Coming Soon to 401k Statements: Participants’ Account Balance as Monthly Income?
Fred Reish (he’s getting a lot of attention from us this month) and Bruce Ashton of Drinker Biddle posted an article that discussed having 401k statements illustrate a participant’s account balance in the form of a monthly income. The article is illustrated below and we find this to be an excellent idea, but the following points would need to be considered in order create a consistent message across providers:
- Universal Equation for Computing the Monthly Income?– This is a key question, as there are many variables that could affect the monthly income projection, including these:
- Rate of return
- Target retirement age
- Annual salary increase percentage
- Distribution percentage
- Consistency Among Providers Could Be Critical – Why is this important? Let’s say there are two friends of similar age and account balances, working for different companies with different plans and they compare notes. If the providers have distinctly different methods of calculating the monthly income, there could be a lot of confusion if their projected monthly income is dramatically different. Additionally, the person with the same account balance but significantly lower projected income could conclude his 401k plan is inferior, even if investment options, funding (personal and employer) and overall plan expenses are similar. Instead, it could simply be a matter of the equation used.
- Concern – Providers might use more aggressive projections of retirement income as a marketing tool for institutional or retail services and products.
Here is the article by Reish and Ashton:
401(k) participants receive quarterly statements of their account balances. Surveys by providers and others generally report on 401(k) account balances in terms of averages, averages by age group, and so on. In other words, it is common in almost all reporting and any conversation about 401(k) plans to refer to “account balances.”
But, the 401(k) industry—plan sponsors, participants, providers and advisers—are beginning to realize that the real purpose of 401(k) plans is—or at any rate should be—to provide monthly income in retirement. As a result, the government, and particularly the U.S. Departments of Labor and Treasury, are increasingly interested in retirement income. Providers and advisers are also focusing on the issue. This is due to the simple truth that, in retirement, 401(k) participants need to withdraw their money on a monthly basis to pay their mortgages, phone bills, rent, utilities, and so on. In other words, 401(k) accounts need to generate a monthly “paycheck.”
In turn, that raises obvious issues about the appropriate way to invest and withdraw money in retirement. For example, a couple—both age 65—can reasonably expect that at least one of them will be alive—and need income—at age 95. (We are working on another article about on the probabilities of living to various ages. That article will be distributed in the next few months.) How can enough money be accumulated over 40 years, say, between the ages of 25 and 65, to provide a 30-year, prepaid retirement? It is difficult to do that. It is also difficult to properly withdraw money in a way that it lasts for 30 years. The sustainable withdrawal rates are surprisingly small, for example, 4% or 5% per year.
About a year ago, the Departments of Labor and Treasury issued a request for information (RFI) about sustainable retirement income. The RFI asked about both insured and uninsured solutions. An organization that we support, the Institutional Retirement Income Council (IRIC), provided detailed and thoughtful responses to the questions. (As a disclosure, Fred Reish was part of the IRIC team that drafted the answers.)
This bulletin quotes four of the questions asked by those agencies and provides the answers given by IRIC. The purpose of this bulletin is not to persuade you to agree with those conclusions, but rather to encourage you to think about the questions and answers. We believe that everyone in the retirement community—plan sponsors, fiduciaries, participants, providers and advisers—needs to have an answer, or perhaps multiple answers, to these questions. In other words, our purpose is to stimulate thought and encourage debate.
It is always surprising why these ideas aren’t tested ahead of time and decisions about adoption based on evidence rather than personality and opinions.
We have no way of knowing whether this will have a good effect or “blowback.”
It would help clarify the “savings” and not “retirement” reality of 401(k) plans. 401(k) plans are not retirement plans — they can, however, be part of a retirement funding plan.
A fools errand.
I’ve said it before about showing an account balance as an annuity or income stream. I will continue to repeat it to anyone who will listen – this process is as likely to mislead and discourage as to accomplish the author’s intended result.
Most of the proposals I’ve seen won’t even be able to assert that today’s age 65 year old could convert her current account balance into the immediate annuity income stream purported to be available by the proposed annual statement. From such a starting point, the whole concept of projecting a monthly income 35+ years out is much, much more likely to mislead or to discourage than to inform and motivate.
How do you respond to the participant who complains when her account balance grows year after year but the monthly income payable at age 65 declines, year after year? Impossible? Not really. Just have a consistent, year over year decline in interest rates. Unlikely? Not really. Just look at the years since 2002. Some plan sponsors, I won’t name names, have lots of experience converting account balances in cash balance pension plans to annuity income streams, and yes, we have first hand experience with significant levels of participant confusion … sometimes leading to distrust. How good are those annuity numbers if we should somehow end up with a spike in interest rates say similar to those of the early 1980’s? Will the statement properly adjust so that participants won’t think themselves flush with retirement income?
Perhaps someone will solve this issue by proposing a fixed, constant interest rate assumption, year over year – ignoring any variability in actual interest rates – so participants aren’t confused. That’s realistic and reasonable, right?
The proposal is to issue an annual projection of current savings patterns out 35 or more years to age 65 or 67 for a 30 year old? I’ll stop there. Retirement is a foreign concept to today’s 30 year old. Try projecting anything even 36 months out or maybe 60 months out. If historical patterns hold, in 60 months, the median employee in American will be working somewhere else (with a totally different 401(k) plan).
What the policy folks are probably looking for is something to spur workers to save more. See the need, see the projection, see the gap, save more, please! They want workers to change behavior. I was thinking about the last time we got a retirement disclosure “improvement” to focus on income – probably the “relative value” regulations. Remember that? That was about five years ago. Seen any studies how that added layer of complexity in the form of a required, enhanced disclosure changed participant behavior? You won’t either
Because the assumptions will have to be conservative, the report will be scary, especially to young workers in a down market. Will this scare them into saving more or lead them to give up on saving in plans at all. In some workforces the report could be constructive, in others destructive. Beware unintended consequences.
Chad, I fully believe this is where we are headed. There is a change in the focus of the industry, from accumulation years to distribution planning. I am currently working on a white paper entitled “GMWB (Guaranteed Minimum Withdrawal Benefit) – The 4 Letters Every Plan Sponsor Should Know”
Not a new idea. It has done by certain Administrators in various forms since the 70’s.to help sponsors see the need for greater PS contributions and latter for participants to see the need for larger deferred contributions.
I have yet to see this on a participant statement first hand. Which providers/administrators have you seen accomplish this?
David, I completely agree with you. However, I also think this is something people NEED to see, whether they want to or not.
Chad, a few plan sponsors include a retirement preparedness calculation on their annual total rewards statement. My former employer had been doing this for over 15 years when I left (showing not only the projections of account balances and annuity equivalents but also using a pay replacement ratio, adjusting for the defined benefit plan and social security, and for post-retirement inflation). The point is, a simple conversion to an annuity equivalent at age 65 is likely to be as confusing as it is informing for the majority of Americans. Throw in variable interest rates and inflation, and … This simply appears to be another simplistic disclosure proposal that, based on experience, won’t change behavior.
Providing estimated monthly benefit amounts on participant statements will move the debate forward on retirement income adequacy and should support stronger efforts for retirement planning education by employers and industry partners. How many participants will eclaim that they would have saved more if they would have only known the ramifications of only deferring up to the maximum match. The next question becomes how the participant will use these estimated retirement amounts in preparing a logical wealth accumulation plan with help from professionals.
Thanks for your points Jack. I have heard of this, but have never seen it first hand. I have a hard time understanding how this could NOT be beneficial to the participant, understanding that it won’t immediately change behavior. Instead, it at minimum does not allow people to assume, as Marc points out, that ” they would have saved more if they would have only known the ramifications of only deferring up to the maximum match.”
Information doesn’t cure anything, but a lack of information can create a lot of issues. In our opinion, having this type of information available could be highly valuable to all parties involved so to influence higher savings rates for participants. No one should assume, as you have pointed out, that this would take the place of any ‘automatic’ or default measures to ‘move the needle’ for investors.
As Jack points out, it is very tough to separate out what benefits employee’s savings for retirement and what raises revenue for providers. It would be great if benefits coincided.
As can always happen, any head-down drive for more assets (sales as priority #1,2,3…) can backfire — especially when fiduciary standards are involved. What exactly are the material benefits of proposals to the proposer or where are the exclusive benefits for the employees?
Framing these efforts as intrinsically or universally for the good of employees or “retirement income” will eventually be viewed as deceptive — at best — and reduce trust.
We cannot expect asset-gatherers to be their own best allies in this task.
Regardless, the facts are that achieving retirement income adequacy is now an historically unprecedented challenge for all societies — let alone plan sponsors, providers, advisors, employees and policy makers. We really have no concrete experience, evidence, models or theories on adequately describing, let alone understanding and effecting, this massive (and growing) challenge.
We do have proliferating “products/solutions” and “answers” primarily addressing the rising anxiety of all parties. No proof however.
Here is a good analogy. The medical facts about stroke are poorly understood and effective knowledge, let alone treatment, is likely decades away. However, hospitals and medical centers have been very financially successful creating “stroke centers” which medically don’t do anything new but people flock to them. Believe the term is “palliative care.” Is that good-bad, right-wrong? People flock to these centers. Because something can be sold – shouldn’t it be?
Being detailed, hard-headed and critical thinker about retirement matters will not make any of us “friends” but — it’s a dirty job and someone has to do it.
Fred Reish recently posted on this solution — here is our blog post on his piece.
Cautions on Retirement Income “Promises” from 401(k) Plans:Response to Fred Reish Proposals http://richandco.tumblr.com/post/3928830752/cautions-on-retirement-income-promises-from-401-k
being detailed, hard neaded and a critical thinker…as well as being thoroughly professional might not, as you suggest Elmer, make us any friends. By adopting such a strategy…and following it…will distinguish us and differentiate us from our peers….and we may even become respected
We can jump through all sorts of hoops begging and pleading with people to do what is in their own best interests, but at the end of the day some people think long term and some people think about happy hour. In my experience, the only effective way to get people to contribute to their 401(k) is the matching contribution.
Re-framing the issue to focus on the purpose/end – monthly income – simply makes sense. I would still show the present account balance and caution all participants that the illustration doesn’t mean that they need to purchase an annuity product. The educational value and understanding potential in terms of what it will take in monthly income terms is understandable and as a result a great potential motivator… if read.
The disclosures are not simple, everything comes with potential liability, any dollar movement towards annuities can take profit away from asset gatherers and certainly puts adviser compensation at risk too… just a few reasons why we’re not seeing this yet even though it is a very good idea.
Larry, I understand your point. However, I think that point is key to the ‘adult conversation’ approach that needs to take place is alerting participants it is their retirement, and thus the biggest driver for their success will be their personal contributions to the plan. Target contribution rates of 12% – 20% helps drive those contribution rates higher. We recently went through a new client rollout, and not with a highly paid bunch, but having the online tools available to implement those actions immediately, along with our 1on1 approach resulted in 25%+ increasing their contributions, and another 10%+ to begin contributing.
Michael, I completely agree and this is why having some sort of industry standard would be key. It’s can’t be a pure annuity-based payout in my opinion. For example, Unified Trust has a blended payout arrangement in which (if I remember correctly) 65% is in a diversified portfolio with a 4% payout, the other 35% in a guaranteed annuity. There are a number of different ways to mix this up so having some consistency, as stated in the article, could be key to not make this a sales technique.
TIAA-Cref has this on their statements. If I recall correctly, they looked aggressive in they were annualized income streams (single life?) and based on a rate of return that did not always reflect the allocations potential ROR. I don’t know that ONE monthly income is good enough. There should be a range and/or probability of the maintenance of the distributions.