How reliable are lifetime income illustrations?
by Nevin Adams, EBRIMr. Nevin is affiliated with the Employee Benefit Research Instiitute (EBRI). Reprinted with permission
Over the past several years, a growing amount of attention has been focused on the decumulations of defined contribution plan balances in retirement. Much of that focus has, of course, been driven by concerns that those individuals won’t have enough resources accumulated to fund those retirements. More recently, there has been a sense that one way to help provide a different perspective on these retirement savings would be to provide participants with an estimate of what their current or projected savings would produce in terms of a retirement income stream.
In May 2013, the U.S. Department of Labor’s Employee Benefits Security Administration (EBSA) published an advance notice of proposed rulemaking (ANPRM) focusing on lifetime income illustrations. Under that proposal, a participant’s pension benefit statement (including his or her 401(k) statement) would show his or her current account balance and an estimated lifetime income stream of payments based on that balance.
As noted in a recent EBRI Notes article[i], there appears to be little empirical evidence on the likely impact of such a lifetime income illustration on defined contribution participant behavior. In an attempt to provide some additional evidence with respect to potential defined contribution participant reaction to lifetime income illustrations similar to those proposed by EBSA, EBRI included a series of questions in the 2014 Retirement Confidence Survey that would provide monthly income illustrations similar in many respects to those provided by the EBSA’s online Lifetime Income Calculator.
Projections and critical assumptions
Of course, any such projection is necessarily required to make a number of critical assumptions—including future contribution activity, future rates of return, future asset allocation, and future annuity purchase prices. Moreover, the estimates we provided were different in several aspects, notably:
- Rather than using normal retirement age for the calculation, we asked their expected retirement age.
- Since the age of the spouse was not known for married respondents, only the single life annuity income illustration was used.
- Given that the information was being provided to the respondent during a phone interview, only the projected monthly income (based on the projected account balance given the respondents’ reporting of their current balances) was provided.
What we found was that fewer than 1 in 10 (8 percent) of the defined contribution participants said the monthly amount was much less than expected, though another 1 in 5 (19 percent) said it was somewhat less than expected[ii]. However, more than half (58 percent) thought that the illustrated monthly income was in line with their expectations.
Considering those results, it is perhaps not surprising that the vast majority (81 percent) of the respondents indicated that they would continue to contribute what they do now after hearing the projected monthly income amount, while 17 percent replied that hearing this information would lead them to increase the amount they are contributing. Similarly, the vast majority (89 percent) did not believe this information would impact their expected retirement age.
They may not have been much surprised by the results, but the vast majority of respondents said the retirement income projection was useful; more than 1 in 3 (36 percent) respondents thought that it was very useful to hear an estimate of the monthly retirement income they might expect from their plan, and another 49 percent thought it was somewhat useful. Moreover, the utility of the projection appeared to transcend the results; 90 percent of those whose illustrated values were lower than expected found the estimates somewhat or very useful, and nearly as many (86 percent) of those whose values were equal to what they expected also found the estimates somewhat or very useful. Even among those who felt the values were higher than expected, 79 percent found the estimates somewhat or very useful.
I’ve heard from several in the industry since the results were released who were surprised – that the survey respondents weren’t surprised. It is, of course, possible (as the article explains) that these respondents’ current participation in employment-based plans has already provided them the education and information necessary for an appreciation both of the projected total and the monthly income estimate, and thus a greater alignment of those projections with their expectations. It could also be that, having given some thought to the subject of savings and retirement over the course of the interview, they had more realistic expectations.
Of course, whether those expectations about living on those amounts in retirement will turn out to be realistic remains to be seen.
[i] The EBRI March 2014 Notes article, “How Would Defined Contribution Participants React to Lifetime Income Illustrations? Evidence from the 2014 Retirement Confidence Survey,” is available online here.
[ii] There were some interesting differences by income level; combining the “much less” and “somewhat less” categories, we found that 42 percent of those in the lowest quartile for illustrated monthly income indicated that the value was less than expected, versus only 9 percent of the highest quartile.