Your 401(k) statement will soon contain lifetime income estimates. What there is to know.
401(k)s participants should start seeing a “lifetime income illustration” on their statements this year, getting an estimate of the guaranteed monthly income their checking account balance would generate if they purchased an annuity. For many savers, however, the estimate will be more of a guess.
Under an interim rule, as required by the Security Act 2019, plan administrators must provide two estimates: one for a single life annuity, which gives the owner monthly payments until death, and a another for a joint annuity, which extends these monthly payments to a surviving spouse. Estimates should appear next to participants’ account balances on statements at least once a year beginning this year, or quarterly if the plan allows participants and beneficiaries to manage their own investments. A final rule is expected later this year.
Financial planning experts say the illustration provides valuable information to savers and could encourage workers to contribute more by illustrating how their future earnings may fall short of needs or expectations. But they also say savers should be careful because the assumptions used to calculate monthly payments are too general to provide an accurate figure for most individuals.
Lynda Abend, chief data officer for John Hancock Retirement, a 401(k) plan administrator, said the company’s 3 million plan participants will begin seeing the illustration on their first-quarter statements this year. “I think that’s a good starting point,” says Abend, “but there are certainly limits to the formal advice we have.”
These limits are easy to identify. On the one hand, the illustration will be based on the participant’s current account balance and will assume that payments begin immediately. It will also assume that participants are currently 67 years old, or their actual age if older.
The illustration will use a gender-neutral Internal Revenue Code mortality table to determine how long participants and spouses are likely to live, and therefore how long these payments can last. This ignores data from the National Center for Health Statistics showing that American women live an average of 5.1 years longer than American men.
In addition, plan administrators should use the current 10-year constant maturity Treasury rate to calculate monthly payments. The 10-year MTC is the approximate rate used by insurers to price immediate annuities.
A Department of Labor fact sheet uses the example of a participant with an account balance of $125,000 purchasing an annuity with an interest rate of 1.83%. With a single life annuity, this participant would receive monthly payments of $645 until death. A joint annuity would provide monthly payments of $533 until the death of the owner, at which time the surviving spouse would begin to receive the same amount.
Mr. Tyler Ozanne, Senior Financial Advisor at Probity Advisors, notes that the 10-year CMT fluctuates daily, which limits the accuracy of monthly payout projections. At the end of March, this rate was 2.48%, against 1.63% a year earlier.
“The lower the rate, the lower the payout of an annuity, and the higher the rate, the higher the payout,” Ozanne said. “So this year’s calculation on your statement won’t necessarily be next year’s calculation.”
Also, since the illustration doesn’t take future earnings into account, it likely won’t be relevant for younger workers who have recently started saving for retirement, Ozanne said. Given the formula in the illustration, he fears these workers will be shocked by their meager monthly income projections, which could be “very discouraging and actually deter them from saving.”
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Conversely, the illustration can serve as a wake-up call for middle-aged workers and those nearing retirement, urging them to save more, says Chad Parks, founder and CEO of Ubiquity Retirement + Savings. , which offers 401(k) plans for small businesses. .
“It’s going to be a harsh reality for a lot of people as the country faces a looming pension crisis,” Parks said. “Use it as an estimator and then play around with the numbers to see how you might change that, which is if you’re saving an extra $100 on every paycheck, what’s that going to do to this number?”
Other considerations ignored by the illustration include inflation and the desire of many seniors to leave money for their children, Ozanne says. Retirees who collect annuities do not receive annual cost-of-living adjustments as they do with Social Security, so the illustration may provide an inaccurate picture of the purchasing power of older people throughout life. a long retirement, he said.
Moreover, once savers have returned their assets, that money usually cannot be left to heirs. “If leaving an inheritance to your children is one of your financial goals, the [illustration] is really irrelevant,” says Ozanne. “For the individual saver, whatever your age, you have to take this number with a grain of salt.”
Abend said John Hancock Retirement emphasizes to plan participants that the illustration is only an estimate of their monthly retirement income and should not be relied upon in making financial decisions. . She said the illustration should lead savers to speak with a financial advisor and use online tools provided by their 401(k) administrator, including monthly income calculators that factor in future income and estimated returns. investments.
“I think this will get some attention, and hopefully it will spark more questions from participants who want to better understand their own financial situation,” Abend says. “I think it’s important that attendees have the tools at their disposal to personalize and personalize for this reason.”
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