Will you outlive your 401(k)? New rules calculating lifetime income have some flaws.
You probably have money saved up for retirement in a 401(k) plan, but do you have any idea how long that money will last? Or how much it would provide each month in retirement? Probably not — until now.
A new federal rule for 401(k) plans says the statements employees receive will need to say how the money in their accounts would translate into monthly income when the employee is 67 (presumably in retirement). Individual retirement account (IRA) managers don’t have to do this.
When you’ll see 401(k) lifetime income illustrations
The rule — part of the 2019 Secure Act retirement savings law — takes effect this fall. Some employers plan to make 401(k) statements with lifetime income illustrations available this summer; a few 401(k) record-keepers and plan sponsors like TIAA have already been providing these kinds of retirement income illustrations on their own.
“I think [the new rule is] a good attempt to give people an idea” what their 401(k) might mean as monthly income, Terry Savage, a personal finance journalist and author, said in a recent episode of the Friends Talk Money podcast I co-host with Pam Krueger and her. You can listen to the episode wherever you get podcasts.
It’s quite possible, however, that the new projections sent to employees will disappoint them.
A 401(k) with $125,000 in it would translate to about just $500 or $600 in monthly income with these new illustrations. Already, 37% of workers are worried about outliving their savings and investments, according to the recent Transamerica Center for Retirement Studies survey, “Emerging From the COVID-19 Pandemic: The Retirement Outlook of the Workforce.”
Flaws in the lifetime income illustrations
There are a few big flaws worth noting in the way the new rules calculate these lifetime-income illustrations for 401(k) plans.
They assume the employee won’t be making any future 401(k) contributions between now and age 67 and that their account balance won’t grow over time with increased earnings. The illustrations also don’t consider the effect inflation may have on what 401(k) retirement income would really be worth by the time employees turn 67.
“So, the illustration may be a little bit misleading,” Savage noted. “But at least it gets people started thinking about lifetime income.”
Krueger, founder of the Wealthramp service for vetting financial advisers, also thinks the monthly-income numbers are a useful retirement planning tool.
“Illustrating how a lump sum of your 401(k) savings turns into a monthly stream of income for the rest of your life feels like it’s going to take a lot of the mystery out of it. Great attempt, and it’s coming from the right place,” she said.
A caution from an expert
But, Krueger noted, she spoke to a respected thought leader in the 401(k) and financial education world, who offered a caution.
“He told me that the 401(k) providers can show the employees numbers that might be in the ballpark, but they will tend to have a bias toward being way too conservative,” she said.
In other words, the monthly income figures will be lower than the amounts the 401(k) savings would likely deliver as monthly-income annuities.
Added Krueger: “It leads me to feel like it’s just a wake-up call to not rely too heavily on this number that you’re going to see on your statement.”
Converting 401(k)s into monthly annuities
These lifetime-income illustrations are coming out at the same time more employers are starting to let employees convert their 401(k)s into monthly income in retirement.
According to The Wall Street Journal, more than 80% of employers now offer retirement income options, up from 50% in 2018, because a 2020 law made it easier for employers to offer annuities as retirement options for employees with 401(k)s.
It’s usually best to not convert all of your 401(k) into monthly income, though. That’s because when you annuitize, you lock in a set amount of money each month, but inflation could mean you’d want — or need — more money in the future just to keep up with rising costs.
Krueger advises employees nearing retirement to meet with a fiduciary financial adviser for unbiased guidance if they are considering annuitizing some of their 401(k)s.
One annuity worth a look: a QLAC
Savage suggested that if your 401(k) offers Qualified Longevity Annuity Contracts, or QLACs, you should look into putting some of your plan’s retirement savings into them.
With a QLAC, Savage explained, “you take a portion of your money and say, ‘I want to buy this now at age 65 but don’t start paying me until I’m 75.”
By doing so, you’ll get much larger monthly checks when they money starts arriving than if you took some of your 401(k) as annuity immediately upon retirement.
Congress considers further changes
More changes may be coming. The House of Representatives recently passed legislation known as Secure 2.0 with big bipartisan support; it is now before the Senate. If signed into law, it would automatically enroll employees in 401(k)s if their employers offer them. Data show that contribution rates are much higher when the plans have auto-enrollment.
The Secure 2.0 legislation would also raise the amount that people 62 to 64 years old could put into 401(k) plans each year. Currently, people over 50 are allowed to make what are known as annual “catch-up” contributions of up to $6,500 more than the normal limit; Secure 2.0 would let people 62 to 64 put in up to an extra $10,000 a year in catch-up contributions, if they can afford to do so.
“I hope it has enough support to pass,” said Savage.
Richard Eisenberg is the former Senior Web Editor of the Money & Security and Work & Purpose channels of Next Avenue and former Managing Editor for the site. He is the author of “How to Avoid a Mid-Life Financial Crisis” and has been a personal finance editor at Money, Yahoo, Good Housekeeping, and CBS MoneyWatch.
This article is reprinted by permission from NextAvenue.org, © 2022 Twin Cities Public Television, Inc. All rights reserved.
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