Since the enactment of the Pension Protection Act of 2006, periodic benefit statements must be provided to participants and certain beneficiaries in defined contribution (DC) plans, including 401(k) plans. For DC plans offering participant-directed investment accounts (which is typically the case today), these statements must be provided quarterly. Benefit statements are not currently required to contain any information about account balance projections or the amount of current or projected monthly income an individual’s account might generate.

The trend away from defined benefit (DB) plans has resulted in greater reliance by retirees on the amounts they have accumulated in DC plans. The Department of Labor (DOL) has voiced a growing concern over the last few years that this shift leaves plan participants with inadequate retirement assets.

Last month, in an advance notice of proposed rulemaking (Notice), the DOL indicated that it was considering a new form of participant disclosure that would require DC plan sponsors to display “lifetime income” information on participant benefit statements. The DOL believes providing information about account projections and projected monthly income may lead participants to change their savings and investing behavior, that is, to view their DC plan accounts as retirement accounts that could provide a lifetime income stream rather than as savings accounts.

The New Benefit Statement – Projected Account Balance and Lifetime Income Illustrations

In the Notice, the DOL considers a proposal that would require benefit statements for all DC plans to include the following information:

  • The value of the account balance as of the last day of the period covered by the statement (i.e., “current balance”);
  • A projected account balance at normal retirement age; and
  • Two lifetime income illustrations, the first based on the participant’s current account balance and the second based on the projected account balance.

As described in the Notice, the new addition to the participant benefit statement might look something like this:

Click here to view.

The DOL indicated that when determining the projected account balance at “normal retirement age,” it is proposing to use the ERISA definition of that term, i.e., the earlier of: (A) normal retirement age under the plan or (B) the later of (i) attainment of age 65 or (ii) the fifth anniversary of the time the participant commenced participation in the plan. However, the DOL also stated that it would consider using other definitions, including the definition under the Social Security Act (which differs based on birth year).

Methodology for Projecting an Account Balance

The Notice states that for projections to be both meaningful to participants and beneficiaries, and not overly burdensome for plan administrators to perform, certain standards, rules and assumptions should be adopted. To project an account balance the following variables would be taken into account:

  • The participant’s current account balance;
  • The number of years until the participant retires;
  • Future contributions to the account (both employer and employee);
  • The rate of investment return; and
  • An inflation adjustment factor to convert the projected amount to today’s dollars.

The DOL is considering adopting a general-reasonableness standard for the assumptions with a regulatory “safe harbor.” The general-reasonableness rule would permit plan sponsors to use “generally-accepted investment theories” to provide both future contributions and investment returns to produce lifetime income amounts that are expressed in current dollars. In contrast, the safe harbor would be narrower and would prescribe the following assumptions for contributions, returns and inflation that would be per se reasonable:

  • Contributions continue to normal retirement age at the current annual dollar amount, increased at a rate of 3 percent per year.
  • Investment returns of 7 percent per year (reflects approximately 4 percent real return and 3 percent future inflation).
  • A discount rate of 3 percent per year for establishing the value of the projected account balance in today’s dollars.

Methodology for Converting an Account Balance into a Lifetime Income Stream

In determining the method for converting an account balance into a lifetime income stream, the DOL chose to use an annuitization approach and to convert the participant’s account balance into a lifetime monthly payment similar in form to a payment from a DB plan. The DOL chose this approach because the purchase of an annuity provides a level income for the life of the participant. Annuitization would also require that the regulations provide assumptions that would work for a variety of plans. A DC plan that currently offers an annuity distribution would be permitted to use the actual mortality and interest rate provisions contained in the plan’s annuity contract. However, the Notice would provide a safe-harbor approach for plans that do not offer an annuity. Such plans could use either reasonable mortality and interest-rate assumptions based on generally-accepted actuarial principles or the assumptions to be outlined in final regulations.

Disclosure of Assumptions

The Notice also provides that the benefit statement must contain a disclosure of assumptions used for the projected account balance and the illustration of the lifetime income streams in order to make it clear to participants and beneficiaries that projected amounts are not guarantees. The benefit statement must also include a statement that the lifetime income stream is only an illustration and that actual periodic payments that may be purchased at retirement will depend on numerous factors and may vary substantially from the lifetime income stream illustration in the benefit statement. As is the case with all participant communications required under ERISA, the assumption disclosures must be written in a manner calculated to be understood by the average plan participant.

Plan Sponsor Concerns

Two frequent concerns have been expressed to the DOL by the retirement plan community: (i) the expense to plan sponsors of providing uniquely personal information on the benefit statements; and (ii) litigation exposure for the plan fiduciaries from plan participants and beneficiaries where actual assets do not meet expectations based on the lifetime income disclosures.

The DOL believes these concerns are overstated. As to costs to the plan for producing the disclosures, the DOL points out that ERISA already requires pension benefit statements to include participant account information, therefore this would merely be an addition to this existing requirement. Furthermore, some plan sponsors have been providing information similar to what is required under the Notice without finding it burdensome.

The DOL believes the concern about potential lawsuits would be mitigated by the disclosure of assumptions that put participants on notice that the illustration is not a guarantee. The DOL will also consider creating a safe harbor on which plan administrators may rely when developing lifetime income illustrations for pension benefit statements.

The DOL is welcoming comments on most parts of the Notice, including an overall response to whether there is an alternative to a regulatory mandate to ensure that participants and beneficiaries will receive constructive and helpful lifetime income illustrations. Plan sponsors and other members of the retirement community can submit comments by July 8, 2013.