Congress, the DOL, and the IRS have all made efforts over the past decade to evaluate the role of lifetime income strategies in defined contribution retirement plans.
This is in part because defined contribution (e.g., 401(k)) plan participants bear the investment risk for their retirement savings, as well as the burden of determining how much they need to save and the amount and timing of withdrawals in retirement to protect against longevity risk. One of the changes made by the SECURE Act to help savers with these challenges is to require plan sponsors to provide projections to show workers how their retirement savings will translate into a stream of income in retirement, so they can increase their savings rate, if needed, while they’re still working.
Under the SECURE Act, plan sponsors must add to their benefit statements, at least once every 12 months, a projection of the monthly amount a participant could receive in retirement based on their current account balance. The SECURE Act also requires the DOL to provide assumptions and a model disclosure that plan sponsors can use to satisfy this projection requirement with assurance that they will not be liable for estimates derived from the projections. The DOL recently released the standard assumptions and model language plans may use to create these projections.
Lifetime Income example:
- Payments will begin on the last day of the benefit statement period (for example, December 31 for a 4th quarter statement).
- The participant will be age 67 on the date payments will start, or his/her actual age if older.
- A single annuity will pay a fixed monthly amount for the life of the participant with no survivor benefit.
- A qualified joint and survivor annuity will pay a fixed monthly amount for the life of the participant and the same fixed monthly amount to a surviving spouse after the participant’s death.
- The 10-year constant maturity Treasury securities rate as of the first business day of the last month of the statement period must be used to calculate the monthly payments. (This rate is similar to the rate used by insurance companies to price immediate annuities.)
- The participant’s life expectancy will be determined based on the gender-neutral mortality table used to determine lump sum cashouts from pension plans.
Plan administrators must also include certain explanations with the projections to help participants better understand the projections. The DOL’s rule provides a model disclosure that includes these participant-level explanations. If plan administrators use the DOL assumptions and model, they will also be relieved of liability for legal claims from participants whose actual income in retirement falls short of the projections provided.
EXAMPLE: Assume the participant is 40 years old and is not married. Her account balance is $125,000 on the statement ending date, December 31, 2022. Under the DOL’s standard assumptions, the participant could expect her current account balance to provide $645 per month, beginning at age 67 and lasting throughout the rest of her life under a single life annuity. If she marries and purchases a QJSA instead, she would receive $533 per month during her lifetime, and a surviving spouse of the same age would receive $533 per month for the rest their lifetime.
This rule will be effective in one year. In the meantime, plan sponsors may want to discuss with their plan service providers the steps being taken to include the lifetime income disclosures on the plan’s benefit statements.
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For plan sponsor use only, not for use with participants or the general public. This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.