Discordant Disclosures

Simple, Standard, Universal is Best

One industry professional recently called for “standardized lifetime income disclosure, ASAP.”¹ I agree with his goal. I disagree with his solution.

He concludes: “The simplest, least confusing and best way to present this information is to tell the participant what sort of age-65 life annuity he or she could buy with his/her current account balance.”

Well, a projection of an age 65 annuity will almost always be inaccurate. Period-to-period changes in estimates will be hyper confusing to everyday plan participants. Confusion will be compounded for participants who receive multiple disclosures – from current and prior employer-sponsored plans. Just as important, the proposed mandated disclosure only applies to employer-sponsored plans subject to ERISA. It won’t apply to a considerable portion of the accumulated retirement savings invested in Individual Retirement Accounts (IRAs). Those accounts will only reflect cash balances.

For example, unless the plan provides an annuity payout option with unisex provisions, a woman can’t buy the same amount of age-65 life annuity as a man can. What would have happened had this mandated disclosure been implemented 40 years ago, when the first 401(k) plans were introduced, and today’s age 65 retiree first started to save? The early 80’s were a period where life expectancy was noticeably less, and interest rates were dramatically higher. So, assuming the disclosure was repeatedly updated with each quarterly statement or once a year to reflect changes in annuity purchase rates (as well as contributions, investment performance, turnover, new enrollments, distributions and rollovers to IRAs, hardship distributions, etc.), an annuity amount would have fluctuated dramatically. The result would be anything but simple and informative. Period-to-period changes in the annuity would certainly be confusing to the point of misleading to almost all everyday plan participants. And, as a result, the estimated annuity would have no value for participants who will want to rely on projections in their savings and payout decision-making.

Achieving the Goal – Standardized, Simple, Least Confusing

Standardized, simple, and least confusing is easy. There is already a retirement savings individual account distribution mandate in place today - enforced by a 50% tax for non-compliance. It is called required minimum distributions (RMD).² If you want a standardized, simple, least confusing disclosure, have each employer-sponsored plan and IRA show what the account balance would provide as a stream of income as if the individual were age 70 ½ today (assumes current dollars, that earnings on investments would fully offset post-retirement inflation). The projection would show a residual account balance at some age, perhaps starting with 100.

RMD disclosure is best if the goal is a standardized, simple, discloure that is as least confusing as possible in that:

• It would trigger a one-time expense, updated only when IRC §401(a)(9) requirements change; 
• There would be no confusing, period to period changes; 
• The sum of the payouts would always equal the account balance; 
• It requires no projection of inflation or interest rates; 
• The number would be the same regardless of the taxation of the account balance (taxable, return of after-tax contributions, Roth contributions and earnings thereon); and 
• The number would be the same for every individual born on the same day, regardless of the type of plan or IRA, the service provider, the plan advisor, or the plan sponsor. 

So, the account balance, coupled with an RMD calculation would clearly reflect only the impact of added contributions and investment performance. Further, upon separation, a rollover to an IRA (or to a subsequent employer-sponsored plan) would not impact the estimated income stream.

Best?

I certainly agree that best = a standardized, simple, and least confusing communication. So, best is clearly cash, expressed in current dollars. That is because many participants have retirement savings outside of IRAs or employer-sponsored plans subject to ERISA.

However, if the goal is a standardized, simple, least confusing lifetime income communication, the RMD display is best. Here’s why:

• See the above list for simple, standardized, and least confusing - reflecting the existing mandate and applicable in the same way to all retirement savings accumulations;³ 
• Almost all service and product providers are already using software, administration to make distributions to comply with RMD; 
• More and more individuals are working beyond age 65; 
• Most workers have multiple employers during their working careers, with diverse plans⁴; so 
• The participant could simply add the income streams. 

Remember, we are talking about everyday American workers with multiple accounts, varied disclosures over a period of 40, 50, 60, 70 years (including 10, 20, 30 years in retirement); many will also receive the spouse’s disclosures, also reflecting multiple accounts.

Standardized, simple, least confusing, best – you can do that. As a plan sponsor, you can do that today using RMD – you don’t need a mandate.

1M. Barry, Barry’s Pickings: We Need Standardized Lifetime Income Disclosure, ASAP, 7/3/18, Accessed 8/26/19 at: https://www.plansponsor.com/exclusives/barrys-pickings-need-standardized...
²Internal Revenue Code Section 401(a)(9), IRC §401(a)(9)
³Author’s note: A decision would have to be made regarding Roth IRA assets to standardize the result, either excluding it from the required minimum distribution income stream (showing it as part of the residual account balance) or including it as part of the income stream even though not required.
⁴See: J. Towarnicky, 401(k) Trends - Where We’ve Been and Where We May be Headed – Part 1, 4/18/18, Accessed 8/26/19 at: https://www.psca.org/blog_jack_2018_23 Mind the (Coverage) Gap, 8/19/19, Accessed 8/26/19 at: https://www.psca.org/blog_jack_2019_46 Narrowing Retirement Savings Gaps, 5/16/19, Accessed 8/26/19 at: https://www.psca.org/blog_jack_2019_31 . Author’s note: I believe participants say they want lifetime income disclosure because they don’t realize that: (1) They would pay for the estimate through increased fees, (2) the projections won’t be accurate, (3) the projections can’t be relied upon, and (4) even an estimate of the monthly income from an annuity with a known account balance for an individual already age 65 would not be accurate - if only because of unisex pricing. Some industry experts argue that a “snapshot” reflecting the existing account balance would be meaningless – in terms of retirement preparation. They believe the projection should include future savings based on the existing retirement savings plan and elections – to demonstrate whether the participant is “on track” for a financially successful retirement. But, given the trends in turnover, the unknowns in terms of future employment, investment earnings, inflation rate, salary/wage changes, etc., any projection of outcomes over the next 10, 20, 30 or more years is certain to be misleading, potentially wildly inaccurate. The DOL cited a behavioral economics study in support of their proposed rulemaking, as evidence of the effectiveness of this type of disclosure – see: Department of Labor, Employee Benefits Security Administration, Fiduciary Requirements for Disclosure in Participant-Directed Individual Account Plans; Proposed Rule, 73 FR 142, 7/23/08, Accessed 8/26/19 at: https://www.govinfo.gov/content/pkg/FR-2008-07-23/pdf/E8-16541.pdf. It states, in part: "… we find that providing income projections along with general plan information and materials assisting people through the steps of changing contribution rates resulted in 29% higher probability of a change in contributions relative to a control group... In addition, individuals sent this treatment increased their annual contributions by $85 more than the control group ..." Turns out that they surveyed folks from a major university where the average contribution rate before intervention was 3.19%, and 3.33% after intervention. Average contribution went from $2,324 to $2,450 a year ... Average tenure was 12.3 years, average age 45 and average income almost $60,000. The percentage in the sample that changed their contributions was 4.09% in the control group (who didn't receive the special disclosure and intervention, attention and new tools) versus 5.3% in the test group (5.3% is 29% higher than 4.09%). So, whether or not people got the lifetime income information, some increased their contributions. Imagine if the study conclusion had been: 96% of participants who received the intervention failed to increase their savings! Importantly, the study used a population much older than the target, paid more, with a much higher profile intervention than a “page 5” projection on one of the quarterly account statements. All that disclosure could achieve was a 1.21% higher response rate compared to the control group, only $85 per year per participant in additional savings. Finally, displaying the age 65 annuity equivalent to today's account balance will introduce concerns of futility or impossibility. Again, what is the goal? If the goal is to increase contributions, we know what works (automatic features) and more mandated disclosures attempting to predict some future lifetime income stream are not it.