Participants in 401(k)s should begin seeing a “lifetime income illustration” on their statements this year, getting an estimate of how much guaranteed monthly income their current account balance would generate if they purchased an annuity. For many savers, however, the estimate will be more like a guess.
Under an interim rule as required by the 2019 Secure Act, plan administrators must provide two estimates: one for a single-life annuity, which gives the owner monthly payments until death, and another for a joint annuity, which extends those monthly payments to a surviving spouse. The estimates must appear alongside participants’ account balances on statements at least annually beginning this year, or quarterly if the plan allows participants and beneficiaries to direct their own investments. A final rule is expected later this year.
Financial-planning experts say the illustration provides valuable information for savers, and could encourage workers to contribute more by illustrating how their future income might fall short of needs or expectations. But they also say savers should be careful as the assumptions used to calculate monthly payments are too general to provide an accurate number for most individuals.
Lynda Abend, chief data officer for John Hancock Retirement, a 401(k) plan administrator, said the company’s 3 million plan participants will begin seeing the illustration on their first-quarter statements this year. “I think it’s a good place to start,” Abend says, “but there are definitely some limitations to the formal guidance that we have.”
Those limitations are easy to identify. For one, the illustration will be based on the participant’s current account balance and assume that payments begin immediately. It also will assume that participants are currently 67 years old, or their actual age if they’re older.
The illustration will use a gender-neutral mortality table from the Internal Revenue Code to determine how long participants and spouses are likely to live, and therefore how long those payments may last. That ignores data from the National Center for Health Statistics showing that American women live 5.1 years longer than American men, on average.
In addition, plan administrators must use the current 10-year constant maturity Treasury rate to calculate monthly payments. The 10-year CMT is the approximate rate used by insurers to price immediate annuities.
A Labor Department fact sheet uses an example of a participant with a $125,000 account balance purchasing an annuity with an interest rate of 1.83%. With a single-life annuity, that participant would get monthly payments of $645 until death. A joint annuity would provide monthly payments of $533 until the owner dies, at which point the surviving spouse would begin collecting the same amount.
M. Tyler Ozanne, senior financial advisor with Probity Advisors, notes that the 10-year CMT fluctuates daily, which limits the accuracy of monthly payment projections. In late March, that rate was 2.48%, up from 1.63% a year prior.
“The lower the rate, the lower the payout on an annuity, and the higher the rate, the higher the payout,” Ozanne said. “So, this year’s calculation on your statement is not necessarily going to be next year’s calculation.”
What’s more, since the illustration doesn’t take into account future earnings, it likely will be irrelevant to younger workers who recently started saving for retirement, Ozanne said. Given the illustration’s formula, he worries those workers may be shocked at their meager monthly income projections, which could be “very discouraging and actually disincentivize them to save.”
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Conversely, the illustration may serve as a wakeup call for middle-aged workers and those nearing retirement, spurring them to save more, says Chad Parks, founder and chief executive of Ubiquity Retirement + Savings, which offers 401(k) plans for small businesses.
“This is going to be a harsh reality for a lot of people because the country is facing a looming retirement crisis,” Parks said. “Use it as an estimator, and then play with the numbers to see how you could change that, meaning if you save $100 extra every paycheck, what is that going to do to that number?”
Other considerations ignored by the illustration include inflation and the desire of many seniors to leave some money to their children, Ozanne says. Retirees collecting annuity payments don’t get annual cost-of-living adjustments like they get from Social Security, so the illustration may provide an inaccurate picture of seniors’ purchasing power throughout a long retirement, he said.
Furthermore, once savers annuitize their assets, that money typically can’t be left to heirs. “If leaving an inheritance to your kids is one of your financial goals, the [illustration] is really irrelevant,” Ozanne says. “For the individual saver, no matter what your age is, you’ve got to take that number with a grain of salt.”
Abend said John Hancock Retirement is emphasizing to plan participants that the illustration is merely an estimate of their monthly income in retirement and shouldn’t be relied upon when making financial decisions. She said the illustration should lead savers to speak with a financial advisor and use online tools provided by their 401(k) administrator, including monthly income calculators that factor in future earnings and estimated investment returns.
“I think it’s going to draw attention, and my hope is that it will drive more questions from participants who want to better understand their own financial situations,” Abend says. “I think it’s important that participants have the tools available to them to customize and personalize for that reason.”
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Source: https://www.barrons.com/articles/401k-retirement-annuity-income-51648740803?siteid=yhoof2&yptr=yahoo