Current Thinking

Lifetime Income Illustrations

The primary and, arguably, only reason individuals invest in defined contribution (DC) plans is to eventually have adequate income for retirement. Until recently, it seems the retirement industry has lost sight of that end goal. Many of the machinations of plan committees, plan advisors and participants have been mired in and myopically focused on attaining plan investment gains. While plan returns are, indeed, important during the accumulation phase of the retirement planning journey, it is not the ultimate goal of a DC plan. The goal is to grow each participant’s asset base through contributions and positive investment performance so that each participant’s plan balance can be turned into a stream of lifelong income for retirement. That is the end game.

The industry as a whole has not excelled in helping DC plan participants transition their account balances into a reliable stream of retirement income. Many firms are working on it, but there is a long way to go. And the feathers are about to hit the fan, so to speak. The Department of Labor (DOL) has begun pressing the issue of participant awareness of retirement income and the industry better prepare for a strong reaction.

The SECURE Act of 2019 amended the Employee Retirement Income Security Act of 1974 (ERISA) to require 401(k) and other DC plans to include “lifetime income illustrations” or LIIs in participant benefit statements on an annual basis. Final DOL interim regulations, which provide the details for calculating these LIIs, took effect on September 18, 2021, and a series of DOL Frequently Asked Questions instruct plan sponsors on when they must provide the first disclosures (mid-2022). The DOL is expected to issue final rules, but, in the meantime, plan administrators should be ready to comply with the disclosure requirements based on the current guidance.

Participant-directed DC plan sponsors must provide the LIIs to participants no later than with the second quarterly benefit statements of 2022. That means, the first illustrations need to be in place for the quarter that ends June 30, 2022. For non-participant-directed DC plans, sponsors must provide LIIs on the annual pension benefit statement for the 2021 calendar year (e.g., making October 15, 2022 the deadline).

What are the LIIs? According to the DOL, they must show a monthly income amount assuming the participant is age 67 (or his or her actual age, if older), based on the participant’s account balance as of the last day of the statement period (with no additional contributions), converted to a lifetime income equivalent as a:

1. Single life annuity (SLA) and
2. Qualified joint and survivor annuity (QJSA).

There are other assumptions that go into the calculations, but that is it in in a nutshell. As you can surmise, those LIIs are not necessarily the most accurate projections for some participants, because if a person is age 30, 40, or even 50, they probably are not retiring any time soon and are still making plan contributions. The younger the participant, the more inaccurate the LIIs will be, as the illustrations are based on the participant’s current, not projected, account balance. The income illustration that a 62-year-old who has been in a 401(k) plan for years will receive likely will be a reasonably accurate monthly retirement income number. In contrast, a 32-year-old with four years of plan participation may be quite shocked and upset to see the small pittance of retirement income he or she can expect to receive.

These illustrations have the potential to shock a lot of plan participants. And then what do you suppose will happen? Nervous plan participants tend to call their plan sponsors and complain. Clearly, it is essential for plan sponsors and their service providers to get in front of these upcoming less-than-optimal LIIs from a messaging and communication perspective at least. And it would be ideal to have a proactive, comprehensive solution that would empower both plan sponsors to design plans that are conducive to producing successful retirement outcomes, and participants with accurate retirement income projections and the clear means to achieve them.

Pentegra’s SmartPathTM series may be one such solution that allows plan sponsors to assist participants in understanding and achieving better retirement readiness. The Pentegra SmartPath™ is a series of progressive plan design metrics that help participants set a reasonable level of savings, increase their contributions over time, achieve proper investment diversification and best maximize a plan’s investment alternatives.

It is encouraging to see the DC market shift from an accumulation mindset to a retirement income focus. Very soon plan sponsors must implement the formalized SECURE Act and DOL LIIs rules and, although they are far from perfect, they do press the issue of helping participants understand how their retirement plan balances translate into monthly retirement income. But beyond participant understanding through well-crafted financial wellness programs, is the need for plan sponsors to take action that will help participants achieve more successful retirement outcomes through plan design strategies and novel retirement income options.

About the Author

Richard Rausser

Richard W. Rausser has more than 30 years of experience in the retirement benefits industry. He is Senior Vice President of Thought Leadership at Pentegra, a leading provider of retirement plan and fiduciary outsourcing to organizations nationwide. Rich is responsible for helping to shape and define Pentegra’s viewpoint on workplace retirement plans, plan design strategy, retirement success and employee savings trends. His work is used by employers, employees, advisors, policymakers and the media to produce successful outcomes for American workers.  In addition, Rich is responsible for Pentegra’s Defined Benefit line of business, which includes a team of Actuaries and other retirement plan professionals as well as Pentegra’s BOLI line of business.  He is a frequent speaker on retirement benefit topics; a Certified Pension Consultant (CPC); a Qualified Pension Administrator (QPA); a Qualified 401(k) Administrator (QKA); and a member of the American Society of Pension Professionals and Actuaries (ASPPA). He holds an M.B.A. in Finance from Fairleigh Dickinson University and a B.A. in Economics and Business Administration from Ursinus College.