Before too long, you should be seeing something new on your 401(k) statement: a retirement income number that tells you how much your balance would yield in lifetime income from an annuity. But where does this number come from, and should you trust it? 

The SECURE Act and Annuities

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in late 2019, included a number of provisions to help boost retirement savings. For example, it raised the age to begin taking required minimum distributions (RMDs) and made it easier for small businesses to set up retirement plans for employees. 

The SECURE Act also made it easier for retirement plan sponsors to offer annuities in 401(k) plans. Although annuities can serve a purpose, they can also be overly complex and carry excessive fees. Though the lure of lifetime retirement income can be tempting, especially in down markets, annuities may not offer the same long-term returns that diversified investment portfolios will.

The new law requires that plan participants receive a projection on what their 401(k) balance would yield in monthly “retirement income” or “lifetime income” if converted to an annuity. This projection will have to be disclosed at least once per year, and the Department of Labor (DOL) has until December 2020 to finalize how the number is calculated. 

While getting a sense of what your income might be can provide peace of mind about your retirement savings in general, there’s the potential that this projection will be misleading, so take it with a grain of salt.

Eyeing Lifetime Income Projects with Caution

A lifetime income projection from an annuity may look appealing. However, its usefulness comes down to the inputs used to reach that very important number, which you would use in deciding between buying the annuity or drawing down your retirement portfolio.

The risk is that this lifetime income number could end up being a sales tactic for annuity offerings. For example, this Barron’s article cites criticism over how one insurer was arriving at its calculations. 

From inflation projections to investment return assumptions, even small tweaks to such inputs can yield significant differences in projected lifetime income and how that compares with drawdowns from retirement accounts over time.  

“While the devil will be in the details of what DOL requires in such disclosures, they will likely be telling participants the amount of lifetime income that they could achieve in a somewhat fictitious, perfect world,” said John Lowell, an Atlanta-based actuary and advisor with October Three Consulting, in an article from the Society for Human Resource Management.

Putting Retirement Income Projections in Context 

Rather than considering only the retirement income projections that plan sponsors must include as part of the SECURE Act, you should consider comparing this annuity-based projection against other retirement planning calculations.  

For example, some 401(k) participants have access to calculators through their plan administrators. You can use such calculators to adjust variables like the retirement savings rate and annual investment return to get a sense of your projected portfolio income in retirement. 

At the least, you could estimate your overall balance at the time you retire based on current savings rates and determine how you would draw down the balance so that it sustains you over time. You can then compare this number against the annuity lifetime income projection. 

Also make sure to read the annuity’s terms carefully before purchasing one. Lifetime income can provide a sense of security that is especially attractive in volatile markets where portfolio values fall. But annuities can lock you in a lower rate of return than you would receive on a long-term, diversified investment portfolio. You should also make sure you understand the fees and any potential penalties associated with the annuity.

Consider Talking with a Financial Advisor

Retirement planning is complicated, and comparing an annuity against a portfolio adds another layer of nuance. You might consider discussing your options with a financial advisor to help determine the optimal solution for your situation. Our Plantation, FL financial planning firm considers our clients’ options as part of our comprehensive retirement planning, and we recommend that you work with a fee-only, fiduciary advisor to make sure you get advice in your best interest. 

Schedule a complimentary consultation with a fee-only financial planner to discuss your personal situation in more detail.

This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.