Get Ready to Explain Lifetime Income Illustrations

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.  

A recent call with an advisor in Colorado is representative of a common question related lifetime income illustrations in 401(k) plans. The advisor asked: “When are the new lifetime income illustrations due and what should I be telling my clients who are 401(k) sponsors and participants about them?”  

Highlights of Discussion 

• It’s good you are thinking ahead! Sponsors of participant-directed defined contribution (DC) plans must provide lifetime income illustrations to participants in their plans no later than with the second quarterly benefit statements of 2022 (i.e., the first illustration needs to be in place for the quarter that ends June 30, 2022). For nonparticipant directed DC plans, sponsors must provide lifetime income illustrations on the annual pension benefit statement for the 2021 calendar year (e.g., making October 15, 2022, the deadline). 

• Showing what a lump sum amount will equate to as monthly income is a step in the right direction because people don’t retire on lump sums; they retire on monthly income. However, some say these particular income illustrations have the potential to upset participants and force plan sponsors and advisors into damage control mode because they are based on incomplete assumptions. 

• The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 amended the Employee Retirement Income Security Act of 1974 (ERISA) to require 401(k)s and other DC plans to include lifetime income illustrations in participant benefit statements on an annual basis. Final Department of Labor (DOL) interim final regulations, which provide the details for calculating these lifetime income illustrations, took effective September 18, 2021, and a series of DOL Frequently Asked Questions instruct plan sponsors on when they must provide the first disclosures (mid 2022). 

• According the DOL’s interim final regulations, the income Illustrations must show a monthly income amount based on a DC plan participant's account balance as of the last day of the statement period converted to a lifetime income equivalent as a  

  • Single life annuity (SLA) and  

  • Qualified joint and survivor annuity (QJSA) involving a spouse.  

• The income projections for the new disclosures must be based on the following assumptions: 

  • The participant is retiring at age 67 (the Social Security full retirement age for many workers) or the participant's actual age, if older than 67), 

  • An interest rate that is the 10-year constant maturity Treasuries (CMT) securities yield rate for the first business day of the last month of the period to which the benefit statement relates; 

  • Life expectancy from a gender-neutral Mortality table pursuant to IRC Sec. 417(e)(3)(B), and 

  • The current account value—assuming no further contributions.  

• By not accounting for future contributions, the retirement income projections will be significantly smaller than the actual number at retirement—which could be shocking—especially for younger participants.  Example:  Theresa is age 40 and single. Her account balance on December 31, 2022, is $125,000. The 10-year CMT rate is 1.83% per annum on the first business day of December. The benefit statement of this participant would show the following amounts. 

Source: DOL Fact Sheet  

• It is essential for advisors and plan sponsors to get in front of these upcoming disclosures from a messaging and communication perspective. Specifically, advisors are encouraged to take the following steps to prepare for the statement delivery this summer and fall. 

 1. Alert plan sponsors to the rules, assumptions, and the potential for negative feedback from plan participants. Explain the DOL assumptions upon which the income illustrations are based and how they may understate the actual retirement income amount—especially for younger plan participants. 

2. Craft an employee communication strategy explaining the new statements and assumptions. Provide a positive, encouraging message about the importance of making ongoing deferrals, automatically escalating deferral rates, the time value of contributions, and explain why the actual number will likely be larger—especially with ongoing contributions. 

3. Execute the communication plan and provide ongoing support. 

Conclusion 

Slowly the DC market is shifting from a lump sum accumulation mindset to a retirement income mentality. Plan sponsors soon must implement the formalized lifetime income disclosure rules. Although the lifetime income illustrations under the DOL’s regulations are far from perfect, they do press the issue of helping participants understand how their retirement plan balances translate into monthly retirement income. Plan sponsors and advisors can use this impetus to carefully craft their participant communications and messaging. A key differentiator for advisors, moving forward, will be the ability to effectively support participants in transitioning to a true retirement income mindset.