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September 21, 2021

Lifetime Income Illustrations

Every year, Vanguard’s Institutional Investor Group analyzes account data from five million retirement accounts. Across these accounts, the typical account balance varies widely, depending upon the method used for calculation.

The average 401(k) savings balance is $129,157, however, the median account balance is only $33,472, according to Vanguard's latest data. This amount of retirement funds is not enough money for most people to live on for the rest of their lives. To prepare yourself for a retirement that mirrors your current lifestyle, there are two critical things you should be doing now. First, determine how much money you need to live on at retirement age and from your investment and/or savings. And two, save more money, if additional funds would be needed to get you to your goal.

Let’s assume you want your savings to provide you with $5,000 a month at retirement. How much money do you need in your retirement account to provide this monthly income? Wouldn’t it be nice to have an amount of dollars, based on your current account balance, be displayed right on your benefit statement? Well, the government not long ago passed a law, the SECURE Act of 2019, that requires participant benefit statements to include this information.

The SECURE Act of 2019

The SECURE Act of 2019 requires employers of individual account plans, such as 401(k) & 403(b) and Profit-Sharing Plans, to provide participants annual annuity illustrations. They call this a Lifetime Income Illustration. This lifetime Income Illustration must provide the monthly amount that both a single life annuity and a joint and survivor annuity would pay. This amount is based upon the participant or beneficiary’s current account balance and must be subject to certain assumptions. 

Converting a lump sum of money to a monthly stream of payments, that would be guaranteed for the rest of your life, is called an annuity.

Lifetime Income Illustration—Background

The Department of Labor (DOL) had been considering what lifetime income disclosures might look like since 2010. In fact, during 2013, the DOL came out with a proposal that would require a lifetime income stream illustration, to be displayed on a participant’s benefit statement.

The DOL suggested a single-life annuity, as well as a qualified joint-annuity and a 50% survivor annuity, each with two separate calculations. One would be based upon current account balance and the other based upon a projected account balance, assuming future contributions with investment earnings.

The DOL received many comments on their proposal, but they took no further action until they released—what was referred to as an Interim Rule—in 2020. This was in response to the SECURE Act of 2019 requirements.

These annuity illustrations are intended to increase retirement savings, by showing plan participants what their account balance will look like in the form of an annuity. The Lifetime Income Illustration is for self-directed plans and are due no later than the second quarter of 2022. Plans that do not let their employees self-direct are due by October 15, 2022.

Employers that engage record keepers to account for their employee’s money, will be providing these Lifetime Income Illustrations. However, this is not a service provided by most brokerage firms and there are plans that do not use a recordkeeper. Benefit Equity is working toward to providing these illustrations for employers who invest their plan’s money without a record keeper.

Note: The current law states that the employer is required to provide this illustration. Therefore, employers need to check with their service providers for support to create these required illustrations.

What Is Included on a Lifetime Income Illustration?

The illustration must explain in detail what the lifetime income examples mean and the assumptions used to calculate them. Below are the current illustration rules:

• Assume lifetime income begins as of the last day of the statement period.

• Assume the participants are age 67 (or actual age, if older) on the statement date.

• Assume participants are married and they both are the same age.

• Use the gender-neutral mortality table in the Internal Revenue Code to determine how long participants and spouses are likely to live.

• Use an interest rate equal to the 10-year—constant maturity treasury securities yield rate—to approximate the rate used by the insurance industry to price immediate annuities.

Account balance is the total balance, without regard to vesting, that includes any outstanding participant loans that are not in default.

The table below outlines the DOL’s example of the Lifetime Income Illustration:

Commentary

The government will relieve Plan Administrators/Employers of any liability for these retirement income projections if they follow their suggested calculations and disclosures.

Therefore, you only can use a current account balance, with a low interest rate which is currently 1.30%, and with no projection of future contributions. As stated above, the DOL was looking into providing a projection of future contributions and earnings, but that did not happen. The DOL is taking comments on their Interim Rule and many of us in the retirement plan community are encouraging the DOL to allow for the assumption of future contributions plus earnings.

At Benefit Equity, we do not approve of not providing an estimate of future contributions and earnings, as we believe it is a disservice to employees and may actually discourage employees from saving for retirement.

In the government’s example (above), they assume a 40-year-old with an account balance of $125,000. This amount equates to a monthly annuity at age 67 and a total amount of $646.00. The DOL does not say when the person in their example started saving or how much they save. Our estimate is for someone age 40 to have this amount of money at retirement age, they would likely need to save $8000 to $10,000 a year. If that’s the case and assuming a 5% interest rate, an individual would have around $1M at age 67. This would buy an annuity of approximately $7,000 per month. We believe this type of illustration would be much more meaningful and valuable.

Instead, the DOL’s illustration will take a current account balance and assume an individual is currently age 67. This will be the amount of money one would have if they do not put any more money into the plan, and they would earn the Treasury Security Rate (1.30%).

Using Vanguard’s statistics and the median account balance of $ 33,472, an individual would be projected to receive a single-life annuity of $173—or a joint annuity and a 100% survivor annuity of $143.00 on a monthly basis.

Thank Goodness…There is a Better Way!

The recordkeepers that most of our clients use, include a retirement planning app that projects their current account balance—plus projected future contributions and a current interest rate, to determine their monthly stream of payments or annuity. 

In most cases, our clients are required to add their specific information in the application. However, they can change the specifics, such as their income/salary and how much they contribute, with a current or reasonable interest rate.

Based on your current income, most of these types of apps show if there will be enough money to retire at retirement age. Now, that’s meaningful information and we encourage you to use these programs provided by the recordkeepers.

All of us at Benefit Equity Inc. believe we should help employees determine what their account balance will be, and what it will provide as a stream of monthly payments, when they retire. However, we don’t believe this government’s approach is the best way to go about it.

Ronald Reagan once said…“The most terrifying words in the English language are “I’m from the government and I'm here to help.”

Contact your Benefit Equity Inc. consultant and financial advisor to learn more about the  Lifetime Income Illustration and a whole host of retirement-related topics.

Author: Robert Gorelick, APA, and Founder Benefit Equity Inc.

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