Mandated lifetime income disclosures are as likely to reduce account balances as to increase them, and they are more likely to mislead than inform.
“If the goal is to increase retirement savings, there is ample evidence of what works—automatic features.”
The guidance to implement these mandated disclosures closely follows the actual statute. Unfortunately, this addition is not likely to prompt significant improvements in pre-retirement preparation. Here’s why:
- Cost – No identified dollar amount of savings to participants:
- The agency estimates that the ten-year cost to issue these disclosures is $240MM or more.
- The agency offers no estimate of a dollar amount of savings.
- Participants pay most plan administrative costs – including the cost of disclosures.
- Most participants are decades away from retirement, and potential annuitization.
- Turnover – Confusion and complexity:
- The median tenure of American workers has been less than five years for the past five decades.
- By age 52, American workers have had an average of 12 different employers.
- Where a worker leaves an employer with a plan to join one that does not sponsor a plan, the projection will not highlight the impact on saving – whether or not a worker contributes the same amount to an IRA that would have been contributed to the employer-sponsored plan.
- Even if every employer offered a plan, and even if every worker participated in every plan, a diverse set of estimates is likely to be produced each year (different effective dates, sometimes different assumptions, etc.).
- Accuracy:
- Except where the plan has an in-plan annuity, income projections will always be inaccurate – even for those who are age 67 because estimates incorporate unisex mortality.
- Where participants are married, only a handful have a spouse with the same birth date as the worker – so the J&S estimate will almost always be erroneous.
- Other factors:
- If the individual is married, the number of these disclosures is likely doubled; the complexity, more than doubled.
- These disclosures do not apply to:
- Accrued benefits in defined benefit or defined contribution pensions.
- Projections of Social Security benefits.
- Qualified plan assets once rolled over to an IRA.
- The disclosures do not differentiate the value of the assets based on tax status (e.g., taxable or Roth).
- Year to year projections will not identify the impact of:
- An increase in contributions,
- Investment gains/losses,
- Changes in mortality, interest rates, or attained age.
Note: There is no requirement for an “attribution analysis” that would identify the reason for the change in the lifetime income projection.
- While the assumption of age 67 effectively treats future investment returns as equal to pre-retirement inflation, there is no acknowledgment of the impact of post-retirement inflation.
How will plan participants respond when they get lifetime income guesstimates for each employer-sponsored plan that are accompanied by this explanation?
- ‘‘The estimated monthly payments in this statement assume that payments begin [insert the last day of the statement period] and that you are [insert 67 or current age if older] on this date. Monthly payments beginning at a younger age would be lower than shown since payments would be made over more years. Monthly payments beginning at an older age would be higher than shown since they would be made over fewer years.’’
- ‘‘A single-life annuity is an arrangement that pays you a fixed amount of money each month for the rest of your life. Following your death, no further payments would be made to your spouse or heirs.’’
- ‘‘A qualified joint and 100% survivor annuity is an arrangement that pays you and your spouse a fixed monthly payment for the rest of your joint lives. In addition, after your death, this type of annuity would continue to provide the same fixed monthly payment to your surviving spouse for their life. An annuity with a lower survivor percentage may be available and reducing the survivor percentage (below 100%) would increase monthly payments during your lifetime, but would decrease what your surviving spouse would receive after your death.’’
- ‘‘The estimated monthly payments for a qualified joint and 100% survivor annuity in this statement assume that you are married with a spouse who is the same age as you (even if you do not currently have a spouse, or if you have a spouse who is a different age). If your spouse is younger, monthly payments would be lower than shown since they would be expected to be paid over more years. If your spouse is older, monthly payments would be higher than shown since they would be expected to be paid over fewer years.’’
- ‘The estimated monthly payments in this statement are based on an interest rate of [insert rate], which is the 10-year constant maturity U.S. Treasury securities yield rate as of [insert date], as required by federal regulations. This rate fluctuates based on market conditions. The lower the interest rate, the smaller your monthly payment will be, and the higher the interest rate, the larger your monthly payment will be.’’
- ‘‘The estimated monthly payments in this statement are based on how long you and a spouse who is assumed to be your age are expected to live. For this purpose, federal regulations require that your life expectancy be estimated using gender-neutral mortality assumptions established by the Internal Revenue Service.’’
- ‘‘The estimated monthly payments in this statement are for illustrative purposes only; they are not a guarantee.’’
- ‘‘The estimated monthly payments in this statement are based on prevailing market conditions and other assumptions required under federal regulations. If you decide to purchase an annuity, the actual payments you receive will depend on a number of factors and may vary substantially from the estimated monthly payments in this statement. For example, your actual age at retirement, your actual account balance (reflecting future investment gains and losses, contributions, distributions, and fees), and the market conditions at the time of purchase will affect your actual payment amounts. The estimated monthly payments in this statement are the same whether you are male or female. This is required for annuities payable from an employer’s plan. However, the same amount paid for an annuity available outside of an employer’s plan may provide a larger monthly payment for males than for females since females are expected to live longer.’’
- ‘‘Unlike Social Security payments, the estimated monthly payments in this statement do not increase each year with a cost-of-living adjustment. Therefore, as prices increase over time, the fixed monthly payments will buy fewer goods and services.’’
- ‘‘The estimated monthly payment amounts in this statement assume that your account balance is 100% vested.’’
- ‘‘If you have taken a loan from the plan and are not in default on the loan, the estimated monthly payments in this statement assume that the loan has been fully repaid.”
The disclosures are intended to confirm the (lack of) preparation for retirement with a goal of promoting greater savings. The guidance cites a study of university workers where:
- The average contribution rate before the intervention was 3.19% before and 3.33% after,
- The workforce had average tenure of 12.3 years, average age of 45, average income of ~$60,000.
- 4.09% of control group participants (who got no disclosure/intervention) changed their contributions, compared to 5.3% in the test group that received the disclosure/intervention – Yes, that is 29% higher!
- However, the study shows how ineffective this intervention was. It could have just as easily concluded that:
- 95% of the individuals who received the intervention took no action, and
- The estimated increase in contributions among the 5% who responded was ~$85/year!
Conclusion
Yes! A voluntary estimate of lifetime income based on accumulated savings has merit … but only if the estimate:
- Is accurate,
- Is understandable to everyday workers who often suffer from financial innumeracy,
- Incorporates all retirement-related assets, or can be applied to all retirement-related assets, and
- Can be relied upon for retirement planning purposes.
This mandated disclosure is none of the above.
One study I have often cited to confirm a lack of financial literacy/numeracy shows that only one-third (34%) of survey respondents could correctly answer three straightforward questions.[i]
If you consider this literacy starting point and add in the challenge that workers face in managing multiple plans and processes due to turnover, as well as incorporating a spouse’s plans, a plan administrator’s efforts at disclosing lifetime income is likely to be a Sisyphean challenge.[ii]
If the goal is to increase retirement savings, there is ample evidence of what works—automatic features.
I always appreciate your criticisms, suggestions, improvements, etc. Feel free to contact me at: jacktowarnicky@gmail.com.
Disclaimer No. 1: My comments are my own based on my experience in plan sponsor and consulting roles – they do not necessarily reflect those of any employer, group, or association I have been employed by or affiliated with, past, present, or future.
Disclaimer No. 2: This information was provided by individuals with knowledge and experience in the industry and not as legal or tax advice. The issues presented here may have legal implications and you should discuss this matter with legal counsel prior to choosing a course of action. This article is intended to be informational only. It is not (and you/others should not use it as a substitute for) legal, accounting, actuarial, or other professional advice. Any advice contained in this article was not intended or written to be used, and cannot be used by anyone for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person [or to promote, market, or recommend any transaction or subject addressed herein]. You (others) should seek advice based on your (their) particular circumstances from an independent tax advisor.
[i] A. Lusardi and O. Mitchell, Financial Literacy and Planning, Implications for Retirement Wellbeing, 2011: “Only two-thirds of the respondents understand compound interest. … More of the respondents, three-quarters, can answer the inflation question correctly and understand they would be able to buy less after a year if the interest rate was 1% and inflation 2%. Yet only half of the respondents know that holding a single company stock implies a riskier return than a stock mutual fund. It is also of interest to distinguish between those who can give a correct answer versus those giving either an incorrect answer or saying they “don’t know” … only 9% did not know about interest compounding, but more than one-fifth (22%) gave an incorrect answer. On the inflation question, 10% did not know, while 13% gave a wrong answer. The question about stock risk elicited the most don’t know’s, one third (34%) of the sample did not know, while a smaller fraction (13%) gave a wrong answer.” See: www.nber.org/system/files/working_papers/w17078.pdf
[ii] In Greek mythology, Sisyphus cheated death twice. His punishment? He was forced to roll an immense boulder up a hill, only for it to roll down every time it neared the top, repeating this action for eternity. Through the classical influence on modern culture, tasks that are both laborious and futile are therefore described as Sisyphean.
Jack Towarnicky provides independent benefits consulting and serves as a member of aequum, LLC and of counsel for Koehler Fitzgerald, LLC.
I have a different take. The stated goal of the EBSA Board was to try and illustrate the cost of a secure cash flow protected from longevity risk. This is like the PPA’s change to conservative discount rates for ERISA DB plan funding ratio calculations. In the past, the DB use of expected returns from risk assets to discount the cost of a guaranteed retirement was a diaster, plus it enabled lower sponsor contributions by masking the true economic need. I don’t disagree that what we have for DC is not perfect, but do we really want to continue treating individuals in 410(k) plans like public DB plans? Not only are those funding ratios still screwed up, but they can fall back on tax increases if they get into trouble (I wish I could too!). Solving the problem of the illustration’s intent and meaning for participants to grasp will have to be done with more and better education about what the default safe harbor illustration is meant to convey and why. Perhaps starting with new education for the consultants advising the sponsors? It’s a huge opportunity for advisors to add value!
No, unfortunately, I could talk about this estimate all I want, but it would still be inaccurate and incomplete. Presenting anything else falls ouside the safe harbor.