Employees can more easily assess their retirement readiness when they know how much their current savings will translate to in retirement. Congress understood this when it enacted the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.
Under the act, the Department of Labor (DOL) must provide defined contribution plan sponsors with rules for a “lifetime income illustration” to help participants track their progress. Recently released interim final regulations provide that guidance, though they’re still subject to fine-tuning before their ultimate effective date in mid-2021.
Required illustration parameters
The DOL’s interim regulations establish parameters for the illustrations, while also inviting comments on whether they should be broadened. For now, the illustration must use the following assumptions to give participants of all ages a glimpse of what their current savings will translate to when they retire, based on current dollars:
Start date. The illustration “must calculate monthly payment illustrations as if the payments begin on the last day of the benefit statement period.”
Participant age. Plan administrators must assume, in effect, that the participant is age 67 and beginning retirement, or that both spouses are age 67 for a joint and survivor annuity. (This is an annuity for a couple whose benefit continues at the same amount until the death of the second person.)
Number of illustrations. Two illustrations are to be given: one based on a single-life annuity, and the second on a 100% joint and survivor annuity.
Interest rate. The assumed interest rate for determining the annuity amount is the 10-year constant maturity Treasury (CMT) rate as of the first business day of the last month of the statement period.
Life expectancy. The illustrations must use life expectancy assumptions based on the periodically updated gender-neutral mortality tables contained in the Internal Revenue Code.
Interpreting the illustration
Using those parameters, the interim final regulations provided an example of a lifetime income illustration. According to the illustration, a 40-year-old participant with a $125,000 account balance, and an assumed CMT rate of 1.83%, would receive a single life annuity monthly benefit of $645, or a joint and survivor 100% annuity monthly benefit of $533.
Presumably, 40-year-old plan participants looking at that illustration would conclude that, with another 37 years to go before beginning to take distributions from their 401(k) plan, they’ll need to continue to save aggressively in their account to fund an adequate benefit when they’re 67 years old.
However, an illustration based on this formula is incomplete. It wouldn’t give the participant any indication of what income that $125,000 account balance would generate at age 67 when accounting for the growth of that account between now and when the participant retires. In effect, the illustration given in the interim regulations would be close to identical if given to a 40-year-old participant or a 65-year-old participant. Slight differences would exist because of different mortality assumptions based on the actuarial tables. It’s possible this limitation will be addressed in the “final-final” version of the regulations.
The DOL stated that it picked the 67-year-old assumed retirement age for the projected income illustration because that’s the age at which most people will be eligible for a full Social Security benefit. Still, the agency invited input on whether it should permit income illustrations to include additional retirement age assumptions.
The interim regulations provide flexibility for plan sponsors that offer in-plan annuity options from licensed insurance carriers and contain separate disclosure requirements for plans that make deferred income annuities available to participants. To simplify compliance, the regulations contain model language that plan administrators can use for the required explanations. Until the DOL issues final regulations, plan sponsors can rely on the interim final rule. Once the final regulations take effect, plan sponsors must provide lifetime illustrations annually.
Sidebar: ERISA relief for rule followers
The “lifetime income illustrations” required under the Setting Every Community Up for Retirement Enhancement Act (see main article) are hypothetical and not promissory. Still, plan sponsors might fear participant litigation if reality doesn’t ultimately match the illustrations. To neutralize such fears, the regulations include “liability relief.”
According to the Department of Labor’s summary of the regulations, “generally… no plan fiduciary, plan sponsor, or other person will be liable under ERISA for providing a lifetime illustration that satisfies the requirements” of the regulations. To qualify for this relief, a plan administrator must derive the lifetime income equivalents in the single life annuity and qualified joint and survivor annuity using the assumptions set forth in the interim regulations. Also, plan administrators must use the interim regulations model language, or language “substantially similar in all material respects” to the model language, in participants’ benefit statements.
Word-for-word adoption of the model language isn’t required. Plan administrators can make minor, nonsubstantive changes to the interim rule’s model language or format in their plans’ benefit statements without losing relief from liability. Any such changes may not, individually or in combination, affect the substance, clarity or meaning of the model language. For example, plan administrators may not deviate from any of the interim rule’s required assumptions about the required commencement date, age, rate of interest and mortality.
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