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DOL issues interim final rule on lifetime income illustrations

Health and Benefits|Retirement|Total Rewards
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By Gary Chase and William (Bill) Kalten | October 15, 2020

The lifetime income illustrations are intended to encourage DC retirement plan participants to save more for retirement.

The Department of Labor (DOL) has issued an interim final rule (IFR) that will require plan administrators of ERISA-covered defined contribution (DC) plans to include lifetime income illustrations on participant benefit statements at least once annually. A related fact sheet is available here. The rule implements section 203 of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.1

The lifetime income illustrations are intended to encourage participants to save more for retirement by showing the estimated monthly lifetime income that could be paid from their account balance. The IFR also includes model language that plan fiduciaries may use to explain the lifetime income illustrations and the assumptions used to calculate them. Plan fiduciaries that use the model language will receive liability protection in the event a participant's account balance at retirement does not generate the income stream described in the disclosure.

The interim final rule will take effect on September 18, 2021, and includes a 60-day comment period; however, the DOL stated in a news release that it will “use comments to improve the rule before its effective date,” so the rule might change before it is final.

Background

In 2013, the DOL released an Announced Notice of Proposed Rulemaking that would require that pension benefit statements provided to DC plan participants include lifetime income illustrations; however, developing a rule for providing realistic illustrations that are administratively feasible and incentivize participants to save more for retirement — but that also do not cause confusion or make participants feel that saving enough for retirement is impossible — proved to be a challenge, so the rule was never finalized.

In late 2019, the SECURE Act amended ERISA to require DC plan administrators to show a participant’s accrued benefit on his or her pension benefit statement as both a current account balance and an estimated lifetime stream of payments. Using DOL assumptions, plan administrators must show participants equivalents of their retirement savings as monthly income under two potential scenarios: 1) as a single life income stream, and 2) as an income stream that factors in a survivor benefit. Plan administrators using assumptions and rules provided by the DOL receive liability protection. To accelerate the issuance of guidance regarding the lifetime income disclosure, the SECURE Act required the DOL to issue a model disclosure within one year of enactment.

Interim final rule

Annuitization assumption requirements

Under the IFR, a benefit statement must include the account balance as of the last day of the statement period, and at least annually the statement must include the lifetime income illustrations showing the account balance as both a single life annuity (SLA) and a 100% qualified joint and survivor annuity (QJSA). The IFR includes the following model chart:

IFR model chart
A model chart showing the account balance as both an SLA and a 100% QJSA.
Account balance as of [DATE] Monthly payment at 67 (single life annuity) Monthly payment at 67 (qualified joint and 100% survivor annuity)
$125,000 $645/month for life of participant $533/month for life of participant
$533/month for life of participant’s surviving spouse

Except for certain in-plan annuities (which are subject to special rules, discussed below), the lifetime income illustrations must be based on the following methodology:

  • Account balance assumptions. The lifetime income illustrations must be based on the value of a participant's account balance as of the last day of the statement period. The participant is assumed to be 100% vested in his or her account. The account balance also must include the outstanding balance of any participant loan, unless the loan is in default.
  • Assumed commencement date. The annuity commencement date is assumed to be the last day of the statement period.
  • Assumed age at commencement. The participant is assumed to be age 67 (or actual age, if older) as of the last day of the statement period. In the preamble, the DOL explains that age 67 was chosen to align the lifetime income illustrations with the Social Security normal retirement age. This would ensure that the disclosures are more consistent than if the plan's normal retirement age (which varies by plan) was used.
  • Marital status. For purposes of calculating the value of the QJSA, the participant is assumed to be married with a spouse who is the same age as the participant.
  • Interest rate. The interest rate used to calculate the lifetime income illustrations is the 10-year constant maturity Treasury securities yield rate for the first business day of the last month of the statement period. This rate was chosen because it reflects the interest rate that would be used to price a commercial annuity.
  • Mortality table. The mortality table used to calculate the lifetime income illustrations is the 417(e) mortality table in effect for the last month of the period covered by the benefit statement. The DOL selected a unisex mortality table to simplify administration and reflect what would be used to calculate an annuity under an ERISA plan; however, it acknowledged that the insurance industry would use a gender-specific mortality table. As a result, using the 417(e) mortality table would overstate a woman's monthly benefit and understate a man's monthly benefit when compared with an annuity that could be purchased outside of an ERISA plan.

The DOL also explained its decision to exclude the following factors from the calculation of lifetime income illustrations:

  • No insurance load. An insurance load is the amount used in annuity pricing to reflect an insurance company's administrative expenses and profit margin. The DOL decided not to include an insurance load because of the difficulty in selecting one that could uniformly apply to all annuity products. In addition, due to the use of conservative interest rate and mortality assumptions, a load is effectively factored into the calculation of the lifetime income illustrations.
  • No inflation adjustment. An adjustment to the lifetime income illustrations to reflect the impact of inflation is not included when calculating the lifetime income illustrations. Rather, the payments are assumed to be level over the lives of the participant and beneficiary. The DOL was concerned that adding an inflation adjustment would complicate the lifetime income illustration and potentially confuse participants, and that a lower inflation-adjusted starting payment could discourage participants from saving. As a result, the DOL elected to include a disclosure about declining purchasing power rather than include an inflation adjustment in the illustration.
  • No term certain or other features. The IFR does not address the treatment of lifetime income streams of payment that include a term certain or other features (such as guaranteed lifetime withdrawal benefits).
  • No projection of future earnings or future contributions. The DOL decided to use an immediate annuity approach instead of a deferred annuity approach (which would have considered future contributions and earnings). Using a current annuity for the lifetime income illustrations — which would show lower payment amounts — could discourage participants by making it appear as if it is not feasible to save sufficiently for retirement.

Required explanations and optional model language

Under the IFR, plans are required to include, with the lifetime income illustrations, explanations of the following 11 items:

  1. Benefit commencement date and age assumption
  2. The single life annuity
  3. The qualified joint and 100% survivor annuity, the availability of other survivor percentages and the impact of selecting a lower survivor percentage
  4. Assumption regarding marital status
  5. Interest rate assumption
  6. Mortality assumption
  7. That the lifetime income illustrations are not guaranteed
  8. A variety of factors that could cause a participant's actual monthly income to differ from the illustrations, including that the “actual account balance (reflecting future investment gains and losses, contributions, distributions, and fees)” may be different at retirement
  9. That the lifetime income monthly payment amounts will not be adjusted for inflation in future years
  10. That the monthly income illustrations assume that the participant is 100% vested in his or her current account balance
  11. That the monthly income illustrations assume that any outstanding plan loans that have not been defaulted are repaid by the time the participant retires

The IFR provides optional model language in two formats: 1) separate paragraphs for each of the 11 points, which are incorporated into an existing benefit statement; and 2) a consolidated model benefit statement, which includes all of the required disclosures and is attached as a supplement to a benefit statement.

Special disclosure rules: In-plan and deferred annuities

The IFR includes special rules that apply to plans that offer in-plan distribution annuities2 and deferred income annuities (DIAs).3

In-plan distribution annuities

For plans that offer an in-plan distribution annuity provided through a contract with an insurance company, the lifetime income illustrations may be based on the terms of the insurance contract. The IFR includes separate disclosure requirements and optional model language that apply in this case. The lifetime income illustrations would still be required to include illustrations based on an SLA and a QJSA; however, the survivor percentage for the QJSA may reflect the survivor percentage under the contract instead of 100%. The lifetime income illustrations must still assume that payment commences on the last day of the statement period and that the participant or beneficiary is 67 (or actual age if older) on the date of commencement. For purposes of the QJSA, it must assume that a spouse is the same age as the participant or beneficiary.

Deferred income annuities

For plans that offer DIAs, the illustration and disclosure rules above do not apply. Instead, if any portion of a participant's accrued benefit is used to purchase the DIA, the lifetime income illustrations must disclose the amount payable under the DIA in addition to the following:

  • The date payments are scheduled to commence and the participant's age on such date
  • The frequency and amount of deferred income stream payments under the contract as of the commencement date, in current dollars
  • A description of the survivor benefit, period certain commitment or similar feature
  • Whether the deferred income stream of payments is fixed or will adjust with inflation or on some other basis

The IFR does not include model language for a DIA. Since the DIA disclosure requires the use of actual payment amounts, model language is not needed. Note that the portion of a participant's account balance that is not invested in the DIA remains subject to the IFR’s disclosure requirements.

Limitation on liability

Under the IFR, a plan fiduciary or sponsor, or other person, will not be liable under ERISA for providing the lifetime income stream disclosures if:

  1. The assumptions required under the IFR are used in preparing the lifetime income illustrations
  2. An explanation accompanies the lifetime income illustrations that is "substantially similar in all material respects" to the model language provided in the IFR

Following are examples of permitted changes to the model disclosure:

  • Replacing references to "this statement" with "your statement"
  • Adding references to the plan name
  • Adding the name of the employer or plan administrator instead of using "we"
  • Changing "if your spouse dies first" to "if your spouse predeceases you"
  • Describing an SLA as a "payment form" instead of an "arrangement"

The IFR allows for additional lifetime income illustrations beyond those that are required (for example, to reflect the time value of money), provided they are clearly explained, presented in a manner that is designed to avoid confusing or misleading participants, and are based on reasonable assumptions; however, the limitation of liability would not apply to these additional illustrations.

The liability limitation also does not apply to lifetime income illustrations for DIAs, since the disclosure would reflect the actual payment amount and not a hypothetical amount based on assumed factors.

Going forward

Plan sponsors should work with their plan administrators to discuss a plan for compliance. Issues that should be considered include:

  1. The required lifetime income illustrations in the IFR do not take into account future earnings or contributions, which will result in an unrealistically small lifetime income number for younger participants. This could discourage additional retirement savings and conflict with most of the disclosures and online tools currently in use. Sponsors should consider whether to provide additional lifetime income illustrations, understanding that the liability shield would not extend to such disclosures.
  2. Plans that offer or are considering offering a lifetime income solution will need to consider how to align disclosure of the plan's lifetime income solution with the lifetime income illustrations required by the IFR, and whether supplemental communications will be necessary to avoid confusion.

However, the ability to implement the lifetime income illustrations is somewhat limited, as the DOL may modify the rules to reflect comments prior to the effective date.

Footnotes

1 For more information on the SECURE Act, see “SECURE Act crosses finish line,” Insider, December 2019.

2 An in-plan distribution annuity is the option to have all or a portion of the account balance paid through an in-plan annuity that is purchased at retirement.

3 A deferred income annuity is an investment option under the plan in which contributions are directed, and at a specified age, some or all of the funds in this investment option may be paid out as an annuity.

Authors

Director, Retirement and Executive Compensation

Senior Director, Retirement and Executive Compensation

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