The big push for defined contribution plans, such as 401(k)s, is designed to encourage employees to save as much as possible while they are working so they have a nest egg for their retirement years. Auto-enrollment and auto-escalation are tools employers use to ensure that employees participate in their retirement plans.
Auto-enrollment and auto-escalation may take care of the accumulation phase, but what about decumulation? That’s where obstacles may arise.
The term “decumulation” means disposing of what has been accumulated. In the context of retirement plans, it refers to the process of distributing the plan’s assets after an employee retires.
The ways in which an employee can take distributions from a retirement plan are set forth in the plan document. Most plans limit the available distribution options in order to ease administration and costs. However, most plans offer a lump-sum option. In fact, this is typically the most common option, as most employees will transfer their 401(k) account to an IRA upon retirement. When this happens, the employee becomes responsible for managing their account and making sure that it lasts for the remainder of their lives.
But how good is the average employee as a money manager, and how equipped are they to manage their funds over many years? How are they to know how long they need their money to last or how long it will last at a certain withdrawal rate?
Retiring participants need help with the decumulation phase. However, until recently, plan sponsors had no obligation to help their employees, and most plan sponsors didn’t offer any help. Participants in 401(k) plans have needed, but haven’t had a way to estimate how much retirement income their plan account would provide. Until now!
Enter the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act).
The SECURE Act included three provisions to encourage the adoption of guaranteed income products:
The first change the SECURE Act made sets the stage. This provision requires plan sponsors of ERISA-covered defined contribution plans, such as 401((k), 403(b), and profit-sharing plans, to include a lifetime income disclosure in participant statements at least once a year. The purpose of the lifetime income disclosure is to provide an estimate of the monthly income that the participant’s current account will provide after retirement.
The lifetime income disclosure was required to be included in participant statements for the first time for the second quarter of 2022 or June 30, 2022. So, the first statements containing lifetime income disclosures should now be in participants’ hands.
What do these lifetime income disclosures look like and how might participants react to them? Let’s find out.
The lifetime income disclosure requirements provide a set of assumptions to be used in preparing the disclosures, as well as model language to use in the explanation.
First, the disclosure is to be written in a “manner calculated to be understood by the average plan participant” and must include:
The DOL has prescribed certain assumptions that must be used in the disclosures. These assumptions include:
The Department of Labor (DOL) Employee Benefits Security Administration (EBSA) has provided an example which illustrates the application of the regulatory assumptions (Table 1).
Participant information: Participant X is age 40 and single. Her account balance on December 31, 2022, is $125,000. The 10-year CMT is 1.83% per annum on the first business day of December. The benefit statement of this participant would show the following:
So, now that the first lifetime income disclosures have been sent, have participants even noticed? And if so, what did they think about them? Have any problems been identified?
The first reaction may have been shock – to discover how little their account balances would provide in retirement income – a lot less than they had initially thought, since, as discussed above, the disclosures assume the every participant is age 67 and don’t take into account future contributions or investment gains.
Employees are going to need help understanding the disclosures. Here’s where you as an advisor can shine. You know how the disclosures work and can help participants understand them and their purpose.
In addition, you understand annuities and can explain how they can be used to provide a stream of income after retirement. You can also clarify the disclosures:
Participant responses can vary from those who don’t even look at their statements to those who only read the first page and don’t see the explanations on subsequent pages to those who understand the illustrations and what they mean.
These new disclosures are good news for advisors. Plan sponsors and plan participants are going to need help understanding them. That is something that you as an advisor are particularly qualified to do.
By helping employees understand how to make their retirement account last through their retirement years by using lifetime income products, you’re also helping yourself. You’ll grow your business with new clients and have a good feeling about having helped them have a better retirement.
Follow along for part 2 of this article to read about fiduciary safe harbor for the prudent selection of lifetime income providers and the portability of lifetime income benefits.
The Pension Division at RMC Group specializes in working with advisors who serve the small plan market and its participants. We can help you market and set up presentations and programs that explain to an employee what their lifetime income disclosures are all about, as well as best practices in selecting a lifetime income provider and helping participants handle their product’s portability issues.
Call 239-298-8210 or visit our website at rmcgp.com to discover how we can partner with you to help employees successfully understand their retirement statements.