On Sept. 18, the U.S. Department of Labor (DOL) published in the Federal Register an interim final rule that, in one year's time, will require 401(k) plan sponsors to annually disclose to plan participants estimates on how much income their account balance would produce if used to purchase an annuity.
A pre-publication version of the rule was released by the DOL a month earlier, on Aug. 18, when the DOL also posted a fact sheet about the guidance.
The rule implements Section 203 of the Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted at the end of last year. It requires 401(k) and similar defined contribution workplace retirement plans to provide lifetime income estimates to participants "to give savers a realistic illustration of how much monthly retirement income they could expect to purchase with their account balance," the DOL announced.
The disclosure is intended to help employees determine their readiness to retire. It also is expected to encourage employees to consider annuitization of their retirement assets, meaning using some or all of their 401(k) funds to purchase a lifetime annuity.
A lifetime income annuity is a contract with an insurance company that allows purchasers to convert a portion of their retirement savings into a predictable lifetime income stream.
"Our goal is to help workers and retirees understand how savings translate to retirement income," said Jeanne Klinefelter Wilson, acting assistant secretary of labor for the Employee Benefits Security Administration. "Defined contribution plan savings are meant to stretch across the years of retirement. When workers are reminded of what their balances could mean in terms of an estimated monthly dollar amount, they can use this information to plan both savings and spending."
Robert Melia, executive director of the Institutional Retirement Income Council (IRC), an organization of industry advisors that promotes retirement income solutions, said that "the consistency of messaging created by the rule will reduce confusion while providing standardized statements to participants." He added, "participants nearing retirement will receive factual and consistent information on their retirement security that will reduce their financial stress giving them a realistic idea of their potential guaranteed income."
Michael Barry, senior consultant at retirement plan advisory firm October Three, commented that "the effect of changes in interest rates and asset performance on retirement income must be made transparent to participants. The DOL's new rule is a step in that direction but raises a number of issues" regarding the assumptions plan administrators are directed to make and, consequently, the accuracy of the retirement income estimates, he explained.
Joni Andrioff, senior director at audit, tax and consulting firm RSM, wrote, "The interim rule will likely increase the amount and type of information to be gathered, the actuarial factors appropriate for each individual person, and the increased use of third-party administrators to calculate the monthly amounts. Existing systems will have to be recalibrated to produce the new benefit statements. There could be significant one-time and ongoing costs."
'Existing systems will have to be recalibrated to produce the new benefit statements. There could be significant one-time and ongoing costs.'
The interim final rule will be effective on Sept. 18, 2021, which is 12 months after the date of its publication in the Federal Register. The DOL is providing a 60-day comment period through Nov. 17, and will use comments to improve the final rule before its effective date.
"Since DOL began this project, in 2013, it has been controversial, and there are likely to be a number of comments suggesting significant changes," Barry noted in a blog post.
Annual Disclosure of Projected Income
The SECURE Act instructed the DOL to devise assumptions 401(k) plans can use to estimate the monthly income workers' 401(k) balances are likely to generate over their lifetime. The secretary of labor was also directed to develop a model disclosure.
Under the new rule, plan administrators will show participants equivalents of their retirement savings as monthly income under two scenarios: as a single-life income stream, and as an income stream that factors in a survivor benefit.
The estimates must explain what the lifetime income examples mean and the assumptions that were used to calculate them. Plan administrators are instructed to follow these directives:
- Assume that the lifetime income begins as of the last day of the statement period.
- Assume that participants are age 67 (or actual age, if older) on the statement date.
- Assume participants are married, and their spouse is 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.
"The participant’s account balance is her total account balance without regard to any vesting provision and includes outstanding loans that are not in default," Barry noted.
The DOL's fact sheet provides this disclosure example for a plan participant with an account balance of $125,000 as of Dec. 31, 2022. Even though this participant may be 40 years old and single, the illustration is based on an assumed age of 67 and shows income estimates for both single-life and joint annuities.
|Current Account Balance
|Single Life Annuity
|$645 per month for life (assuming Participant X is age 67 on Dec. 31, 2022).
|Qualified Joint and 100% Annuity
|$533 per month for participant's life, and $533 for the life of spouse following participant's death (assuming Participant X and hypothetical spouse are age 67 on Dec. 31, 2022).
"Interestingly, the plan must provide the stream of payments over the life expectancy of a participant and a spouse by assuming that the participant is married (even if the participant is not actually married) and that the participant's spouse is the same age as the participant (regardless of a spouse's actual age)," Andrioff wrote. "The marital status assumption is a requirement of the SECURE Act."
The rule requires various explanations about the estimated lifetime income payments that plan administrators must provide to participants. "These explanations will help participants understand, among other things, how the plan administrator calculated the estimated monthly payments and, importantly, that these estimates are illustrative only and are not guarantees," the DOL fact sheet explains.
Plan fiduciaries that use the regulatory assumptions and the model language prescribed by the rule will qualify for liability relief and will not be held liable if participants are unable to purchase equivalent monthly payments, according to the DOL. The liability relief addresses plan sponsors' concerns that participants might sue them if actual monthly payments in retirement fall short of the projections provided prior to retirement.
To qualify for this relief, the plan administrator must derive the lifetime income projections using assumptions set forth in the rule and use the rule's model language "or language substantially similar to the model language" in participants' benefit statements, according to the fact sheet.
[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]
Special Rules for In-Plan Annuities
Defined contribution plans that offer annuities through a contract with a licensed insurer have the option of using the rule's regulatory assumptions or basing the lifetime income projections on the actual terms of the plan's insurance contract, subject to certain limitations.
The rule provides separate disclosure requirements for plans that allow participants to purchase in-plan deferred-income annuities, also known as longevity annuities or advanced-life annuities, which provide an income stream at a future date, sometimes decades after the beginning of retirement, to protect retirees who may have spent down their retirement savings. Plan administrators must provide income projections, following the rule's assumptions and other requirements, for any portion of a participant's account that is not invested in a deferred-income annuity.
An Annuities Boost
Other SECURE Act provisions regarding annuities, such as a new safe harbor against lawsuits when plan sponsors include annuities as investments within the plan, are not addressed in the new guidance.
Michael Webb, vice president at retirement plan advisory firm Cammack Retirement Group, noted that "annuity providers were a big winner under the SECURE Act, as a lot of annuity-friendly provisions were added, such as a simple safe harbor that plan sponsors can use to select a lifetime income annuity provider for their plan, as well as a required inclusion of lifetime income projections on benefit statements."
Although the lifetime income illustrations are required to show the form of payment as annuities, however, neither the SECURE Act nor the interim final rule requires defined contribution plans to offer an annuity distribution option.
Some plan advisors are skeptical of the value of lifetime income projections. The DOL "will likely be telling participants the amount of lifetime income that they could achieve in a somewhat fictitious, perfect world," commented John Lowell, an Atlanta-based actuary and October Three advisor.
Kerry Pechter, editor and publisher of Retirement Income Journal, thinks the DOL's approach is too limited. He called lifetime income estimates that are based on annuitizing current 401(k) account values "a fairly useless number," adding, "It won't help participants project the amount of savings they might accumulate by the time they retire if they keep saving at the current rate, or how much they might be able to generate from those savings."
Pechter would like changes to the final rule that would provide for income projections based on participants maintaining or increasing their current savings rates. Doing so "would at least give the participant a target number to aim for, and an idea of the savings rate necessary to reach their goals," he wrote.
Similarly, William Charyk, IRIC president, commented that the interim final rule, "as it currently is structured, would provide to a young participant, whose career and retirement savings have just begun, a statement that would show a very low monthly income equivalent when expressed as a life annuity commencing at retirement age". In many cases, he added, "young participants may see a projected monthly retirement income of only $10 or less," and that "illustrations, based solely on a modest current account balance with no projections for earnings or future contributions, would be unmeaningful at best, and a likely source of confusion and discouragement."
The rule takes effect on Sept. 18, 2021, and will apply to plan statements furnished to participants after that date.
"With the next 12 months to prepare, plan sponsors should work with their record keepers to formulate a plan for compliance," advised Sam Henson, director of legislative and regulatory affairs, retirement services, at Lockton, a benefits brokerage and consulting firm.
"Many plans … have been including some form of information in participants' statements that reflects how their balances translate into the ability to be 'on track' to retire," he pointed out. "Many of these resources are very sophisticated, comprehensive and well-received by participants. The question now is, will plans continue to use those resources that may provide participants better information, or will they use the DOL's safe harbor, or maybe both?"
Related SHRM Article:
Help Employees Turn Retirement Savings into Lifetime Income, SHRM Online, November 2019