020, we noted that that a typical participant ended 2020 with a net loss in their lifetime income despite double-digit asset returns.
That loss was entirely the consequence of 2020’s 75 basis point decline in long-term interest rates. That comes on top of a 100 basis point decline during 2019.
These declines, under the DOL’s methodology, to the extent not offset by asset gains, translate directly into reduced lifetime income.
Preparing participants for the news
Participants who have been focused on significant 401(k) asset gains over the last several years may be somewhat surprised to see the (relatively small) size of the lifetime income their account balance can buy in the current interest rate environment.
Sponsors who have not already been communicating about lifetime income may want to consider what the appropriate messaging may be, to help participants understand these new numbers and what actions they might take – most critically, increasing contributions – to improve them.
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We will continue to follow this issue.