Retirement Income Projections
On September 18, 2021, the Department of Labor’s (DOL) interim final rule on lifetime income disclosures for defined contribution plans will take effect. All 401(k) providers will be required to show participants the equivalent of their retirement savings as monthly retirement income under two potential annuity scenarios.
1. A Single Life Annuity (SLA)
2. Qualified Joint and 100% Survivor Annuity (QJSA)
You may notice that both retirement income scenarios are annuity focused. Let’s first discuss the logistics of this new requirement and then I’ll touch on the differences between an annuity and the widely used percent drawdown rate that 401(k) providers have historically shown.
The Department of Labor’s Employee Benefits Security Administration (EBSA) has released an interim final rule that will require retirement plans to illustrate retirement income projections for plan participants. This requirement was included as part of the SECURE Act (Setting Every Community Up for Retirement Enhancement). The goal of this regulation is to help 401(k) plan participants better understand how their current savings rate and habits prepare them for sufficient income in retirement.
The SLA and QJSA illustrations must be provided to any participant or beneficiary who has an account balance in a 401(k) plan, and must be calculated using the following assumptions:
- Commencement date: The payments commence on the last day of the benefits statement period.
- Assumed age: The participant is 67 years old on the commencement date, which is the Social Security full retirement age for most workers. The participant’s actual age must be used if the participant is older than 67.
- QJSA assumptions:
- The participant and spouse are the same age, regardless of the participant’s actual marital status and regardless of the actual age of the participant’s spouse, if applicable.
- The QJSA pays a fixed monthly amount for the life of the participant, with the same fixed monthly amount going to the surviving spouse after the participant’s death (i.e., a joint and 100% survivor annuity).
- Interest rate: The 10-year constant maturity Treasury rate (10-year CMT) as of the first business day of the last month of the statement period. The 10-year CMT approximates the rate used by the insurance industry to price immediate annuities. If the plan offers an in-plan distribution annuity through an annuity contract, the plan may use the actual terms of the plan’s insurance contract.
- Assumed mortality: The gender-neutral mortality table in Section 417(e)(3)(B) of the Internal Revenue Code. This is the same mortality table generally used to determine lump-sum cashouts from pension plans.
Below is an example of what an illustration may look like:
| Current Account Balance | Single Life Annuity | Qaulified Joint and 100% Annuity |
|---|---|---|
| $125,000 | $645 per month for life (assuming participant X is age 67 on December 31, 2022) | $533 per month for participant;s life, and $533 for the life of spouse following participant's eath (assuming participant x and her hypothetical spouse are age 56 on December 31, 2022) |
The monthly projected income statement must be provided at least annually on a participant’s benefit statement. The projections will assume that participant will be 100% vested in their account balances and will repay any outstanding loan amounts.
To receive liability relief, plan administrators must meet the following requirements when providing monthly payment illustrations:
- Provide illustrations of estimated SLA and QJSA payment amounts.
- Use the IFR’s model language (or substantially similar language)
- Use the IFR’s required assumptions (i.e., account balance, payment start date, age when payments start, interest rate, and mortality table).
Both SLA and QJSA are annuity projections. Annuities are offered by insurance providers likely lobbied to the DOL in hopes of increasing sales.
Historically, 401(k) providers have offered retirement income projection based on a percent drawdown rate. The general rule of thumb is to withdraw no more than 4% of your portfolio each year during retirement. Formally known as the 4% rule (take your investment portfolio at retirement and multiply it by 4% to arrive at an amount that can safely be withdrawn each year without running out of money). The rule also assumes that you will give yourself a 3% raise each year by slowly increasing your withdrawals to cover inflation.
In conclusion, 401(k) providers have historically provided percent drawdown rate retirement income projections. This push by the DOL to now make it mandatory for 401(k)’s to show annuity projections have fingerprints of insurance companies trying to stay relevant in an ever-changing market for small business retirement plans. With that said, this should provide greater education to retirement savers when it comes to retirement income. If you have any questions about retirement income or pension projections contact LT Trust or call us at (833) 458-4015 to learn more!
