On May 8, the Department of Labor (DOL) published proposed rules for modifying DC plan participants' annual benefit statements. In addition to showing benefit accruals, the rule could require an estimate of the "lifetime stream of payments" in retirement. The proposed rule and related information are at www.dol.gov/ebsa.
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| The Department of Labor's Lifetime Income Calculator. |
DOL is going down this road because it believes "participants may have difficulty envisioning the lifetime monthly income that can be generated from an account balance." The best way to understand EBSA's methodology is to test its calculator.
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EBSA assumes (for now) that the participant's wages will increase by 3 percent per year, and the DC plan will average a 7 percent nominal annual investment return, and inflation will average 3 percent annually. For calculating the income stream, EBSA annuitizes the inflation-adjusted retirement-age balance using the 10-year constant maturity Treasury interest rate.
Unfortunately, this method is not very motivating for younger workers. Let's plug into the calculator an illustration for a 30-year-old who begins saving 10 percent of a $50,000 salary ($5,000 a year) in a 401(k) today and continues the habit at 3 percent annual salary growth for the next 35 years. The ending account balance is projected at $394,974 in today's dollars (inflation-adjusted at 3 percent). This represents a lifetime income annuity of $1,975 per month in the first year of retirement, at age 65. By the 20th year of retirement, annuity purchasing power reduces to $1,094 at 3 percent inflation.
A weakness in DOL's method: The projected lifetime annuity amount will be sensitive to changes in Treasury rates – and thus could fluctuate greatly from statement to statement. This method also overstates accumulation and income if the participant's wage growth fails to keep pace with inflation, or actual investment returns (net of fees) fall short of 7 percent.
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