When Congress passed the SECURE Act in December of 2019, it included a controversial provision that required the Department of Labor (“DOL”) to include estimated monthly retirement income at least once a year in 401(k) plan participant statements.
In its August 18, 2020 News Release, the DOL stated “retirement plans would provide lifetime income illustrations using prescribed assumptions designed to give savers a realistic illustration of how much monthly retirement income they could expect to purchase with their account balance.”
Despite the good intentions here, this disclosure may do more harm than good. Don’t let it harm you.
“The specific reason the DOL is making this proposal is because it’s required by the SECURE Act, which passed last year,” says Macedon, New York-based Richard Barrington, Senior Financial Analyst at MoneyRates.com. “More broadly, the proposal seems to be an attempt to put retirement savings into perspective. In a statement on the proposal, the DOL used an example showing that a single participant with a 401(k) balance of $125,000 could expect that amount to generate $645 per month in retirement income beginning at age 67. This perspective may be valuable because to the average worker, $125,000 might seem like a healthy chunk of savings. It’s only when you break that down to see what kind of monthly income this amount would provide that it becomes clear that for many people this would probably not meet their needs.”
In theory, this kind of disclosure is intended to open the eyes of retirement savers and inspire them to save more. In reality, academic studies suggest it might have the opposite effect.
“We hope that better informed participants will make better decisions, but behavioral finance research has shown that framing information is important when trying to improve participant outcomes,” says Jeffrey Coons, Chief Risk Officer at High Probability Advisors in Pittsford, New York. “In this case, I expect that most participants will be surprised at how little monthly lifetime income can be purchased from their current account balance. While some may be inspired to save more in order to raise their lifetime income estimate, the risk we must guard against is that participants get discouraged and walk away from their retirement savings plan.”
Not all financial professionals agree with this sentiment, though. Some feel the light of transparency is well worth the risk.
“Sure, some people may feel discouraged seeing a low monthly retirement income on their statements, but with education, tools, and calculators, they can make incremental changes to improve their retirement plan,” says Amie Cyphers, 401k Expert/Relationship Manager at SaveDay in Austin, Texas. “It’s better to be educated on one’s retirement plans rather than shooting for an arbitrary number.”
If you’re relatively early in your career, you may find the manner in which the monthly retirement income is calculated offers no practical value to you.
“One factor that does not appear to go into the DOL’s proposal is an adjustment of the projected income for inflation,” says Barrington. “Especially for younger workers, even a low rate of inflation can have a significant effect over time. For example, at a 2% annual inflation rate, the purchasing power of $1 would be cut in half in 35 years. So, monthly income projections generated for a 30-year-old would actually be half as valuable as they appear by the time that person retires.”
This could either shock you into thinking your goal is unattainable or trick you into feeling you are sailing smoothly even though you’re headed towards rough seas.
“Young savers with small balances could potentially get discouraged to see the translation into a monthly lifetime income amount and stop saving altogether,” says Paul Chong, Senior Vice President, Channel Management at CUNA Mutual Retirement Solutions in Madison, Wisconsin. “Despite required disclosures to the contrary, others may be led to believe that their monthly income needs would be met, only to discover that the estimate doesn’t take into account the many factors it takes to produce a more accurate projection. On the flip side, an estimated monthly income illustration could serve as a wake-up call for young workers that outside of Social Security, they will be primarily responsible for their retirement savings.”
This is certainly a potential issue for young workers. But if you’re older, the psychological impact of seeing the “actual” income equivalent of your retirement savings can downright depress you.
“It’s really hard to get started with saving, and seeing a minimal amount can be very discouraging, especially if they are later in life,” says Jared Porter, CEO at 401GO in West Jordan, Utah. “It’s going to affect those late savers negatively if they’re not seeing meaningful progress or are unable to put away as much as they know needs to be contributed. The other aspect to this, and this is probably the most realistic reason, is that they’ll want to access those funds either through a loan, in-service, etc. knowing how much is there and assuming it’s sufficient for retirement—so why continue contributing?”
In general, though, it’s difficult to see how the vast majority of 401(k) participants will see any good news in these projections. About the only thing this exercise is good for is to convince them that, for all their well-promoted promise, annuities simply aren’t a viable retirement solution for those who haven’t saved enough.
“With the estimated monthly income calculated off the value of an annuity that a retiree could purchase with their 401(k) account, people are going to be discouraged with how little monthly income their account would actually provide them,” says Andrew S. Poreda, ESG Research Analyst at Sage Advisory Services in Austin, Texas. “The median 401(k) account balance for Americans is less than $25,000 (2019 Vanguard study), so most Americans really don’t have much money to make any sort of dent into their anticipated retirement lifestyle. This could sway some people from wanting to save at all, but it should be a sad dose of reality that if you want to live a comfortable life in retirement (or retire at all), you need to start saving now.”
As with all other efforts regarding retirement savings, you can’t really achieve the retirement you want without first saving for it.
Maybe that’s a better thing to disclose to employees.