Americans’ readiness to retire has moved from a concern to a crisis. Even Congress, with a comparatively weak recent record for bipartisan compromise, has acknowledged the concern. Late in 2018, in the midst of partisan wrangling, Congress passed the SECURE Act – a law aimed at beefing up the U.S. retirement income system. And it appears there’s a decent chance for some version of a new “SECURE Act 2.0” to pass soon. Congress wants to further encourage retirement savings because people are both underprepared and underfunded. The movement towards improving retirement income prospects started before the pandemic, but the wave of early retirements due to Covid-19 has accelerated the concern. The government, employers, and consumers recognize the looming retirement crisis.
A frequent refrain from consumers worried about retirement is, “but how do I know if I’ll have enough retirement income?” Today is not like the post-war 20th century where workers’ retirement incomes consisted of a defined benefit pension plan, Social Security, and some savings bonds. In today’s economy, beyond Social Security, retirement income is derived from capital that fluctuates with the markets. Consumers have 401(k)s, IRAs, savings in mutual funds, and investments. And the income these assets generate is not necessarily guaranteed to last through retirement.
The government has so much as conceded this troubling state of affairs, as evidenced by two recent changes they’ve made. Both changes are informational in nature and will not in and of themselves add to the retiree’s capital. They will, however, add to the retiree’s financial literacy, which is expected to improve the decisions consumers make about saving for retirement for two key reasons:
– First, a section of the SECURE Act requires employers to provide employees with an annual lifetime income illustration. In other words, now that more employer-provided qualified plans are defined contribution plans rather than defined benefit plans, it’s important to give employees an idea as to how much income a 401(k) or similar plan will generate in retirement.
– Second, the Social Security Administration is rolling out a new and improved Social Security Statement for consumers. A highlight of this new statement is that it provides retirement income projections for all ages starting at 62 and ending at 70. And the focus of the statement is much more targeted at retirement income considerations than filing details.
The Lifetime Income Illustration
The Department of Labor (DOL), which was directed in the SECURE Act to come up with a set of rules for employers to follow on these lifetime income statements, has now finalized the requirements. In announcing the rules, the DOL says it “believes that illustrating a participant’s account balance as a stream of estimated lifetime payments … will help workers in defined contribution plans to better understand how their account balance translates into monthly income in retirement and therefore to better prepare for retirement.” Some highlights of the requirements include:
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– The illustration must provide an annuity income that assumes a participant is age 67 on the assumed commencement of retirement, which is the Social Security full retirement age for most workers. This age assumption may help break the antiquated trope that retirement always begins at age 65.
– To deal with the issue of marital status, the illustration must show an annuity both for the participant individually, and a reduced annuity as though there is a spouse who is the same age and will receive a 100% survivor benefit. This approach leaves a lot to be desired, but it still has value in that it demonstrates the conceptual cost of an annuity when two lives are involved.
– A helpful dose of conservative planning is that the interest rate for the annuity must be based on the 10-year constant maturity Treasury rate (CMT). This rate approximates what is used by the insurance industry to price immediate annuities. It’s bad enough that 401(k) illustrations often assume rosy returns during accumulation. At least this problem is not perpetuated in the calculations used in the lifetime income illustration.
– Not surprisingly, the assumed life expectancy must be gender neutral and based on §417(e)(3)(B) of the Internal Revenue Code (the mortality table used to determine lump sum cash-outs from defined benefit plans). The concern is that mortality is a key consideration in determining whether, in actuality, the illustrated annuity will last as long as the retiree. These plans are not defined benefit plans, where the retirement annuity is by law guaranteed. Rather, with a 401(k) the annuity is just an illustration. Assuming female life expectancy is approximately two and a half years longer than males at age 65, this creates the risk that the provided illustration will cause females in particular to assume their retirement income is safer than it really is. Still, seeing the benefit in the form of annuity rather than account balance will help in consumer awareness.
Below is the meat of a sample illustration provided by the DOL
Most employees will not be seeing these illustrations until next year. Participant directed plans (i.e., most 401(k) or 403(b) plans) generally must furnish lifetime income disclosures by the benefit statement for the second quarter of 2022. Much like the Social Security Statement, this new tool is general in scope, and can be misunderstood. However, it is an important step in helping to recognize how much retirement income an employer-provided plan might pay. And it will hopefully inspire a prospective retiree to contribute more to that plan and/or save more personally.
The Social Security Statement
The standard Social Security Statement (“SSS”) has been around since 1999. It has steadily moved from a printed and mailed statement to an on-line tool, but the information provided hasn’t changed much over the years. Now we’ve been introduced to a fresh, updated statement, and it will help pre-retirees better plan for the future. This statement is being rolled out over a period of time, and at least for now, it appears only to be available in the on-line version of the SSS. Some of the highlights of this new statement include:
– A shorter statement that provides the key information upfront. Four pages has been boiled down to two, and the information particular to the participant now appears up front.
– The new SSS shows the benefits amount for each year between age 62 and 70. The previous version showed estimates for filing at age 62, full retirement age (mainly age 67), and age 70. Retirement planners had often felt that only showing these three scenarios caused both confusion and poor decisions by retirees. Now the retiree can clearly see the many benefits of deferring filing as long as possible.
– There is more information in the SSS about other benefits, such as spousal and disability benefits. And, importantly, there’s more clarity on qualifying for Medicare, and how to get further information.
– Some have complained that the new statement removes the participant’s earnings history. This removal, however, is a worthwhile sacrifice for brevity, and it’s not as though the information disappeared. The SSA.gov website has earnings history, calculators, and related articles on important planning topics. In some ways it’s almost better in that moving the earnings history to the website encourages prospective retirees and their advisors to access the many tools provided by the government.
Prospective retirees may not receive these two new planning tools for a few months. This does NOT mean the brakes should be put on retirement income planning. Getting ready to retire is a process, not an event, and new information can be folded into the process as time proceeds. As I discussed in a previous post, many of the retirement income calculations one comes up with are based on software that is susceptible to the “garbage in garbage out” challenge. Prospective retirees should review and refine their expectations as they approach ever closer to their planned retirement date.
Use these tools to make an informed choice, not to quickly check the box and be done. Your retirement depends on it.