The DOL’s New Lifetime Income Disclosure Rules Are (Mostly) Reasonable, But Will Plan Participants Notice?
By David E. Morse
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 requires that 401(k) and other defined contribution (DC) plan participants receive a yearly estimate of the amount of lifetime income they could expect by annuitizing their plan accounts at retirement. The goal is to encourage folks to save more and, at retirement, consider buying an annuity to generate a stream of monthly income with at least a portion of their nest eggs. The reality is likely to be different.
On September 18, 2020, the U.S. Department of Labor (DOL) issued a Final Interim Rule providing guidance to employers about how to calculate the lifetime income estimates, and a wordy and confusing “understandable explanation” for employers to use to inform participants about how to use the estimates in their retirement planning. The new disclosure will appear in participant statements starting in 2021.
To provide a basic estimate of the lifetime income an employee reasonably could expect from annuitizing his or her 401(k) account, the employer would have to decide when payment starts, whether there is a survivor benefit, how long the employee (and beneficiary) will live, and what discount rate to use. Here is how the DOL is telling employers to run the numbers:
- Retire at age 67. Monthly payments will begin at age 67, the full Social Security retirement age for most workers. While many people actually retire by age 65, the two-year difference may just nudge some to consider working a bit longer.
- One-size-fits-all mortality. Life expectancy will be measured using the unisex IRS tables. Statistically speaking, however, women live longer than men and this one-size-fits all mortality will overstate the payments women can expect and understate that of men.
- Two Payment Estimates. The DOL rule requires two different monthly income estimates: one for a single life annuity and one for a joint and 100% spousal survivor annuity beginning at age 67. (The “spouse” and participant are assumed to be the same age.) The estimated payments are going to be somewhat lower for a joint and spousal annuity than for a single life annuity. By providing both estimates, a single participant or one with a domestic partner or alternate family situations might find the two estimates confusing and irrelevant to their situation (e.g., may not have a spouse or partner). While the DOL is right to highlight that participants may wish to consider a survivor benefit, it should clarify that this is a decision to be addressed at retirement based on personal circumstances.
- Use a conservative discount rate. This crucial assumption will use the 10-year constant maturity Treasury securities yield rate. The DOL intentionally chose this benchmark because it uses a somewhat-lower rate that will, in turn, yield modestly lower monthly payments. Insurance companies will add in their administrative costs and profit in setting market prices. The DOL’s use of a conservative discount rate is a rough way to factor in these charges so the estimates generated for plan participants will be more likely to reflect actual market prices.
How Do DOL’s Lifetime Income Estimates Compare With Real-World Annuity Costs? With the help of an actuary and an insurance broker, I conducted a somewhat-scientific comparison of the DOL lifetime estimate and actual annuity costs. I assumed a $100,000 account balance on July 30 for a 67-year-old male New Yorker (costs vary by state) and his 67-year-old female spouse.
Following the DOL Rule, the projected monthly payments for a single life annuity and joint and 100% survivor annuity payments would be $450.54 and $365.61 per month, respectively. On the open market, this 67-year old “couple” could buy an annuity from one of several financially solid insurance companies that would pay 7% to 10% more than the DOL illustrations. If my back-of-the-envelope estimate is accurate, the DOL’s conservative estimate may induce some folks to save more — but the low estimate may discourage others from even trying to save. Time will tell what effect the DOL’s methodology has on participant behavior.
The “Understandable” Explanation of the Lifetime Income Needs a Rewrite: Accompanying the annuity illustration will be DOL’s explanation of how to read and use the estimate, but this two-page, lawyer-written notice is more likely to baffle than inform. Getting folks to read a single paragraph is difficult enough, with one page the limit of human patience. Faced with two pages of jargon, many will not bother reading even the first paragraph. An unread disclosure is worthless. What the DOL should do is hire an English major or sports columnist to rewrite the explanation in plain English.
Important Factors Overlooked by the Estimates: For simplicity, the DOL estimates ignore such critical considerations as future investment return and inflation. For example, a 30- and a 50-year-old participant with identical account balances will see the same age-67 projected monthly payments on their statements. Clearly, the younger participant is in better financial shape. But perfect being the enemy of good, the DOL opted for a one-size-fits-all illustration. Ideally, employers and plan recordkeepers will innovate with drop-down menus that allow participants to customize their estimates using alternative retirement ages, as well as factor in future savings and investment income … or perhaps not, given the litigation risk of deviating from the DOL rule.
Employer Innovation Could Be Risky: Employers are understandably concerned about participant lawsuits claiming injury from “misleading” estimates/explanations. The DOL offers litigation protection if the new rule is followed, including using the DOL’s model explanation. Employers taking the time and expense to write understandable explanations, offer customized estimates, or make other tweaks do so at their own risk. Look no further than well-meaning employers who rewrote the government’s model COBRA notice into English: They were hit by a raft of class action lawsuits for “misleading” participants. The DOL should expand the litigation safe harbor to allow (dare I say encourage) employer enhancements to both the estimates and the explanation.
Will the Savings Needle Move? Maybe, and only barely. Some people may increase their contributions when they notice how little their 401(k) balances will provide in monthly income. (There will be lots of research on the impact of the new disclosure in a few years.) A very few may be nudged to consider buying an annuity. But the new rule will not solve the “annuity puzzle” that makes most folks extremely reluctant to exchange a pile of immediate cash for a guarantee of much-smaller monthly payments for the rest of their lives. And it obviously will not help those without access to a workplace-based savings plan. To move the savings needle, Washington should enable universal savings plan availability with auto-enrollment — the only proven techniques for getting workers to save.
David E. Morse is a partner with K&L Gates, LLP, a global law firm.
December 2020, 20-13
Chase, Gary and Kalten, William, “DOL issues interim final rule on lifetime income illustrations,” Willis Towers Watson, October 15, 2020.
Morse, David, “Annuity Illustrated: DOL’s Lifetime Income Disclosure Rules Are (Mostly) Reasonable; Will Participants Notice?,” Benefits Law Journal 33 (Autumn 2020).
Morse, David, “Annuities: The Broccoli of Retirement Planning; Nudging People to Choose Lifetime Income over Cash,” Benefits Law Journal 31 (Autumn 2018).