The SECURE Act is changing the way Americans save for, plan for and think about retirement. Among the many changes brought about by the SECURE Act is a new disclosure for 401(k) plan participants – an estimate of lifetime annuity income. Beginning at the end of 2021, every 401(k) participant will not only see their account balance, but also how much monthly income that account balance can generate for them. This change in reporting, though not without some limitations, will help millions of American savers better understand their true readiness for retirement. Using this new metric in conjunction with a sound income-focused retirement plan can help you attain your goals for a vibrant retirement.
There have always been numerous disclosures and reports that 401(k) sponsors (usually the company you work for) have been required to give to their participants. The disclosure of fees charged to participant accounts was the last key update to retirement plan laws before this one. Before 2021, though, 401(k) plans had only to inform you of your current account value as of the end of each quarter and year. While knowing how much money is in your nest egg is nice, it’s not particularly useful from a planning standpoint. On its own, it’s just a number in time – it doesn’t help you understand what that account balance will do for your retirement lifestyle. Obviously, the bigger the balance the better, but unless you’re especially keen on finance, or use a financial professional, it’s hard for people to translate current account balance to retirement lifestyle.
The SECURE Act of 2019 changes all that. The act now requires that every 401(k) plan participant be told not only their current account balance, but also how much monthly income that account balance could generate in retirement.
Specifically, plan participants will know their current account value and their projected monthly income payable at age 67. The monthly income is calculated as an annuity payment, which means that the payments are guaranteed – they’re not dependent on stock market performance. You will be given two different annuity payment estimates:
Your 401(k) plan sponsor is required to provide these numbers to you at least once per year. They may do so more frequently.
This might seem like a small change. After all, you’re only getting two new numbers once per year. And, they’re only projected numbers, not even guaranteed. What’s the big deal?
The real benefit to showing you this calculation – the estimated monthly income your 401(k) nest egg can generate – is that it will help you think in terms of guaranteed income in retirement, not just in terms of account value. This is important because a nest egg, no matter how big, doesn’t necessarily help you in retirement unless you can turn it into a stream of income that will help you pay bills and live the lifestyle you desire.
So, whether your 401(k) balance seems small or big, having a look at how much income it can provide you in retirement will help with your financial planning. It’s said that ignorance is bliss, but when it comes to retirement, it can be catastrophic. If you don’t know how much income your nest egg can generate, it’s hard to make and stick to a plan. Ignorance of the income potential of your nest egg can lead to two opposite negatives:
By giving you your estimated monthly income in retirement, you can avoid both of these extremes. If you’re projected to do well, you can worry less. If you’re behind where you think you should be, you can make adjustments to your retirement plans.
While the new reporting requirement is helpful, it does have a few pitfalls. In other words, it’s a good first step, but you can’t exactly take it at full face value. First of all, this number is still only a “snapshot” in time. As of a certain date (usually the end of the calendar year), your nest egg was capable of producing the income figures they show. Unless you converted your full account balance to an annuity on that date, this isn’t the actual amount of income you’ll receive in retirement.
There are two other factors at play here that minimize the accuracy of your income projections:
In the first place, the current yield on the 10-year Treasury bond is pitifully low in historical context. Due to the massive monetary easing the Federal Reserve has engaged in since 2008, and especially since the COVID-19 crisis, the yield has been below 2%. Your actual returns are not guaranteed, of course, but they’re likely to be significantly higher than 1% to 2%.
You’re also likely to continue depositing money into your 401(k) plan. Your peak earning years are likely near retirement age, so you’re likely to contribute more during these later working years than earlier in your career. These deposits will also earn investment gains over time.
In short, the income calculations are likely to understate your potential lifetime income. This will be especially true the further from age 67 you are. This artificially low number could have a negative consequence on your determination to save. If you see the projected income and become depressed or discouraged, you might be tempted to stop saving all together. Or, you might not care to increase your savings rate because you figure it doesn’t matter anyway. On the other hand, you might think you’re all set and not need to save any further. Resist both of these temptations. Instead, use these new projections to improve your retirement plan.
Now that we know what these lifetime guaranteed income calculations are, and some of their shortcomings, we can talk about how to use them as part of your retirement plan.
Like we reviewed before, the benefit to looking at your 401(k) as a stream of monthly income is that it helps you understand what your retirement might be like. An account balance doesn’t do that. Your 401(k) balance converted to a stream of income can be added to other sources of retirement income. For most people, that means Social Security income. It may also mean:
When you add all of these income payments together, you can start to get a precise look at what your total monthly income in retirement will be. Now it’s not just a random account value; you’re looking at a reasonable estimate of how much income you’ll have to live on.
Once you have this total monthly income from all sources, you can compare it to any goals you’ve set, or at least your projected expenses. By the way, you should seriously consider working with a financial professional on these matters. If you already have one, review these numbers with them. If you’re not yet working with a financial professional, consider finding one you’re comfortable with.
When you sit down with your financial professional, you can compare your total projected income with your likely expenses, or your personal income goal. You can make adjustments based on how close you are, including:
You can’t make decisions about your asset allocation, risk tolerance and savings needs without a good estimate of your total retirement income and your likely expenses.
By reviewing your 401(k) projected income every year and considering it in the context of your other expected retirement income, you’ll be able to transition to retirement with a much clearer picture of your financial status.
At some point in time, you’ll start reducing your stock market exposure and begin accumulating assets that are designed to provide income in retirement. You’ll definitely want to lower your risk profile as you near retirement, since big market losses close to retirement age can have a terrible impact on your retirement success.
Work with your financial professional to choose products that will maximize your income while safeguarding your principal. Historically, people switched to government and AAA-rated corporate bonds to generate retirement income.
They also owned dividend-paying “blue chip” stocks that were considered unlikely to experience stock price crashes. However, today’s ultra-low interest rates have lowered the income potential from these investments. Relying on these assets may result in lower income than you’ve planned for, which can lead to a lower standard of living in retirement. In the worst case, you could end up out-living your assets if you have to tap into principal to fund your retirement expenses.
To avoid this, you may want to consider using insurance products that offer guaranteed income payments over your entire life. Like your 401(k) lifetime income calculations, you can guarantee your monthly income through the use of annuities. Annuities provide steady payments, generally monthly, that are guaranteed by the insurance company. They promise to pay you a fixed amount for the rest of your life, or over the life of you and your spouse if you prefer.
By moving your various 401(k) and other retirement savings accounts to this kind of product, you can lock in a lifetime of income payments, no matter how long you live, and you also eliminate investment risk. In other words, once you start receiving your income payments from the insurance company, you don’t have to manage or worry about the investment performance of your assets. The insurance company takes that risk off of your shoulders. These aspects of annuities in retirement can bring great peace of mind to retirees.
A successful retirement comes down to preparation. Getting more actionable information from your 401(k) plan sponsor can help you be better prepared for retirement, but it won’t make any difference on its own. To really put the new regulations to work for you, you need to incorporate your projected lifetime income data into your overall retirement strategy. The best way to do this is to work with a financial professional. A financial professional will help you make accurate forecasts about many of the factors that will impact your retirement success, including:
There are a lot of moving parts, and if you make a poor estimate of any of them, your results will suffer. But by working with a financial professional, you can improve your chances of making accurate estimates of these factors, which will help you execute a successful retirement strategy.
You can also use your financial professional to help you choose the appropriate investments for your portfolio. This is a key role, because as you get closer and closer to retirement age, reducing risk becomes increasingly important. You’ll also need to select income producing assets for your retirement. You’ll want to be careful here, because some of these products can come with high fees. You have to know what you’re getting into.
Working with your financial professional to craft a realistic plan will help you succeed in staying the course. If you make decisions based on realistic and achievable goals, you’ll be much more likely to stick with your plan. If you don’t have a firm plan, or if it’s not based on a realistic appraisal of your circumstances, you’re more likely to get off course and fail to meet your retirement goals. Instead, work with your financial professional to make your plan, and stick to it. By incorporating the new 401(k) plan disclosures into this plan, you’ll be better equipped to make sure your retirement plan is a success.
Alliance America is an insurance and financial services company dedicated to the art of personal financial planning. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.