Fat City – or Not Quite Ready?

We want to subtitle this one: We’re from the DOL and we’re here to help.

Let’s face it – “Lifetime Income Disclosures” does not a sexy title make. But the DOL’s new rule is important. We never want the perfect to be the enemy of the good. David Morse, Partner with law firm K&L Gates helps us think through the strengths and weaknesses of what retirement savers will see when they get their first disclosures. Along the way he talks about universal workplace savings, retirement savings “lost and found”, and his mother ❤. Read on!

David Morse, we are so excited to talk to you today. We’re going to start by asking you a little bit about yourself.

Certainly! I'm an employee benefits lawyer with the New York office of K&L Gates. I've been doing employee benefits work, I have to say it, for the last 40 years. Recently I've taken a keen interest in savings and participant behavior and the fact that so many people don't save money. Folks are looking for solutions to make it very easy for people to do the right thing, to nudge them to save.

As part of that interest I've worked with the states of Oregon, California, Illinois, Maryland, and a number of others who have set up or are trying to set up Auto IRA programs. I've also worked with private sector clients. I am really encouraging them to use automatic enrollment in their 401(k) plans and to be very aggressive about how much people contribute and in choosing reasonable prudent investments and keeping fees low.

You recently wrote about lifetime income and the new SECURE Act lifetime income disclosures.

Just about every economist and financial expert says that nearly everyone when they go to retire should crack their nest egg by buying an annuity. I used the A word, sorry. But nobody does it. Even when I've had clients whose plans offer an annuity within their 401(k)s, no one takes the annuity. It's what one economist called “the annuity puzzle”. I mean, people are not willing to fork over a big chunk of money in exchange for seemingly small lifetime payments. They're just wired not to do it.

Read here: Annuities — the broccoli of lifetime income.

Can we tell a personal lifetime income story?

OK, just between us -- I told my mother once that she should buy an annuity and I thought she was going to hit me. I'm an only child. So, you know, I’d be the only one who would have been hurt if she had died early. And she was ready to smack me.

She was not ready.

She was never ready and she would never have done it.

So this part of the new SECURE Act is trying to move the needle a little bit to get people to think about their pile of money in terms of what they could get for lifetime income. Under this new disclosure rule taking effect in 2021, every defined contribution plan participant is going to get at least an annual statement showing how much money they could expect in lifetime payments, if they took their current 401(k) balance and converted it into an annuity.

Interesting – how does this work?

The way the calculation is done, there are a number of assumptions that the Department of Labor (DOL) requires a plan sponsor to make.

One: you're going to assume that the person is 67 years old, which is the Social Security normal retirement age, when they take the money. Two: the DOL tells plan sponsors what interest rate and what mortality table to use. Three: the DOL’s calculation assumes you have a hypothetical spouse, whether or not you're married, who is exactly the same age as you and who will take a survivor annuity at age 67. So the calculation assumes you and your identical spouse will begin a joint and survivor annuity when you both turn age 67.

OK, and?

A couple of things that the DOL’s calculation doesn't do. First, it doesn't assume that your retirement account balance is going to continue to grow until you're 67. They just ignore that because it was too complicated to draft assumptions for too many varied situations. The calculation also doesn't do anything with inflation. So under this calculation a 30-year-old and a 50-year-old with the same size 401(k) balance will get statements saying they're going to be entitled to identical amounts per month for the rest of their lives.

That's a bit confusing and doesn’t reflect the growth of accounts over time. But the hope is that they're going to get people to start thinking of their balance as something to provide a level of replacement income.

What do you know about the results of the standard calculation?

With the help of a very friendly actuary and insurance broker, I tried to test the DOL’s assumptions. I had the actuary calculate how much lifetime income the DOL disclosure would estimate for someone with a $100,000 account balance. And then I asked the broker to tell me how much annuity I could actually buy. I also went on the web to test an independent annuity purchase.

Surprisingly, the DOL’s lifetime income estimate was conservative. I could actually get a better deal on the open market than the DOL estimated. That’s better than having it work the other way.

We know there are some parts of the lifetime income disclosure guidance you don’t like.

I think the big problem with this effort is the legal disclosure that comes with it.

With your statement and lifetime income estimate, you’ll get a chart, which is good – and then you'll get a government-written explanation of what the information means and what you're supposed to do with it. The explanation is two pages long, and it's written by lawyers and -- us lawyers are just awful in communicating with humans because we're trained to think about what could go wrong. The disclosure doesn’t use enough simple language and it's too long.

Disclosures should be written like a sports column.

I think the whole realm of financial disclosures needs to be dramatically simplified. Disclosures should be written like a sports column, very, very short and to the point. Tell people where to go if they want more information, but it's got to be simple and all the important stuff needs to be in the first paragraph.

Let’s take a moment for the good part of this new legislation: the chart and the lifetime income estimate. Why does that matter?

Think about the person with the $200,000 account balance. Let’s say that's two and a half years of pay. People tend to think: That's a ton of money. I am in fat city!

Then if you show them, Hey, actually, that's only going to provide you a small amount of income for the rest of your life, they get a dose of reality. They might say, hmm, maybe I need to save more, or maybe I need to retire later.

It’s just those two things, a reality check, and a nudge to save more. Well actually three things … maybe you get a couple of people thinking about buying annuities.

I don't think it's going to move the annuity usage needle much because people are just hardwired against annuities, but anything you can do to help people think about lifetime income is something. Until you make it really effortless for people to take lifetime income you're not going to get much take-up at all.

It sounds like you would call this a step in the right direction, but only a step.

Yes. A little teeny tiny baby step.

We like baby steps here. Switching gears – let’s talk about what happens to accounts with small balances when people leave their employers. What's the current concern?

So what happens -- and most of my clients do this -- is the law allows an employer to notify that former employee plan participant and say, Hey, do you want your money? Do you want to roll your money over to an IRA? What do you want us to do with it? It turns out that a huge number of former employees do not respond to this question.

If the employee doesn't respond and the balance doesn’t exceed $5,000, the employer can set up an IRA in the name of that plan participant and roll the funds out of the company’s 401(k) plan into the IRA. Under DOL guidance, they have to invest that person’s money in essentially a money market account.

As we all know, money markets are paying effectively zero. That IRA is going to start shrinking every year as it earns less than the cost to maintain itself. It just has to. And don't forget, we're already talking about account owners who were not paying attention. So that person probably is going to continue not paying attention. Over time that that IRA will evaporate.

Nobody wants that.

Agreed. There are some fintech solutions people are promoting. I've worked with a company called Capitalize, where they're trying to make it easier for folks to find their “old” 401(k)s and employer-sponsored accounts, and aggregate them into one IRA, invested for the long-term. So that's one part of a solution. (Editor’s note, Retirement Clearinghouse is another company working in this space).

There's also been proposed legislation about this, and I really hope in the next administration that it takes off. This legislation would create what's being called a “retirement savings lost and found”. This is important because there's all this money -- not only in the IRAs we just talked about, but at employers in accounts that are above the $5,000 small account threshold but the individual no longer works for that company. People just forget about these accounts. Often after a while employers can't find the participant either. There’s a real risk that these assets will be lost to the person who saved them in the first place.

We feel pain just talking about it.

It’s not good. I just spent an hour on a conference call with a client related to lost accountholders. This was a large plan sponsor who is going through the list of people they can't find that are entitled to a benefit. They're paying money to try to find them and some people have just disappeared.

It would be so wonderful if employers could just send this money to the Feds, say the PBGC, and participants could just call 1-800-PBGC and say, here's my Social Security number, where's my money?

And your money would be there protected in some sort of IRA, well-invested, with very little fees. We would avoid this lost and wasted retirement money. To me that is low hanging fruit.

David, what else haven’t we asked that’s important to you in this retirement space?

There's the whole idea of universal workplace savings that you have written about and promoted a lot. Clearly, extending coverage is key. Give people a chance to save and make it easy for them to do the right thing.

Final question. Any pandemic silver linings?

Silver lining? Mostly it's been difficult. When the government basically shut down New York, I did escape with my three adult children and my son-in-law and two cats to a house in Vermont. We spent quite a rather long period there, and lots of time together getting to know each other as adults. We had a few friendly tussles over who got the bandwidth as we were all working! But my wife and I really got to know our adult kids better and that was a very nice silver lining.

That's awesome. We hear that a lot that family focus has been a big plus for people in a really tough time.

I vote for ending the pandemic.

Well let's hope that someone comes around and vaccinates us all very soon.

From your mouth to God's ears.

Thank you David Morse! David can be reached at david.more@klgates.com.  You can read his “from the editor” Benefit Law Journal columns by accessing his bio on the K&L website or at LinkedIn.

This piece was featured in the December 3, 2020 edition of Retirement Security Matters. For more fresh thinking on retirement savings innovation, check out the newsletter here.