On August 18, 2020, the Department of Labor issued an interim final rule (IFR) regarding calculation and disclosure of the Lifetime Income Stream Equivalent (LISE) amounts of current account balances for participants in 401(k) and other qualified defined contribution plans. Subsequent to the release of the IFR, there has been significant attention in the financial press regarding the proposed rules and the assumptions specified by the DOL (on an interim basis) for converting (or translating) defined contribution plan account balances into LISE amounts. This post will not repeat the new rules set forth in the IFR and discussed in the many published articles, but will instead focus on what we perceive to be the significant guidance shortcomings, particularly the requirement to disclose fixed dollar (non-inflation indexed) lifetime annuity payments rather than inflation-adjusted payments.
Since the Actuarial Approach we advocate involves converting assets of all types into real dollar (inflation-indexed) lifetime income for retirement budgeting purposes, we were, of course, interested in what assumptions the DOL would specify for their calculations. See our post of May 29, 2020 for our recommendations regarding DOL guidance regarding LISE calculation and disclosure, including:
- Modifying the current DOL Life Income Calculator to make it more robust,
- Directing participants in the model disclosure to the more robust DOL calculator so they can model alternative assumptions, and
- Expressing LISE amounts in inflation-indexed (real dollar) lifetime payments so they could be added without adjustment to anticipated Social Security benefits.
Somewhat disappointing to us, the DOL interim final rule contains none of the above items.
Since there was no mention of directing participants to a DOL website to help them model alternative assumptions in the SECURE Act, we can only assume that the DOL IFR drafters believed they did not have the authority to require it. This is unfortunate because the disclosure specified in the IFR provides only limited financial planning guidance, and plan participants could significantly benefit from being able to model alternative assumptions.
The DOL drafters did, however, address their decision to require disclosure of fixed (non-inflation adjusted) LISEs rather than inflation-adjusted LISEs. We will discuss their rationale in the next section.
Rationale for fixed dollar LISEs
On page 19 of the IFR, the DOL drafters argued for fixed (non-inflation indexed) LISE’s by saying
- “many other commenters cautioned the Department against adopting complex methodologies for what should be a simple hypothetical illustration. These commenters asserted that many plan participants do not properly understand the concept of inflation, and that an inflation-adjusted income illustration (with a resulting lower starting income amount) would add unnecessary complexity and potentially confuse participants,” and
- Further, the lower starting income amount might discourage participants from saving, according to some commenters.
Instead, the DOL drafters decided to include the following language in the model disclosure:
“Unlike Social Security payments, the estimated monthly payments in this statement do not increase each year with a cost-of-living adjustment. Therefore, as prices increase over time, the fixed monthly payments will buy fewer goods and services.”
We find these arguments for disclosing fixed dollar LISEs largely unpersuasive. We believe inflation-indexed lifetime annuity payments to be no more difficult to understand than fixed dollar amounts. Further, the stated benefits of the guidance (on page 52) are:
“The Department anticipates that the IFR will provide two primary benefits to participants: (1) strengthening retirement security by encouraging those currently contributing too little to increase their plan contributions, and (2) saving some participants’ time in understanding how prepared (or unprepared) they are for retirement by making lifetime income information readily available.”
In our opinion, the guidance requiring fixed dollar LISEs appears to be in direct conflict with these two stated benefits.
Summary
As currently drafted, we question whether the benefits of LISE disclosure anticipated by the DOL drafters are worth the costs (which will generally be borne by plan participants). Internet websites that provide up-to-date fixed dollar life annuity quotes at age 67 (and other ages) are currently available (e.g., Immediateannuities.com), and many plan sponsors already provide more robust planning information than anticipated under the IFR.
We think it is a shame that the IFR drafters did not require a reference in the model language directing participants to the DOL lifetime income calculation website. It should be noted that directing participants to the DOL website is already currently required under Section 105 of ERISA for individual account plans in order to obtain “sources of information on individual investing and diversification.” As suggested in our May 29, 2020 post, we believe our ALRIE workbook is a fine example of a more robust tool for the purpose of converting defined contribution account balances into real lifetime income.
Finally, we believe participants can better plan their retirements if provided with LISEs that use best-estimate assumptions to recognize the likely effect of future inflation, rather than being cautioned that unlike Social Security payments, future price increases will cause fixed LISE payments to “buy fewer goods and services.”
