If you are fortunate enough to have a company sponsored 401K plan, you will likely see some new (and potentially confusing) illustrations on your statements in the coming months. The changes are related to the 2019 Secure Act passed by congress. The mandate requires 401k administrators to provide an estimate of “guaranteed lifetime income” assuming your current 401K was completely “annuitized”.
What does it mean to “annuitize” your current 401k balance? In essence, to “annuitize” means to convert the entire sum of money in the 401k into a steady stream of payments over a period of time (typically the remainder of one’s expected life). There are many factors which impact this calculation, including the rate of return, fees, life expectancy, and of course, the balance of your 401K. Like so many rules and regulations intended to provide transparency , this new information may create significant confusion and/or lead to potentially incorrect conclusions regarding one’s preparation for financial life in retirement.
This new information provides an estimate of the monthly benefit payment amount for the account owner at age 67 (or their actual age, if older than 67). If the account owner is younger (say 40), there are many years of contributions and growth remaining that would not be considered in the calculation, thus skewing the projected monthly payment amount too low. This would be true for any individual with a relatively small balance (ex. someone that changed jobs many times over their career and rolled past 401k’s into an IRA).
In addition, the calculation will use a generic gender-neutral mortality table from the IRS – so life expectancy may be greatly different from one participant to the next, including if the individual is male or female (women live 5 years longer than men on average). There is no established rules for what assumptions must be included when calculating the monthly payment projection, such as return on investments, future contributions impact, etc.
Beyond these calculation shortcomings, practical implications exist. For example, if the projected income is low (or too high), it may actually discourage savers from continuing to save (what’s the point?). Additionally, retirement security is as much about what you accumulated during working years as it is about what you will spend in retirement. According to a recent WSJ article, the average retiree spends roughly $400 per month more than they budget (about $5,000/year), so saving early and often is critical for a secure retirement. This is why a more comprehensive approach to retirement (and financial planning in general) is appropriate.
Speaking about annuities in general, we continue to encourage our clients to exercise extreme caution when considering the purchase of an annuity, particularly inside a company 401K. These products are often sold as “guaranteed lifetime income”, but the trade-off of long-term real returns and flexibility more than offset the perceived reduction in risk. Most annuities do not provide a cost of living increases (inflation), so what may look like a decent monthly income payment today may feel less adequate years from now when it comes to true purchasing power. Annuities are typically more complex than advertised and generate less income, growth, and steal flexibility (with higher fees) when compared to a well balanced portfolio of stocks & bonds. Remember, annuities are an insurance product, not an investment vehicle and should be treated as such. Unfortunately, the Secure Act effectively provides a green light for insurance companies to solicit retirement savers (more than they already do). CAUTION!
Rather than making clients feel more secure, the new changes enacted by the Secure Act may cause unnecessary confusion and stress. Like so many scenarios within the financial world, the “devil is in the details”, we believe a deeper understanding is required to fully grasp your bigger financial picture. Let us help put the puzzle together. As you begin receiving 401k statements with this new lifetime income estimate, consider sharing it with our team; we can assist you find “financial peace of mind”.
As always, we are here to help bring clarity. If you desire to revisit some of our previously published thought around annuities and insurance, they can be found at the links below.
https://nvestwealth.com/annuities-free-lunches-magic-bullets/
https://nvestwealth.com/life-insurance-is-not-for-saving/