Get ready to do some explaining. Sponsors of participant-directed defined contribution (DC) plans must provide “lifetime income illustrations” to participants in their plans no later than with the second quarterly benefit statements of 2022. That means, the first illustration needs to be in place for the quarter that ends June 30, 2022. For nonparticipant directed DC plans, sponsors must provide lifetime income illustrations on the annual pension benefit statement for the 2021 calendar year (e.g., making October 15, 2022, the deadline). Translating what a participant’s account balance would equate to as a stream of monthly retirement income is beneficial for planning purposes. But these particular income illustrations, required under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, have the potential to upset participants and force plan sponsors and advisors into damage control mode because they are based on faulty assumptions. Let’s review the assumptions, identify the potential issues, and discuss next steps.

First, the need for retirement income disclosures for DC plan participants is a step in the right direction to help participants really see what their savings could be as a monthly income amount. The current lump sum value that appears on participant statements is frankly, in our view, not relevant as people do not retire on lump sums; people retire on monthly income. The SECURE Act of 2019 amended the Employee Retirement Income Security Act of 1974 (ERISA) to require 401(k) and other DC plans to include lifetime income illustrations in participant benefit statements on an annual basis. Final Department of Labor (DOL) interim regulations, which provide the details for calculating these lifetime income illustrations, took effective September 18, 2021, and a series of DOL Frequently Asked Questions instruct plan sponsors on when they must provide the first disclosures (mid 2022). The DOL is expected to issue final rules, but, in the meantime, plan administrators should be ready to comply with the disclosure requirements based on the current guidance.

What Are The Lifetime Income Illustrations?

According the DOL’s interim final regulations, the income Illustrations must show a monthly income amount based on a DC plan participant's account balance as of the last day of the statement period converted to a lifetime income equivalent as a

1. Single life annuity (SLA) and
2. Qualified joint and survivor annuity (QJSA)

The DOL provided model language and model notices in the regulations that plan administrators can use for each of the required illustrations. Plan sponsors and other fiduciaries are relieved of fiduciary liability and protected from participant litigation if they provide these illustrations. To qualify for this relief, the plan administrator must derive the lifetime income equivalents (i.e., the SLA and QJSA) using the assumptions set forth in the regulations and must use the model language, or language substantially similar to the model language, in participants’ benefit statements.

While regulation’s safe harbor requires the income illustrations be based on these two forms of annuities, keep in mind that annuities are just one tool that can be used to help solve the retirement income puzzle. Novel retirement income products are coming on the market.

Additional non-annuity income solutions may provide more flexibility and better meet the needs of participants. We believe a solution should always start with the problem, rather than a product.

You Know What Happens When You Assume?

Peeling back the onion (or regulations, in this case), the income projections for the new disclosures must be based on the following assumptions:

• The participant is retiring at age 67 (the Social Security full retirement age for many workers) or the participant's actual age, if older than 67,
• An interest rate that is the 10-year constant maturity Treasuries securities yield rate for the first business day of the last month of the period to which the benefit statement relates;
• Life expectancy from a gender-neutral Mortality table pursuant to IRC Sec. 417(e)(3)(B), and
• The current account value—assuming no further contributions.

Note the last mandatory assumption: The current account value, assuming no further contributions. We believe this assumption is not reasonable, nor is it helpful—especially for younger participants. The younger the participant the more inaccurate the retirement income projection will be. By not accounting for future contributions, the retirement income projection will be significantly smaller than the actual number at retirement.

The income illustration that a 62-year-old who has been in the 401(k) plan for years will receive likely will be a reasonably accurate monthly retirement income number. In contrast, a 32-year-old with four years of plan participation may be quite shocked and upset to see the small income projection. Clearly, it is essential for financial professionals and plan sponsors to get in front of these upcoming disclosures from a messaging and communication perspective.

Specifically, financial professionals are encouraged to take the following steps to prepare for the statement delivery this summer and fall.

1. Alert plan sponsors to the rules, assumptions, and the potential for negative feedback from plan participants. Explain the DOL assumptions upon which the income illustrations are based and how they may understate the actual retirement income amount—especially for younger plan participants.
2. Craft an employee communication strategy explaining the new statements and assumptions. Provide a positive, encouraging message about deferral rates and automatic escalations, and the time value of contributions, and explain why the actual number will likely be larger—especially with ongoing contributions.
3. Execute the communication plan and provide ongoing support.

It is good to see the DC market continuing to shift to a retirement income focus. The formalized SECURE Act and DOL lifetime income disclosure rules will soon be implemented. Although the lifetime income illustrations under the DOL’s regulations are far from perfect, they do press the issue of helping participants understand how their retirement plan balances translate into monthly retirement income. Plan sponsors and financial professionals can use this impetus to carefully craft their participant communications and messaging. A key differentiator for financial professionals, moving forward, will be the ability to effectively support participants in transitioning away from a lump sum accumulation mindset to a true retirement income focus.

This material is for informational purposes only and is not to be construed as specific tax, legal, or investment advice. You are strongly encouraged to consult with your independent financial professional, lawyer, accountant or other advisors as to investment, legal, tax and related matters.

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