LAST REVIEWED Oct 11 2021 10 MIN READ
By The Human Interest Team
Lifetime income disclosure rules went into effect on September 18, 2021, adding a new annual disclosure requirement for 401(k) and 403(b) plans
Participant benefit statements must illustrate the amount an account would produce if used to purchase a single life annuity and a joint life annuity
New disclosures must be included no later than the June 30, 2022 benefit statement (and are required at least annually afterwards)
On September 18, 2021, the interim final rule (IFR) of the “lifetime income disclosure rule” went into effect. Unveiled in September 2020, by the U.S. Department of Labor (DOL), the IFR adds a new annual disclosure requirement for participant benefit statements that applies to both 401(k) and 403(b) plans.
Plan administrators must now show a participant’s account balance in the form of a lifetime income illustration on the benefit statement at least once a year.
Lifetime income illustrations are designed to help participants understand how the money they’ve saved in their 401(k) plan converts into estimated monthly payments over the span of a lifetime. Let’s review how the lifetime income disclosure rule applies to your business.
SECURE Act amendments to lifetime income disclosure rules
On December 20, 2019, ERISA was amended by section 203 of the SECURE Act (Setting Every Community Up for Retirement Enhancement Act of 2019). Included in these changes, the SECURE Act directed the DOL to take regulatory action to provide defined contribution plan participants with a tool that would help them better understand their retirement savings in the form of lifetime income illustrations.
In September 2020, the DOL published the IFR, which requires 401(k) plan sponsors to annually disclose estimates to plan participants on how much income their account balance would produce if used to purchase an annuity. The IFR went into effect on September 18, 2021.
The DOL issued FAQs to clarify points unaddressed in the IFR. To review, the FAQs outlined that for calendar year plans that issue benefit statements quarterly, new disclosures must be included no later than the June 30, 2022 benefit statement. After this date, the lifetime disclosure is required at least annually. Under the SECURE Act, plan administrators must show participants’ account balances in the form of two lifetime income illustrations:
Monthly payments in the form of a single life annuity (SLA).
Monthly payments in the form of a qualified joint and survivor annuity (QJSA)
Annuities are long-term contracts between an investor (referred to as the annuitant) and a financial institution such as a mutual fund or insurance company that are used to fund retirement. These contracts require annuitants to make either lump-sum or periodic payments in exchange for a guaranteed income stream. While an SLA offers the highest monthly payment, it does not provide benefits to dependents and ends when the annuitant dies. A QJSA provides a lifetime payment to an annuitant in addition to their spouse, children, or dependents.
Participants must be shown account balances in the form of both SLA and QJSA illustrations, regardless of marital status. Additionally, the lifetime income disclosure requirement applies whether or not the defined contribution plan offers an annuity form of payment.
Required assumptions for lifetime income calculations
The DOL has outlined regulations in the IFR that provide plan administrators guidance to be used when converting a participant’s current account balance (assumed to be 100% vested) into a lifetime income stream. The assumptions, which may not be exactly relevant to your individual situation, reflect what could be a typical experience of someone reaching retirement and include:
A relatively late retirement age (67, chosen to reflect when most people reach full retirement age for Social Security claiming purposes, rather than the typical retirement age of 65 years)
An interest rate based on a 10-year average from the Treasury
An assumption that, for purposes of converting a participant’s account balance into a QJSA, participants are married and their spouse is the same age as the participant
No inflation adjustment
Required explanations and model language
To help participants understand lifetime income illustrations required by the IFR and the SECURE Act, pension benefit statements must include concise, comprehensible explanations of the assumptions behind the illustrations. These items include:
Benefit start date and age assumptions
Marital, interest rate, and mortality assumptions
Definitions of SLAs and QJSAs and how they work
Language illustrating that these illustrations are estimates only
The fact that estimated monthly payments aren’t adjusted for inflation
Other factors to consider which may significantly influence monthly payments.
To help, the IFR provides optional model language inserts, which plan administrators can use to help reduce the costs, liability, and administrative burdens of implementing lifetime income illustrations. Plan sponsors may modify model language, but it must be similar to the DOL’s model language. Snippets of explanations may be used in the body of benefit statements, where appropriate, or explanations may be provided in an appendix to the benefit statements.
What does the new lifetime income disclosure rule mean for employers?
The SECURE Act clearly provides that the plan sponsor and other fiduciaries will not be liable under ERISA solely by reason of providing lifetime income illustrations if the illustrations are derived from the DOL assumptions and the disclosure includes the explanations in the DOL’s model disclosure. This means the plan sponsor will not be liable under ERISA if actual payments in retirement are less than those shown in the illustrations.
Does this mean all 401(k) and 403(b) plans must now offer an annuity as a form of distribution?
No. At this time, there’s no requirement to add annuity options to retirement plans. The lifetime income disclosure is meant as an educational tool for participants to help them understand what kind of income stream their retirement plan account balance could provide at normal retirement age.
How effective will lifetime income disclosures be?
Time will tell. On one hand, the IFR standardizes lifetime income illustrations across defined contribution plans, which, according to the DOL, could minimize confusion for participants, reduce some complexities of retirement planning, and save participants time by making lifetime income information readily available. Participants can use these illustrations to calculate their own income streams. Furthermore, a standardized model could make it easy for workers to add together their estimated Social Security and ERISA benefits.
However, providing a lifetime income illustration based on current account balances is inherently challenging. Baseline assumptions could result in an inaccurate illustration of lifetime income because they don’t consider future contributions. Instead, these illustrations are based on speculative information regarding future contributions and investments. Additionally, assuming an average retirement age can be a challenge.
Note: The DOL allows plan sponsors to include expanded illustrations as long as they are clearly explained and reasonable assumptions are used.
How employers can generate lifetime income disclosures
While the obligation to provide lifetime disclosures falls on the plan sponsor, most will rely on recordkeepers, such as Human Interest, to both calculate the annuity amounts and draft the disclosure to include on benefit statements. Human Interest will soon begin work to draft the model notices and develop any required programming used to generate the annuity information.
If you have any questions about 401(k) plans, please contact us.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.