United States: DOL Issues Initial Guidance Describing Proposed Lifetime Retirement Income Notices

New guidance issued by the U.S. Department of Labor (DOL) aims to help participants and beneficiaries with the "decumulation" phase of retirement planning by requiring sponsors to provide illustrations of lifetime retirement income.

As many employers have shifted from defined benefit plans to defined contribution plans such as 401(k) plans, the U.S. Department of Labor (DOL), the Internal Revenue Service (IRS) and many others have long worried that participants lack sufficient information to determine the monthly retirement income that their account balances will provide for their lifetimes. In 2010, the IRS and the DOL issued a joint Request for Information (RFI) on the use of annuities in 401(k) plans, and later held a joint hearing to receive testimony on issues such as the following:

• Specific participant concerns regarding the selection of a lifetime income option relative to other distribution options
• The potential disclosure of 401(k) account balances as monthly income streams
• A potential fiduciary safe harbor for selection of lifetime income products

In the intervening three years, DOL and IRS officials have repeatedly indicated their interest in facilitating lifetime income for defined contribution plan participants.

More recently, the DOL and IRS have begun issuing written guidance. For example, in 2012, the U.S. Department of the Treasury and the IRS released an initial package of guidance intended to remove regulatory barriers and simplify the offering of lifetime income benefits to retirees. For more information about that guidance, which focuses primarily on how the minimum distribution rules, joint and survivor rules, and disclosure rules apply to longevity annuity contracts, click here.

Then, in May 2013, the DOL issued an advance notice of proposed rulemaking (the Notice) describing lifetime income disclosure regulations that the DOL is considering issuing. According to the DOL, the proposed rules would modify the requirements governing the benefit statements issued to participants and beneficiaries in defined contribution plans. By way of background, plan administrators currently are required to notify participants and beneficiaries of the fair market value of their account balances as of the last day of the period covered by the statement. The DOL is considering modifying these rules to require plan administrators to provide the following additional information:

• The projected account balance (in current dollars) at a participant or beneficiary's normal retirement age
• An estimated lifetime income stream based upon the current account balance
• An estimated lifetime income stream based upon the projected account balance

The benefit statement also would be required to provide an understandable explanation of the assumptions used to project the account balance to normal retirement age and to convert these account balances into lifetime income streams. In addition, the benefit statement would contain a disclaimer that projections are estimates only and not guarantees. According to the DOL, the presentation of this data on a participant's or beneficiary's benefit statement might look something like this:

The new information potentially required to be disclosed is discussed in more detail below.

Projected Account Balance

For a participant or beneficiary who has not yet reached normal retirement age, the benefit statement would show the current dollar value of his or her projected account balance at normal retirement age. The projection would utilize assumptions about future contribution amounts (employer and employee), investment returns and inflation adjustments. The Notice describes the contemplated standards, rules and assumptions that a plan administrator would have to follow when projecting account balances.

• General Rule. Projections would be required to be based on "reasonable assumptions" taking into account generally accepted investment theories, and would, at a minimum, require consideration of future contributions, investment returns and inflation.
• Safe Harbor. The DOL plans to include a safe harbor prescribing a specific set of assumptions for future contributions, investment returns and inflation, the use of which would be considered per se reasonable. As proposed in the Notice, the safe harbor would assume that contributions increase at a rate of 3 percent per year, investment returns are 7 percent per year, and the inflation rate is 3 percent per year.

Estimated Lifetime Income Streams

The benefit statement would provide estimated lifetime monthly income streams based on the participant's or beneficiary's current account balance and—for a participant or beneficiary who has not reached normal retirement age—his or her projected account balance. The conversion of the projected account balance would remain in current dollars, thereby giving a participant or beneficiary an estimate of his or her buying power upon reaching retirement. The Notice assumes that the form of payment would be calculated as a single life annuity and, if the participant or beneficiary were married, a single life annuity with a 50 percent survivor's benefit.

• General Rule. Plans that offer an annuity form of distribution must use the mortality and interest rate provisions contained in the plan. Plans that do not offer an annuity form of distribution must use reasonable mortality and interest rate assumptions taking into account generally accepted actuarial principles. Note that the calculation of estimated lifetime income streams would require consideration of the following five factors: the date the payments would start; the age of the participant or beneficiary at the date the payments would start; the form of the payment; the expected mortality of the participant or beneficiary and, if applicable, his or her spouse; and the interest rate for the applicable mortality period. The Notice explained that, aside from mortality and interest rate assumptions, all of this information is available to plans.
• Safe Harbor. As proposed in the Notice, the safe harbor would prescribe a specific set of assumptions for mortality and interest rates, the use of which would be per se reasonable. The Notice describes the rationale for such assumptions.

Additional resources

In addition to the Notice, the DOL published a fact sheet on lifetime income illustrations and a lifetime income calculator.

Next Steps

Once again, the Notice merely indicates that the DOL intends to issue proposed rules on lifetime income disclosures at a later date. The DOL would need to formally issue proposed regulations, provide a public comment period and issue final regulations before lifetime income disclosure obligations would apply. The DOL is soliciting comments by July 8, 2013; more than 50 comments have been submitted to date, and one coalition of associations representing plan sponsors and service providers has already requested a 30-day extension of the deadline. The DOL has asked for comments on a variety of issues, including the following:

• Whether it makes sense for a benefit statement to include all of the additional information described above
• Whether normal retirement age is the appropriate age to use in making projections
• Whether other variables should be utilized in projecting account balances and calculating lifetime income streams
• Whether the safe harbor assumptions described above are reasonable
• Whether guidance from the Financial Industry Regulatory Authority is needed on the application of its communications rules to any required lifetime income disclosures
• How to factor in the in-plan annuity arrangements that are available as investment options under some plans
• Whether there are reasonable alternatives to DOL regulations that may induce plan administrators to provide participants and beneficiaries with lifetime income illustrations

To the last point, some commenters have questioned whether the authority upon which the DOL proposes to act is sufficiently broad to allow the DOL to mandate these new disclosure requirements (although the Lifetime Income Disclosure Act recently re-introduced by a bi-partisan group of lawmakers in the U.S. Senate and House of Representatives would require annual lifetime income disclosures for defined contribution plans such as 401(k) plans and would expressly provide fiduciary relief for providing such disclosures (more on that concern below)).

It may be tempting to critique the Notice as limiting the ways in which lifetime income streams could be calculated, or as creating an additional participant or beneficiary disclosure obligation for plan administrators. However, in actuality, the Notice signals a change that could be beneficial for plan administrators as well as for participants and beneficiaries.

Specifically, many larger plans already provide some tool (often through the plan's investment education/advice feature) that allows participants and beneficiaries to project lifetime income streams in order to address retirement adequacy, a business imperative for many large employers. ("Retirement adequacy" means employees have sufficient savings to support themselves in retirement. If employers cannot demonstrate to employees that they can afford to retire, employees may continue to work merely because they cannot afford to retire.) To address this concern, as noted above, some forward-thinking plan sponsors have begun to explore in-plan annuity arrangements, even in advance of DOL and IRS guidance. Having a DOL-sanctioned methodology (including safe harbors) for providing lifetime income illustrations should provide welcome protection from some of the fiduciary liability associated with educating participants and beneficiaries on the "decumulation" phase of their retirement. However, before many plan fiduciaries consider offering actual lifetime income distribution options (as opposed to lifetime income illustrations), they would like to see the DOL provide fiduciary protection for the purchase of annuities and alleviate some of the administrative challenges to offering in-plan annuities posed by the transferability and liquidity requirements of Section 404(c) of the Employee Retirement Income Security Act of 1974. (The solutions to other administrative challenges to in-plan annuities falls within the purview of the IRS rather than the DOL.)

Many participants and beneficiaries currently are simply unable to calculate the monthly retirement income that their plan account balance may buy them, and may be under the mistaken impression that they have sufficiently planned for retirement based on what they view to be their large 401(k) plan account balance. An illustration of expected lifetime income, while sobering, hopefully will go a long way towards increasing participants' savings rates. Once participants and beneficiaries become familiar with their lifetime income illustrations, they may be better able to plan for issues such as the need for longevity annuities (addressed in the IRS guidance described above) and the need to pay significant retiree medical expenses (estimated at $220,000 by one recent study).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.