by Fred Reish

There are two fundamental issues facing 401(k) and 403(b) participants:

  • How much do I need to retire?
  • How do I make my retirement account provide income for as long as I live?

Unfortunately, most “defined contribution” retirement plans, such as 401(k) and 403(b) plans, do not answer those questions. As a result, members of Congress are becoming concerned about how to fill that gap in participant knowledge and retirement plan communications.

As a partial solution, in late 2019 Congress passed the SECURE Act, which requires that plan sponsors include “lifetime income illustrations” on participants’ benefit statements. (Note that this SECURE Act requirement only applies to ERISA-governed plans, that is, private sector plans, and thus does not apply to government sponsored retirement plans.) The Act required that the Department of Labor (DOL) issue guidance explaining how plan sponsors should calculate the illustrations. The Act also directed the DOL to provide explanations for plan sponsors to give to their participants about those illustrations. In return for following those rules, plan sponsors would receive a fiduciary “safe harbor’ to protect them against any claims that the illustrations were misleading or incorrect. More specifically, the SECURE Act provides:

[n]o plan fiduciary, plan sponsor, or other person shall have any liability under this title solely by reason of the provision of lifetime income stream equivalents which are derived in accordance with the assumptions and rules [prescribed by the Secretary] and which include the explanations contained in the model lifetime income disclosure [prescribed by the Secretary].

From a legal perspective, that is very broad protection from liability and, as a result, plan sponsors should be comfortable in providing these illustrations.

This article uses “plan sponsor” to refer to a company that sponsors a retirement plan and to the executives and managers who are fiduciaries for the plan. It is common for companies to set up plan committees to handle the fiduciary responsibilities for operation of a plan. The SECURE Act places the compliance burden on the committees, that is, those executives and managers. Fortunately, in most cases, a plan’s service providers, and in particular, a plan’s recordkeeper, are developing the illustrations and disclosures for the participants. That is true of almost all participant-directed savings plans. However, for other “pooled” defined contribution plans, such as profit-sharing plans, the burden may fall directly on the plan sponsor. In that case, the plan sponsor has to provide the illustrations and disclosures to the participants (and should consider engaging a retirement plan service provider to do that work).

The DOL issued its regulation in September of 2020. The SECURE Act said that the illustrations wouldn’t be required until one year after the regulation was issued. Then the illustrations had to be provided for a calendar quarter within the twelve months after the regulation’s effective date. Because of that timing, the first practical date for providing the illustrations and disclosures was in the first quarter of 2022, for the quarter ending on December 31, 2021. However, the first illustrations could be provided as late as in the third quarter of this year for the period ending June 30 of this year. Updated illustrations have to be provided at least once every 12 months thereafter.

Because of these changes, the participants in defined contribution plans have just, or will soon, receive their lifetime income illustrations. As a result, plan sponsors need to be aware of these rules, make sure that their providers are doing the work to satisfy the requirements, and decide whether additional information or education is needed for their employees.

The Requirements for the Lifetime Income Illustrations

The Department of Labor’s requirements are specific and detailed:

  • The illustrations must be for a single life annuity and a joint and survivor annuity (even if the participant isn’t married)
  • The annuity income must be stated as a monthly amount.
  • The participant and the spouse are assumed to be age 67 on the calculation date (that is, the date of the account balance that is being illustrated, g., December 31, 2021), regardless of their actual ages (unless the participant if over 67).
  • The illustrations must be based on an IRS-developed mortality table and an interest rate based on 10-year Treasury securities.

The plan sponsor must then provide certain explanations to the participants, such as the definition of a single life annuity, a statement that the illustrations are estimates and are not guaranteed, and so on.

In other words, the government has taken all discretion out of the calculations and specified the disclosures that must be given to participants (including sample language for the disclosures). And, as explained earlier in the article, in exchange for following these rules, plan sponsors receive a fiduciary safe harbor for any concerns or complaints about the illustrations and explanations.

Issues with the Illustrations and Disclosures

While the illustrations will encourage participants to think of their account balances as a source of retirement income, they may not be as helpful as hoped. That is because of how they are calculated, for example, all participants are assumed to be 67 on the date of the account balance that is used for the illustrations.

As an example, if a plan’s first illustrations are based on the participants’ account balances on December 31, 2021, the illustrations will assume that all of the participants in the plan (and their spouses) are 67 on December 31, 2021.

To illustrate how misleading that can be, assume that a plan has three participants and all three have account balances of exactly $100,000 on December 31, 2021. This illustration shows their monthly lifetime income and their “projected” monthly lifetime income (both based on a single life annuity). The difference between illustrated (using the SECURE Act method) and the projected retirement income (assuming a very conservative earnings growth for each account between the participants’ current ages and their when they will actually be 67 years old).

Actual Age

Assumed Age

Account Balance

Illustrated

Projected

Joan: 40

67

$100,000

$401

$525

Joe: 55

67

$100,000

$401

$452

Clair: 67

67

$100,000

$401

$401

As this example shows, the lifetime income illustration for Joan, at age 40, would the same amount as Clair’s at age 67, even though common sense tells us that Joan’s account will grow to be much more than $100,000 by the time she reaches 67…due to the compounding of earnings over 27 years. A larger account will obviously “buy” an annuity that pays more than the illustration of $401 a month.

That raises two questions for plan sponsors: (i) should they provide education or explanations to their participants so that the new illustrations make sense, and (ii) should plan sponsors work with their providers to also give “projections” to their participants?

Concluding Thoughts

Participants in defined contribution plans are now receiving the mandated lifetime income illustrations. That is required by law. Unfortunately, the illustrations, while helpful in some ways, are likely to be confusing, and perhaps even misleading, to many participants. Plan sponsors can take steps, by working with their financial professional and providers, to help their participants understand the new information.

Contact HUB to speak to a retirement specialist and learn more about HUB Retirement Services.