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Recent regulations require plans to provide projections for participants showing how much lifetime income they can expect their account to generate when they stop working. The hope is that these illustrations will help focus pre-retirees on future retirement income and meeting retirement goals rather than simply on saving.
A new report by Prudential explores how lifetime income projections should be calculated and how plan sponsors can make participants more aware of their income challenges and participants, as well as how they might react to such projections.
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The Department of Labor specified how lifetime income disclosures must be calculated in an Interim Final Rule issued last year. According to the rule, a participant's current account balance must be used to illustrate their potential retirement income in two scenarios: conversion to a single life annuity or conversion to a qualified 100 percent and survivor life annuity, both at age 67. Future contributions and investment earnings are excluded from the projections.
The calculations must be based on the 10-year constant maturity rate as of the first business day of the last month of the statement period and the IRS' gender-neutral mortality table.
Participants will need more information
The report noted that because projections are based on the current account balance, they will greatly underrepresent future retirement income for most participants. Instead, the illustrations provide a snapshot of what the participant would have if they retired at that moment.
As such, participants will need more information to help them decide if they are on track to meet their retirement income goals and what steps they can take to catch up if they've fallen behind, said the report.
On the other hand, the illustrations could lead to misplaced optimism for those nearing retirement, because assumptions made on annuitization of an entire DC account balance could lead to an artificially high projection.
Most retirees, said the report, rely on a safe withdrawal rate of 4 percent to draw down their retirement savings rather than annuitizing. Participants are likely to need help choosing whether to draw down their retirement account on their own or annuitize it, said the report.
3 potential reactions of participants
Illustrations will change over time depending on age of the account, interest rates, contributions and fluctuations in investment returns. It is important for participants to understand these factors as illustrations could impact their behavior, said Prudential. It outlined three potential examples of participant behavior.
In example one, plan participants early in their career with smaller account balances could either become discouraged by a low projection or seek help with improving their situation. Prudential's survey found that 68 percent of respondents would view that information negatively, with 30 percent indicating they'd be concerned, 23 percent saying they'd be worried and 16 percent saying they'd be scared.
Only 20 percent said they'd be curious, 17 percent comfortable, 17 percent excited, 10 percent surprised and 5 percent encouraged, according to the report. Nearly 80 percent, however, said they would be somewhat or extremely likely to take action based on that illustration.
In example 2, early-career savers see modest and steady progress with their account balance increasing $5,000 and their monthly retirement income increasing $25 per month year over year. This scenario yielded more positive although still mixed reactions, with about half of respondents signaling concern, worry or fear. Seventy-eight percent indicated they were somewhat or extremely likely to take action such as increasing their contribution or reaching out to their plan provider, the report found.
In the final example, savers closer to retirement who have been contributing for years see a projected income higher than their current income. Prudential expects some of these savers to begin to view their illustration as an actual amount. Respondents were asked to react if they found out their actual monthly income would be less than the illustrations projected. Nearly half indicated they would be concerned, 38 percent said they would be discouraged and 29 percent they would be worried, for a net negative reaction of 79 percent. Three out of four said they would be somewhat or extremely likely to take action, and more than 60 percent said they would seek help from their plan provider and engage more with retirement planning tools and calculators.
"The survey results strongly indicate that many participants will be motivated to take additional action to improve their projected lifetime income," said the report. "This is a good result. This also means it will be critical for participants to receive further advice and guidance from plan sponsors so they can glean greater meaning as to what this retirement income projection means in terms of whether they are on track."
The study said plan sponsors can meet this demand for help among participants by increasing personalized and customized messaging with a focus on retirement income; providing managed accounts, planning tools and calculators; offering investment solutions; and expanding financial wellness programming.
Kristen Beckman is a freelance writer based in Colorado. She previously was a writer and editor for ALM's Retirement Advisor magazine and LifeHealthPro online channel. She also was a reporter for Business Insurance magazine covering workers compensation topics. Kristen graduated from the University of Missouri with a degree in journalism.
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