The SECURE Act offers useful information, but only if you can understand it.
If you’re an American worker who hasn’t been living under a rock since you started earning a paycheck, you know that saving for retirement is crucial, but is much more challenging compared to participating in a defined benefit pension like those enjoyed by our grandparents’ generation.
Since then, employers have willy-nilly offloaded accumulation and investment risks onto their employees by doing away with pensions, replacing them with defined contribution plans such as 401(k), 403(b), and 457 plans.
It’s now up to you to decide how much to invest in your employer’s defined contribution plan (if it even has one), and how to allocate that investment between different investment options. Even if you’re a diligent saver and investor, and have a far-above-average $250,000 in your 401(k), do you have any idea how to assess that vs. what you’ll need to be able to retire?
Enter the so-called Setting Every Community Up for Retirement Enhancement (SECURE) Act.
Though it hurt many middle-class (and wealthy) Americans’ ability to maximize the value of what they leave behind for their kids, the SECURE Act includes several important and positive changes, including especially, in Section 203, a new requirement that plans provide annual lifetime income projections to plan participants.
The SECURE Act’s Lifetime Income Projection Requirement and When You May See It
The SECURE Act requires administrators to disclose to plan participants (i.e, to you) at least annually your “lifetime income stream,” which is how much you could expect to be paid monthly if you were to convert your plan balance to a stream of guaranteed monthly checks.
The Act requires at least two illustrations: the first assuming you’re married to a spouse the same age as you, and that the monthly checks keep coming until both of you pass; and the second, assuming the payments end upon your passing.
The Department of Labor (DOL) is responsible for providing guidance to plan administrators. This includes rules on how to generate income projections, a model of lifetime income disclosure including what it should explain, and the assumptions used to convert total accrued benefits to lifetime income streams.
Plan administrators will begin incorporating the lifetime income projection into participant benefit statements in the first half of 2022.
This article details what you can expect the projections to tell you, what they won’t tell you, what to do once you see them, and what to avoid doing.
What Your Lifetime Income Projection Will Tell You (and What It Won’t Tell You)
The idea behind the lifetime income projection disclosure is to illustrate for you how your balance would translate into lifetime income.
Example Scenario 1: Near Retirement with 10x the Median 401(k) Balance
To see how this might play out, let’s look at two hypothetical workers, John and Kelly.
John is a 65-year-old widower, earns $150,000 a year, and has accumulated a higher-than-average $654,000 in his 401(k) plan. Including his employer’s generous dollar-for-dollar match, he plans to add $40,000 this year to that plan, after which, he plans to retire and claim his Social Security benefit of $2500 a month.
Assuming his investment return is 4% above inflation this coming year, his final balance will be just over $720,000. Using Charles Schwab’s annuity calculator, converting the full $720,000 into an annuity would buy John monthly payments of $3796 (as of this writing). Including his Social Security benefits, he can expect just under $6300 a month, or $75,600 a year. Given that his current income, less the $20,000 he sets aside for retirement, is $130,000, he’ll replace only 58% of his pre-retirement income. That’s much less than the 80% replacement typically suggested by financial planners.
Despite having set aside more than 10 times the median amount in his 401(k) for his age cohort, John is looking at some unappealing options, including delaying his retirement or severely curtailing his plans for a comfortable retirement.
Example Scenario 2: 30-Year-Old with $0 Saved for Retirement
Kelly is 30 and single, earns a solid $80,000 a year and hasn’t started contributing to his employer’s 401(k). However, seeing a $0/month projection shakes him and he plans to maximize his 401(k) contributions to the allowed $19,600 from now until retirement, which he wants to be at age 60. His employer will also match dollar-for-dollar, but only up to $15,400 a year, so his total plan contribution will be $35,000 a year.
Assuming the same 4% inflation-adjusted annual returns, Kelly can expect just under $1,940,000 by the time he turns 60. The Schwab annuity calculator estimates that converting it all into an annuity would result in single-life monthly payments of $20,663. That $247,556 a year retirement income is more than triple his current income, and that’s before counting on any benefits from Social Security (which he’d have to wait a few years into his retirement to become eligible).
Despite having saved nothing from his first 8 years of post-college employment, Kelly can make changes now that will move him from a dismal retirement future to a very rosy one indeed!
How You Should View Your Own Lifetime Income Projections
Since you’re still in the accumulation phase, you probably think of your plan in terms of how much money you’ve set aside, your balance. As you approach retirement, that balance will (hopefully) become a very high number. Likely larger than anything you ever bought, including your home and car(s) combined!
However, it’s crucial that you also start thinking of that balance in terms of what kind of retirement it would fund. Unfortunately, even if your plan balance is double the value of your home, it may well be insufficient to fund a comfortable retirement.
That’s what the new illustrations will try to show you – what level of retirement income you can expect if you would convert your full plan balance into an annuity.
What it won’t tell you is how to accomplish such a conversion, whether converting your entire balance would be smart (likely not), or what would be the consequences of converting the full balance into an annuity (nothing left behind once the annuity stops its payments).
The projections mandated by the SECURE Act will also not tell you how things change if your spouse is much younger (or older) than you, or the impact of other sources of retirement benefits and/or income (e.g., your spouse’s income, your own and your spouse’s Social Security benefits, any rental income, part-time work, etc.).
Expert Perspective: I’m nervous my lifetime income projection will suggest I may never be able to retire. How worried should I be and what should I do with this information?
Brandon Renfro, CFP®, Ph.D., RICP®, EA
Belonging Wealth Management
“Keep in mind these lifetime income projections are estimates based on the assumption that you use your entire account balance to purchase an annuity. The vast majority of people are not likely to do that, so that reduces the usefulness of the estimate. If you don’t plan on purchasing an annuity with your retirement savings, then the estimate on your statement isn’t really a good one.
You really need to have an idea of what your own distribution strategy will be so you can translate your savings balance into a meaningful retirement income number. That’s part of what planning before you reach retirement is meant to accomplish – give you an idea of whether you are on track, ready, or need to make some adjustments.”
What You Should Do Once You See Your Lifetime Income Projection (and What Not to Do)
First, expect that your projections may fall above, close to, or below the level of income you expect to need in retirement; and that if yours falls into that third category, you have time between now and when you retire to adjust your savings and improve your projections.
Oh No! My Projected Lifetime Income Is A Lot Lower Than I Expected! Now What?
First, don’t panic. Small changes made now can make a big difference in your ultimate results.
Second, revisit your budget (you have one, right?) to minimize expenses that don’t align with your values and priorities, so you can increase how much you set aside for retirement.
Third, use several calculators to get a better sense of how your personal situation changes things relative to the SECURE-Act-mandated projections. Kerry Pechter of Forbes test-drove half a dozen other calculators and reports on the pros and cons of each. The test drive necessarily had to make a set of assumptions – a married couple with moderate risk tolerance, both aged 50 and wanting to retire at age 67; one earning $100k and the other $50k; neither has an existing pension or annuity; the higher-earning spouse already saved $150k and adds $6k/year, while the other has $75k saved and adds $4k/year. Mr. Pechter concluded that this hypothetical couple appears to be much less prepared for retirement than he thought, but believes this may be due to the calculators assuming people will survive into their 90s. However, if it’s your own retirement at stake, would you risk assuming you’d die earlier?
Finally, consider hiring a certified financial planner (CFP) to design a financial plan for you to get from you are now to where you want to be to meet your financial goals, including a comfortable retirement. You might also consider working with a financial advisor who has earned their Retirement Income Certified Professional (RICP) designation as these individuals have specialized knowledge to help ensure you don’t outlive your retirement savings.
Woohoo! My Projected Lifetime Income Is A Lot Higher Than I Expected! Now What?
First, congratulations! You’ve worked hard and lived frugally enough to achieve what few of your colleagues managed to do.
Second, before you celebrate by redirecting your retirement plan contributions to an exotic vacation in Bali, use the same calculators recommended by Forbes’ Pechter (above) to better tailor the projections to your specific situation. Perhaps your spouse is much younger than you, and you plan to buy a joint-and-survivor annuity, in which case the monthly payments will be much less generous.
Finally, consider if increasing your retirement contributions even further wouldn’t be a wise choice, considering that none of us can accurately predict how the market will behave in the future – if there’s a major bear market right before your retirement date, you might need to scale back your retirement budget by a lot.
Questions and Answers on Lifetime Income
Q. What options do I have if I want to convert my retirement savings into an income stream? Are there options beyond an annuity?
A. The easiest option is to purchase an annuity with the portion of your portfolio that you want to convert into a payment stream. There are various types of annuities, and different options as to guaranteed amounts to be paid, how long the payment stream will last, etc. Another option is to invest the money in bonds that pay a stream of interest payments. The drawback of the bond option is that once a bond reaches maturity, it stops paying interest, and you have to roll the money into another bond, which may have a lower yield. Bond’s values also fluctuate, but if held to maturity, they should return their nominal face value, which can be reinvested (or bequeathed to your kids). This assumes the bond issuer doesn’t default.
Q. Should I keep my money in my employer’s plan for a lifetime income stream option or roll it over to another provider?
A. In principle, you can do either, since ERISA and the new SECURE Act include important fiduciary protections. Having said that, you could roll over into another plan, including an IRA, if you find one with higher benefits and/or lower fees.
Q. If an annuity is such a great option, why am I only hearing about it from my employer now?
A. Most annuities are complicated products with high fees. Also, if you want to leave money for your kids once you pass away, you shouldn’t convert all of your retirement funds into annuities, since those stop making payments once you (or you and your spouse) pass away. A caveat to that is that if you accept lower monthly payments, you can get a guarantee of a minimum payout total, so if you die too early some of the money will go to your beneficiaries. However, experts recommend converting a portion of your portfolio into annuities, as this provides you with a retirement-income “floor,” and allows you to spend more in retirement than the 3% or so that’s currently considered a viable long-term draw from an investment portfolio.
Q. If I leave my company, can I take an annuity with me?
A. Yes. The SECURE Act has provisions for rolling annuities from inside an employer’s plan to other plans, including IRAs.
Q. Do I have to wait until my employer sends my statement that includes my lifetime income projections?
A. Not at all. You can use DOL’s existing calculator, which asks for (a) your retirement age, (b) your current account balance, (c) how much you add to it each year, (d) how many years until you retire, and (e) the date of your plan statement that shows the balance in (a) above.
This simplistic calculator assumes a 4% inflation-adjusted annual growth of your plan balance and converts the estimated balance into hypothetical annuity amounts. The results reported include your estimated balance at retirement, lifetime monthly income if payments stop at your death, and payments if you choose to have checks continue to be paid to your spouse, should he or she survive you, until his or her death. The calculator shows these numbers two times – if you were to retire immediately, and if you waited the number of years you stated in (d) above.
Since this is such a basic and imperfect calculator, you’d do well to go further afield and look at other offerings, such as the ones suggested by the above-mentioned Mr. Pechter.
Expert Perspective: Financial Professional Insights on Lifetime Income
Kevin Hartnett
Sensenig Capital Advisors
Q: What are the potential benefits of allocating assets in my 401k plan to a lifetime income annuity?
Kevin: Running out of money and no longer receiving a paycheck are two of the most common concerns we hear from clients close to retirement. Lifetime income annuities can be an appealing solution to this problem because they provide a certain level of guaranteed income that lasts the retiree’s lifetime. We can think of this lifetime income annuity solution within a 401(k) as a self funded pension. Once the retiree starts receiving the guaranteed income it is not subject to the typical ups and downs of the stock market.
Q: What are the potential pitfalls of allocating assets in my 401k plan to a lifetime income annuity?
Kevin: While this option may feel like it’s improving retirement security there are some important points to consider. Annuities are typically more complicated than the usual fund offerings that currently exist in the majority of 401(k) plans. In other words, it may be harder for the current 401(k) participant to fully understand the terms and fees of the contract. In addition, if the annuity does not have an inflation rider then the level payments purchasing power will be eroded overtime. Think about how much it cost to fill up your gas tank 20 years ago vs. today? This means that eventually those level payments might not be enough down the road. If it does have an inflation rider there is usually an additional cost associated, which leads me back to the first point.
Q: Should I consider allocating assets in my 401k plan into a lifetime income annuity?
Kevin: It depends, there are some important things to consider such as cost, capacity for risk, and the financial stability of the company backing the lifetime income annuity to name a few. If you have a low capacity to take risks, meaning you can’t bear the ups and downs associated with traditional investment experience, then a lifetime income annuity might be a viable option for you.
Q: What happens if I change my mind after investing in a lifetime income annuity and want the money I invested back?
Kevin: You will most likely be able to get your money back but how much you get back depends on the contract and the length you’ve been investing in the annuity. If it’s within the first couple of years you will likely have to pay a surrender charge to the insurance company which can erode some of the savings you’ve already worked hard to create.
Some Further Reading
Here are more in-depth resources if you want to understand the SECURE Act more fully, especially if you’re interested in other changes it enacted beyond the lifetime income projection requirement.
• Lifetime Income Provisions Under the SECURE Act
• SECURE Act Alters 401(k) Compliance Landscape
• SECURE Act Is No Lifetime Income Free-For-All
• Understanding the SECURE Act’s Lifetime Income Provisions
• Getting SECURE Act’s Lifetime Income Provisions Right
The Bottom Line
The SECURE Act enacted a host of changes affecting retirement and estate planning. Some of these hurt American workers, others are expected to help. The Lifetime Income Projection mandate can help you get a sense of what you can expect from your retirement plan balance once you retire and start drawing money instead of adding to the plan.
These projections will likely shock many Americans who over-estimate what they can expect to spend in retirement. However, this is not necessarily a bad thing, as these workers can make changes now that will make their future retirement more comfortable than what staying their current course would allow.
About the Author
Opher Ganel
My career has had many unpredictable twists and turns. A MSc in theoretical physics, PhD in experimental high-energy physics, postdoc in particle detector R&D, research position in experimental cosmic-ray physics (including a couple of visits to Antarctica), a brief stint at a small engineering services company supporting NASA, followed by starting my own small consulting practice supporting NASA projects and programs. Along the way, I started other micro businesses and helped my wife start and grow her own Marriage and Family Therapy practice. Now, I use all these experiences to also offer financial strategy services to help independent professionals achieve their personal and business finance goals.
Connect with me on my own site: OpherGanel.com and/or follow my Medium publication: medium.com/financial-strategy/.
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