Americans’ willingness to retire has turned from a concern to a crisis. Even Congress, with a relatively weak recent record of bipartisan compromise, has recognized the concern. In late 2018, amid partisan bickering, Congress passed the SECURE Act – legislation to strengthen America’s retirement income system. And it seems that there is a good chance that a version of a new “SECURE Act 2.0” will be adopted soon. Congress wants to encourage more retirement savings because people are both under-prepared and under-funded. The movement towards improving the outlook for retirement income began before the pandemic, but the wave of early retirements due to Covid-19 has accelerated the concern. Government, employers and consumers recognize the looming retirement crisis.
A frequent refrain from worried consumers about retirement is, “But how do I know if I will have enough retirement income?” Today is not like post-war 20e century when workers’ retirement income consisted of a defined benefit pension plan, social security and some savings bonds. In today’s economy, beyond social security, retirement income comes from capital that fluctuates with the markets. Consumers have 401 (k), IRAs, savings in mutual funds, and investments. And the income generated by these assets is not necessarily guaranteed to last until retirement.
The government has even conceded this troubling situation, as evidenced by two recent changes it has made. Both changes are informative in nature and will not by themselves add to the retiree’s capital. However, they will add to the financial literacy of the retiree, which should improve consumer decisions about saving for retirement for two main reasons:
– First, an article of the SECURE law obliges employers to provide their employees with an illustration of annual income for life. In other words, now that more qualified employer-provided plans are defined contribution plans rather than defined benefit plans, it’s important to give employees a sense of how much income a 401 (k) plan can earn. or similar will generate upon retirement.
– Second, the Social Security Administration is rolling out a new 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 focused on income considerations. retirement only on filing details.
The illustration of income for life
The Department of Labor (DOL), which was tasked in the SECURE Act to come up with a set of rules that employers must follow on these lifetime tax returns, 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 better understand how the Their account balance translates into monthly income in retirement and therefore better preparation for retirement.Here are some highlights of the requirements:
– The illustration should provide annuity income which assumes a participant is 67 years of age at the assumed start of retirement, which is the social security full retirement age for most workers. This age assumption can help break the archaic trope that retirement always begins at age 65.
– To address the issue of marital status, the illustration should show an annuity for both the individual participant, and a reduced annuity as if there was a spouse who is the same age and will receive a survivor benefit of 100%. This approach leaves a lot to be desired, but it still has value in demonstrating the conceptual cost of an annuity when two lives are involved.
– A useful dose of careful planning is that the annuity interest rate should be based on the 10-year constant maturity Treasury rate (CMT). This rate approximates what is used by the insurance industry to price payout annuities. It is bad enough that 401 (k) illustrations often assume positive returns during accumulation. At least this problem is not perpetuated in the calculations used in the illustration of lifetime income.
– Unsurprisingly, the assumed life expectancy should be gender neutral and based on §417 (e) (3) (B) of the Internal Revenue Code (the mortality table used to determine lump sum withdrawals from defined benefit plans). The concern is that mortality is a key factor in determining whether, in reality, the illustrated annuity will last as long as the retiree. These plans are not defined benefit plans, where the retirement pension is guaranteed by law. On the contrary, with a 401 (k), the annuity is only an illustration. Assuming that the life expectancy of women is about two and a half years longer than that of men at 65, this creates the risk that the illustration provided will cause women in particular to assume that their retirement income is safer than it actually is. Still, seeing the benefit in the form of an annuity rather than an account balance will help educate consumers.
Below is the meat of an example illustration provided by the DOL
Most employees won’t see these illustrations until next year. Member-driven plans (that is, most 401 (k) or 403 (b) plans) are generally required to provide lifetime income information in the statement of benefits for the second quarter of 2022. All like the social security declaration, this new tool is general in scope and can be misunderstood. However, this is an important step in helping to determine the retirement income that an employer-provided plan could contribute. And, hopefully, this will inspire a future retiree to contribute more to this plan and / or to save more personally.
Social security declaration
The Standard Social Security Statement (“SSS”) has been around since 1999. It has gradually moved from a printed and mailed statement to an online tool, but the information provided has not changed much over the years. We have now discovered a new, updated statement, and it will help pre-retirees plan better for the future. This statement is being rolled out over a period of time, and at least for now it appears to only be available in the online version of the SSS. Here are some of the highlights of this new statement:
– A shorter statement that provides the key information in advance. Four pages have been reduced to two, and participant-specific information now appears in the foreground.
– The new SSS shows the amount of benefits for each year between 62 and 70 years. The previous version showed estimates for the deposit at 62, full retirement age (mostly 67) and 70. three scenarios caused both confusion and bad decisions among retirees. Now the retiree can clearly see the many benefits of postponing the deposit for as long as possible.
– There is more information in the SSS on other benefits, such as spouse and disability benefits. And, most importantly, there is more clarity on Medicare eligibility and how to get more information.
– Some have complained that the new statement removes the member’s earnings history. This deletion, however, is a worthy sacrifice for brevity, and it’s not as if the information is missing. The SSA.gov website contains income history, calculators, and related articles on important planning topics. In some ways, this is almost better as moving earnings history to the website encourages future retirees and their advisers to access the many tools provided by the government.
Future retirees may not receive these two new planning tools for a few months. This does NOT mean putting the brakes on retirement income planning. Preparing for retirement is a process, not an event, and new information can be incorporated into the process over time. As I explained in a previous article, many of the retirement income calculations that are offered are based on software that may meet the “trash in the garbage” challenge. Future retirees should review and refine their expectations as they get closer and closer to their expected retirement date.
Use these tools to make an informed choice, not to quickly tick the box and get done. Your retirement depends on it.