The SECURE Act facilitates the inclusion of annuities in 401(k) plans. The DOL wants more awareness of annuities as protected income solutions. They want participants to stop fixating on their current portfolio balance and focus on the retirement income it could produce. Part of this push is the Lifetime Income Illustration (LII) mandate, whose rules will be finalized this May.
Currently, the DOL requires that an LII be included with one pension benefit statement, during any one 12-month period. Lifetime incomes for both single and joint are based on the hypothetical immediate purchase of a payout annuity, financed by a lump-sum equal to the participant’s current portfolio balance.
The DOL has also mandated some very precise language in the statements that starts with a litany of restricted assumptions. To make an LII that’s standard and very simple to produce, they mandated the following limitations:
• Participant and spouse are assumed to be same sex and age (67 or actual age if older).
• Immediate purchase of a Lifetime payout annuity, so no future participant or employer contributions.
• Annuity calculations use a unisex IRS Mortality table (that would never be used for real annuity payouts), and the current 10-Year CMT for interest.
• Evaluation metric is the single gross annuity payment calculated for the annuity.
And this caveat:
“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.” (highlights are mine)
So, the LII illustrates future retirement income estimates that exclude practically everything that will have a material impact on them!
As a result, the DOL has received numerous negative comments. Like those offered by the Defined Contribution Institutional Investment Association (DCIIA), an industry association composed of leading players in the retirement industry (DCIIA comment letter), I believe, says it all. Also, see (The Committee of Annuity Insurers).
The DOL did not listen, ignoring some very wise suggestions from groups “in the trenches” and has sacrificed a meaningful and accurate LII for the sake of simplification and standardization. Congress ordered a deep-dish pizza with everything on it. The DOL delivered a thin flatbread with no toppings!
Check out the sparse data input required in a typical online app for LII illustrations:
The participant could be a male age 35 with a 32-year-old female spouse or a female aged 59 with a 47-year-old male spouse, with very different contributions, portfolios, risk-tolerance, health status, tax brackets, legacy wishes and goals. They’d both get identical single and joint illustrations!
By mandating Illustrations that don’t provide a proper estimate of future retirement income, the DOL has created a dilemma for plan sponsors. They’ve established a safe harbor for their restricted LII that will result in negative participant reactions. This will force sponsors/advisors to provide concerned participants with more accurate income projections that are not safe-harbored. However, most sponsors aren’t prepared. Even with all of the LII warnings, many participants will still be alarmed by the underestimated income.
A recent survey of the DOL’s LII, conducted by Morning Consult on behalf of Prudential Financial, found net negative reactions of 68% for early career savers who see low illustrations in first year of disclosure, and 50% for modest year-over-year progress. For near retirees, seeing projected income higher than actual withdrawal income, the figure was a much larger 79%.
It also found that 79%/86% of pre-retirees would seek “Solutions and tools to enhance their retirement savings/income.” However, the LII provides no guidance for remedies to address enhancing income.
Unlike the NAIC, the DOL has ignored many advances in hardware, financial technology, and evaluation methods developed over the last 20 years!
Among these advances is the use of stochastic methods. It’s considered the most accurate method for projecting the future. The NAIC now requires that insurance companies use stochastic calculations (PBR) for their policy valuations, projecting numerous economic scenarios. If the DOL had wanted a more accurate standard, then, like the NAIC, they should’ve endorsed this methodology.
Recent NAIC Spring National Meeting—Illustration systems recommendations
This is further bolstered by a presentation to the NAIC/Consumer Liaison Committee by industry expert Richard Weber where he asserted that current limited scenario illustration systems are too simple and misleading and should be replaced by ones that make use of statistical modeling.
Protecting the accumulation phase
Unless participants are close to retirement, what happens during the accumulation phase will have a major impact on retirement income. Participants also need to be aware of the vulnerability of their portfolio during this period and how it can be protected. Yet, the DOL’s LII totally ignores it.
Ignoring the accumulation phase misses a great teaching opportunity for the DOL, to bolster its goal of using annuity solutions. For example, demonstrating the purchase of a DOL standardized flexible premium deferredannuity with some or all of the current funds, and planned future contributions. They could also have provided standard economic scenarios to be used, and/or a generator to produce them.
Better metrics—If you can’t measure it, you can’t manage it!
Projections should be in concrete, uniform terms that participants can relate to, the net effect on their pocketbooki.e., the size of every projected payment, net of taxes, adjusted for inflation, relatable in today’s dollars. Results than can also be used to produce investment and targeted income metrics.
Stochastic methods compute these metrics over a wide variety of possible futures, producing ranked percentiles that not only show the most likely projected income but also the range from the worst to the best outcomes.
Plan participants deserve better
This is critical, not just for accuracy, but also for legal and fiduciary reasons, to insure participants are knowingly and adequately informed.
SEE ALSO:
• The Problems with Lifetime Income Disclosures
• DOL Lifetime Income Disclosure Regulation Explained
James Kavanagh is the President of InjAnnuity Inc. Ormond Beach, Fla. Mr. Kavanagh has over 30 years of experience in developing valuation systems and is the author of the BI-SEM method for the evaluation of investment and annuity portfolios.