By Jon Vogler
Senior Analyst, Retirement Research
On May 7, 2013, the Department of Labor (DOL) released an advance notice of proposed rulemaking (ANPRM) that offers guidance and requests feedback on potential regulations that would mandate disclosure of lifetime benefit projections on defined contribution (DC) plan participant benefit statements. Responses to the ANPRM are due by July 8, 2013.
The amounts projected on the illustrations would be based on both:
- The participant's current account balance.
- A projected balance that factors in both earnings and contributions.
The DOL believes that illustrating an account balance as a lifetime income stream will help workers in DC plans such as 401(k)s or 403(b)s to better prepare for retirement.
Strong response to first initiative
In February 2010, the DOL and the Treasury Department (Treasury) published a Request for Information (RFI) on lifetime income options to establish whether they could enhance retirement security for participants by helping them access and use lifetime income arrangements. The RFI drew more than 700 comments. In September 2010, the DOL and Treasury held joint hearings on lifetime income options to consider several specific issues.
Proposed DOL changes to benefit statements
The ANPRM sets forth language and concepts the DOL is considering as part of future proposed regulations governing quarterly benefit statements, including:
- A lifetime income stream illustration based on the current account balance. The illustration would assume the participant had reached the plan's normal retirement age (NRA) as of the date of the statement, even if he is much younger.
- A projected future balance at NRA. A participant's current account balance would be projected to NRA, based on assumed future contributions and investment returns.
- Lifetime income stream based on projected future balance. The projected account balance would be converted to an estimated lifetime income stream of payments — all expressed in current dollars — assuming retirement at NRA. If the participant has a spouse, both lifetime income streams — one linked to the current account balance and one to the projected account balance — would be based on the joint lives of the participant and spouse.
- Explanation of assumptions and calculations. Benefit statements would include:
- An understandable explanation of assumptions underlying the lifetime income stream illustrations.
- A warning that projections and lifetime income stream illustrations are estimates only and not guarantees of future benefits.
Projection and conversion safe harbors
The ANPRM requires that plan administrators use only "reasonable assumptions taking into account generally accepted investment theories" for projecting an account balance to a participant's retirement age and for converting an account balance (current or projected) into a lifetime income stream. The ANPRM does, however, provide two safe harbors under which certain assumptions would be deemed reasonable.
When projecting account balances under the projection safe harbor, a plan administrator could reasonably assume:
- Contributions continue to NRA at the current annual dollar amount, increased at a rate of 3% per year.
- Investment returns are 7% per year (nominal).
- A discount rate of 3% per year to show the projected account balance in today's dollars.
When converting current and projected account balances into lifetime income streams under the conversion safe harbor, a plan administrator could reasonably assume:
- A rate of interest equal to the 10-year constant maturity Treasury securities rate.
- Mortality as reflected in the applicable mortality table under Section 417(e)(3) of the Internal Revenue Code.
- If the participant is married, his spouse is the same age as the participant.
- Payments commence immediately, and the participant is NRA, even if he is younger.
Sample calculation and online calculator
Appendix A of the ANPRM includes a sample calculation of a lifetime income illustration under the regulatory framework. The DOL has also created an online calculator in conjunction with the ANPRM that computes both a projected balance and lifetime income streams. The calculator is located at dol.gov/ebsa/regs/lifetimeincomecalculator.html.
Conclusions and caveats
Four thoughts on the ANPRM process, product and potential:
- The ANPRM feedback requested by the DOL implies a willingness to listen and a degree of flexibility in how the future regulation will be shaped. It's likely, though, that the projections and lifetime income illustrations will remain mandatory rather than voluntary, as requested by some earlier commentators.
- Hopefully, the regulation will provide for more flexibility in the calculation of projected account balances and the presentation of lifetime income streams to permit a variety of reasonable approaches, and to accommodate firms that already provide similar information on participant statements or elsewhere.
- Simple, understandable language is critical for:
- Explaining assumptions used in the calculations, with clarification emphasizing that assumptions are essentially "what ifs."
- Clearly expressing — without a surfeit of legalese — that the amounts shown are simple estimates based on the assumptions and not a guarantee of future benefits. Striking a balance between "plain English" and sufficient cautionary language will be challenging.
- Providing illustrations of lifetime income based on current and projected account balances is a worthy idea — it should help give participants a better understanding of their progress in meeting their retirement savings goals. But the concept raises an intriguing behavioral finance question. Will participants with low or moderate projected monthly income streams actually be:
- Encouraged to save because they realize they will need more to live on in the future?
- Discouraged from saving because seeing how little monthly income their accumulated savings will provide makes saving seem a hopeless cause?
Here are results from a study1 cited in the ANPRM that addresses this point:
- Fully 60% of respondents said they would "start saving more immediately" if an illustration showed that the lifetime income generated by their retirement plan accounts would not be enough to meet their retirement needs.
- Another 32% said they would continue to monitor how their savings affected the illustration and would consider saving more later.
- Only 6% said they would continue saving the same amount.
- Less than 1% said they would save less as a result of seeing the illustration.
Best case scenario, this study accurately reflects reactions of the wider plan participant population when they receive the lifetime income illustrations proposed by the ANPRM.