In this post, we will deviate slightly from our normal focus of trying to help retirees make better financial decisions to focus on the upcoming lifetime income disclosure requirements imposed by the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, as implemented in subsequent Department of Labor/Employee Benefit Security Administration (DOL/EBSA) guidance (which has yet to be finalized). This post is a follow-up to our post of November 18, 2020.
The primary purpose of this post is to estimate the Single Life Annuity (SLA) amounts expected to be communicated to defined contribution plan participants age 67 and younger with $100,000 December 31, 2021 account balances under the new law. Our preview assumes:
- The plan sponsor elects to perform the required disclosure based on December 31, 2021 participant account balances as opposed to a different permitted date
- EBSA does not change current guidance with respect to lifetime income disclosures, and
- The current 10-Year Treasury Constant Maturity Rate of approximately 1.3% remains unchanged until December 1, 2021.
We will also compare the projected SLA amount to be communicated under the new law for participants age 67 and younger with $100,000 account balances with:
- life annuities that may be currently purchased at age 67 with $100,000 from an insurance company,
- Projected Account Balance SLA amounts generated by the DOL/EBSA Lifetime Income Calculator for an August, 2021 valuation date for participants of various ages assumed to retire at age 67 with current account balances of $100,000 and future real dollar contributions of $9,750 per year, and
- Projected age 67 SLA amounts generated by our Actuarial Lifetime Income Estimator (ALRIE) spreadsheet (as modified to make it consistent with SECURE Act mandated assumptions) for similar participants based on different real pre-retirement investment return assumptions.
And finally, we will use this post to once again question the educational value and cost-effectiveness of providing the statements anticipated under the new law vs. simply referring participants to a robust modeling tool that could be made available on the EBSA website in much the same manner as is permitted under current law with respect to referring participants to the EBSA website for required educational material on investments and diversification.
Preview of Expected December 31, 2021 Single Life Amounts under the New Law
To determine SLA amounts under the new law, everyone age 67 or under is assumed (under the law) to be age 67 on the valuation date. The impact of this unusual assumption is to effectively assume zero future real investment return on a participant’s current account balance and to ignore future contributions that may be made on the participant’s behalf.
The new law also specifies assumptions to be used for the interest rate discount and mortality table used in the SLA calculation at the assumed retirement age of 67 (or attained age if later). These are the same post-retirement annuity conversion assumptions used in the current DOL/EBSA Lifetime Benefits Calculator.
The required interest discount rate used in the new law SLA annuity calculations is the 10-Year Treasury constant maturity rate in effect at the beginning of the month containing the SLA valuation date. As of August 24, 2021, this rate was 1.29%. We have assumed a 1.3% rate in our “preview” calculations.
Based on results developed from the Society of Actuaries Annuity Factor Calculator using a 1.3% discount rate, a 2021 valuation year and the MP 2020 projection scale and other assumptions specified in IRC Section 417e(3)(B), we calculated the unisex annuity purchase rate for a 67-year-old to be $17.0108 per each $1 of annual lifetime income (or about $204.13 per each $1 of monthly lifetime income).
Under the current EBSA guidance relative to the new law and the above assumptions, this means that every DC participant in a plan subject to ERISA age 67 or younger would have his or her December 31, 2021 SLA monthly amount determined by dividing his or her 12/31/2021 account balance by about $204.13. For a participant age 67 or younger with an account balance of $100,000 the participant’s SLA amount would, therefore, be about $490 ($100,000/$204.13) per month.
Note that plan sponsors (or plan participants who may be charged for plan administrative services) will have to pay recordkeepers or outside vendors for this new law calculation and the redesign of their benefit statements in order to satisfy the new law disclosure requirements. As discussed above, EBSA currently provides the required calculations for free on their website and has for many years. However, to perform the necessary new law calculations and statement redesign, EBSA estimates a first-year cost to be born by plan sponsors (or participants) totaling $632 million (for all 660,000 plans subject to the new requirements).
Comparison with Current Annuity Purchase Rates at age 67
So, how close is this estimated SECURE SLA amount of $490 per month to current annuity purchase rates for a 67-year-old with $100,000 to spend? Rates available on a monthly lifetime annuity commencing immediately on 8/26/2021 from Immediateannuity.com for an Arizona 67-year-old resident were $509 per month for a male and $476 per month, or $492.50 on average. So, current annuity purchase rates are pretty close, on average, to the unisex amount calculated using current EBSA mandated assumptions. Note that these SLA amounts are fixed at retirement and are not anticipated to increase with inflation after retirement, as is the case for Social Security benefits. Also note that annuities available outside of a qualified defined contribution plan are generally sex-distinct and not based on the average of male and female rates.
Comparison of New Law SLA Amounts with Current Account Balance and EBSA Projected Account Balance SLAs from EBSA Lifetime Income Benefit Calculator
The mortality and interest rate assumptions used to calculate the SLA amounts payable under the new law at age 67 are the same assumptions used for this purpose currently in the DOL/EBSA Lifetime Benefit Calculator. As of August 2, 2021, the 10-year Treasury CMT was 1.2%, so the annuity purchase rate at age 67 for August valuation dates was about $206.67 for each $1 of monthly income, and the SLA amount for a 67-year-old with a $100,000 account balance was $484 ($100,000/$206.67) vs. $490 per month based on a 1.3% discount rate estimate.
The EBSA website calculator shows SLAs attributable to the participant’s current account balance and projected account balance in real dollars. Similar to the unusual approach anticipated under the new law, amounts shown attributable to the participant’s current account balance ignore future real assumed investment returns on the participant’s current account balance, but future real assumed investment returns on the participant’s current account balance are included in the participant’s Projected Account balance SLAs in addition to expected real future contributions and investment returns on those contributions.
The EBSA website Lifetime Income Calculator projected account results shown in the chart below are based on the 1.2% 10-year Treasury CMT rate in effect at the beginning of August rather than an estimated 1.3% rate assumed as of December 1, 2021. In addition, the EBSA website assumes pre-retirement investment return of 7% per annum and 3% inflation, or approximately a 4% real rate of investment return prior to assumed retirement. We entered a current contribution of $9,750 consistent with the assumptions that the participant remains employed until assumed retirement, earns $75,000 per year (increasing at the assumed inflation), contributes 10% of pay each year and receives a matching contribution of $2,250 per year (also increasing with inflation). Amounts shown in the chart below are in today’s dollars, but are not expected to increase after retirement, as is the case with Social Security benefits.
Comparison of New Law SLA Amounts with ALRIE-generated SLA amounts at various ages
Our Actuarial Lifetime Retirement Income Estimator (ALRIE) spreadsheet is a more robust modeling tool than the EBSA website Lifetime Income Calculator in that it permits modeling of several different assumptions regarding future experience that are “hard-coded” into the EBSA Lifetime Income calculator and it can use actual ages of beneficiaries and different percentages of continuation after the first death within a couple. We mention this because we believe the EBSA Lifetime Calculator can be improved as a modeling and planning tool by permitting default assumptions about the future to be overridden by the user and additional functionality added.
Assuming a 19-year unisex lifetime planning period (the life expectancy for the mandated mortality assumption described above is 19.69 years), a 1.3% discount rate and 0% desired increases in payments after commencement, we developed a fixed dollar SLA equivalent to a $100,000 account balance in ALRIE of $491 per month, so quite close to the 12/31/2021 SLA amount anticipated under the new law based on comparable assumptions.
The chart below shows SLA amounts produced by ALRIE assuming retirement occurs at age 67 using the “overridden” assumptions described above and a 2% pre-retirement rate of investment return (4% annual investment return and 2% inflation) vs. the 4% hard-coded in the EBSA Lifetime Income Calculator. We assumed the same annual contributions as described above for the EBSA projections. Therefore, Projected SLAs under the EBSA website calculator are higher than amounts shown below for ALRIE and much higher than amounts that will be shown to younger participants under the new law disclosure.
Monthly Projected SLA Amounts at Age 67 Under SECURE Act, ALRIE and EBSA Lifetime Income Calculator ($100,000 Current Account Balance and $9,750 per annum real contributions)
Assumed Retirement Age
SECURE Act SLA
ALRIE SLA Based on Current Account Balance of $100,000
ALRIE Projected SLA with Assumed Future Contributions
EBSA Projected Account Balance SLA
This chart shows that including future assumed real rates of investment returns and future contributions significantly affects the real dollar SLA amounts that may be reasonably expected at assumed retirement for participants younger than age 67 who are assumed to retire at age 67. Assuming higher rates of real investment return before assumed retirement, as is hard-coded into the EBSA website projections, produces even higher projected SLA estimates than those produced under the ALRIE assumptions used for this chart.
Conclusion—Good News and Bad News
The good news is that the mandated assumptions used to calculate the SLA amounts under the new law appear to do a reasonably good job of estimating age 67 annuity purchase rates currently available from insurance companies for someone who is actually age 67, on average for males and females. We are not sure that this will continue in the future, but it is currently encouraging. It should also be noted, however, that insurance companies generally don’t sell unisex annuities outside of plans.
The bad news is that while the new SECURE Act disclosure requirements may provide some sense of the amount of lifetime income that may be purchased with a participant’s current account balance at age 67, it is likely to confuse many participants (especially those who are not yet age 67) who are interested in determining how much they should be currently saving for their retirement based on when they actually expect to retire and other factors (or worse, they may simply ignore the new law disclosures).
Information provided in the new law disclosure is currently available for free in the EBSA Lifetime Benefit Calculator (the Current Account Balance SLA). Therefore, one can make the argument that the educational and planning value received from the new law disclosure requirements may not be worth the cost.
Making Projected Account Balance SLAs based on reasonable assumptions about the future available to participants would clearly improve a participant’s ability to plan for retirement over the information that is anticipated to be provided under the new law based solely on current account balances. With a few changes to the current EBSA Lifetime Benefit Calculator to make it more robust (like ALRIE) and inclusion of a reference to the DOL/EBSA website on the participant’s benefit statement, we believe participant planning could be significantly enhanced at very little cost to plan sponsors and participants.