Edition

Lifetime Income Disclosure

By Mark Shemtob and Noel Abkemeier

Retirement Section News, January 2023

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The SECURE Act of 2019 requires an annual disclosure to participants in defined contribution plans. The intention is to help participants understand the relationship between their account balances and the estimated retirement income that might be provided from those balances. But the disclosure requirements lack the features needed to provide meaningful information to many participants, which can be misleading if not well understood. Consequently, this provides an opportunity for actuaries to work with retirement plan sponsors to improve the disclosures.

Moreover, the required disclosure estimates income solely from the current account balance and assumes the participant’s age is 67 and will retire immediately. However, evaluating currently funded lifetime income is just one of several parts needed for understanding retirement preparedness. Other aspects such as future contribution levels, investment earnings, and the age at which individuals plan to retire and begin drawing on their accounts are lacking in the disclosure requirement. Hence, Plan Sponsors should be made aware of the limitations of this required disclosure; unless a retiree is at or close to their retirement age.

What can actuaries do to help their DC plan clients add value to the new disclosure requirements?

There are three main areas where actuaries might help their clients:

  1. Communication,
  2. Retiree Income Modeling, and
  3. Financial Education/Advice

Communications

Below are some points that should be communicated to plan participants where actuaries might be of help to their clients.

  1. The disclosure does an inadequate job of helping the majority of individuals in assessing whether they are on a right track to achieve their retirement goals. Under its illustrations, only those that are near or at their retirement age can get value from the income projection. Also, the illustrations do not consider future contributions or investment income—which means that the further the individual is away from retirement age the less meaningful the disclosure becomes.
  2. The projections are based upon the assumption that the retiree will opt to have an annuity purchased at retirement. Although annuities are the ideal vehicle to provide for guaranteed lifetime income, there are non-guaranteed distribution options to consider that are likely more popular. Hence, actuaries might help address the relationship between annuity income estimates and rough estimates under other distribution approaches.
  3. A significant part of many employees’ retirement income will come from Social Security, and information regarding projected benefits can be found on the Social Security website.
  4. The disclosure assumes that participants will retire and start receiving benefits at age 67 and that they are currently at that age. This assumption may not be realistic for most individuals.
  5. Once a reasonable estimate of income at the normal retirement age is determined, it is important to understand the impact of retiring early or deferring retirement. On one hand, retiring early will result in lower benefits—sometimes significantly lower. On the other hand, retiring later will provide larger benefits and could significantly improve financial security—but may not be reasonable for many workers due to life circumstances, or health issues.
  6. Many retirees will want to provide that, if they predecease their spouse or other beneficiaries, a benefit will continue to be paid for the remainder of the lifetime of their spouse/beneficiary. This should be considered when determining whether sufficient amounts are being saved for retirement.
  7. Taxes will generally apply to retirement income. However, for many, they will be lower than what individuals would pay while they were working.
  8. Remind participants that they may have funds from prior employers or IRAs that should be considered in planning. Individuals may want to consider aggregating those accounts for simplicity, provided that appropriate investments are available and fees are reasonable.
  9. The impact of inflation is uncertain, and most retirees may not consider this in their planning. Social Security provides for automatic cost of living increases, but most other forms of retirement income do not, with the most notable exception being public pensions.
  10. Understanding the potential range of life expectancy is important for plan participants. The Actuaries Longevity Illustrator is a tool that can help individuals in this regard.

Retiree Income Modeling

In as much as the required disclosures may be inadequate for most plan participants, how might participants get access to better modeling tools?
Actuaries can help in this regard.

  1. The DC plan could provide a more realistic annual income disclosure in addition to the disclosure required under the SECURE Act. A participant who wants to analyze other planning options would likely need a more robust analysis/modeling tool.
  2. An actuary could identify the features of better modeling tools to illustrate both a more flexible and holistic view of projected outcomes including:
    1. Alternative Retirement Ages
    2. Future contribution amounts
    3. Alternative investment rates of return
    4. Life Expectancy upon reaching retirement age: Both single life and with beneficiary
  3. An actuary might identify tools such as the following:
    1. The plan’s record keeper may provide a more robust income modeling tool.
    2. There may be good tools online that could be used.
    3. The actuary could potentially develop a tool for the client.
    4. The DOL provides a tool; however, it lacks flexibility and may not be appropriate in many situations.

Financial Education and Advice

In reality, most individuals could benefit from general financial literacy education and individual financial advice as they approach retirement age. Helping plan sponsors/clients ascertain and deliver this education/advice can be part of an actuary’s services.

  1. During the early and middle-age working years, financial literacy should focus on:
    1. Maximizing contributions to the extent possible in consideration of other financial needs (e.g., emergency fund, savings for home or education …).
    2. Investment choices that are age appropriate and with low fees.
    3. Avoid using funds for reasons other than retirement (leakage), especially when changing jobs.
  2. Once plan participants are within a few years of retirement or starting retirement, general education may no longer be sufficient. Key considerations include:
    1. When is the person financially ready for retirement?
    2. When to start Social Security?
    3. Should annuities be purchased?
    4. How much investment risk is appropriate?
    5. What life expectancies should be considered in planning?
    6. How is long-term care planned?
    7. What are some effective tax planning approaches?
  3. Finding individual advice
    1. This level of service can sometimes be provided by financial advisors, who may serve as fiduciaries to individual workers.
    2. Employers might identify outside independent advisors willing to provide this service on an hourly basis for those who do not have access to their advisors.

Conclusion

Retirement security in a DC world is a challenge for which employers can use the help of professionals trained in understanding and communicating risk. In this regard, the DOL in its income disclosure requirement has taken a step in that direction; however, it falls short. Consequently, actuaries serving DC plans can help improve on this effort, as well as assist clients in helping their employees secure retirement financial security.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the newsletter editors, or the respective authors’ employers.

Mark Shemtob FSA, MAAA, EA, FCA, MSPPA, is a self-employed consulting actuary and Certified Financial Planner. He can be reached at mshemtob@abarllc.com.

Noel Abkemeier, FSA, MAAA, is the founder and consulting actuary at Abkemeier Actuarial, LLC. Noel can be contacted at nabkemeier@gmail.com.