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How much income will your 401(k) provide?

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Retirement account owners have long had trouble translating the money in their 401(k) into income.

That’s about to change.

Later this year, possibly in the third quarter, plan sponsors will be required to include two lifetime income illustrations on participants’ pension benefit statement at least once annually. In essence, the illustrations show how much income a participant’s account balance would produce in today’s dollars if used to purchase either a single life annuity or a qualified joint and 100% survivor annuity.

And some are praising the new rule, despite the shortcomings to the Labor Department’s interim final rule, which was required as part of The Setting Every Community up for Retirement Enhancement (SECURE) Act.

The final rule, when it goes into effect, should help those saving for retirement not only better understand how much income they will receive from their 401(k), but it will also give folks a fairly good idea if all their sources of income in retirement — Social Security and defined-benefit plans, for instance — will be enough to meet their expected expenses in retirement.

On paper, it all sounds great.

The defined contribution industry, in general, is in favor of the idea of lifetime income illustrations, said Drew Carrington, a senior vice president and head of institutional defined contribution at Franklin Templeton Investments.

“It helps frame the savings and 401(k) plans in sort of the appropriate terms,” he said. “This (the 401(k)) is here to provide income when you’re in retirement. And this is a way to start communicating about your 401(k) balance in those terms, as opposed to more wealth-oriented terms. So, we think that’s all really good. Anything that helps start the process of getting people to think about their retirement accounts as retirement accounts is a positive step.”

Others have a similar point of view. It helps “workers focus on the future and amount of income they may have for retirement, rather than on their account balance today or projected for the future,” said Stacy Schaus, the CEO and founder of the Schaus Group. “The right steps are being taken to improve retirement security.”

Social Security, by way of background, provides would-be beneficiaries an estimate of monthly income at various claiming ages in today’s dollars. The same goes for defined-benefit plans. Participants generally have a sense of how much monthly income they can expect to receive, in the form of an annuity, from their pension plan.  

IRA and 401(k) account owners have always had the ability to translate how much income they could expect to receive from their 401(k), it just required them to do some math, and you wouldn’t want to plan the rest of your life based on those calculations.

Multiplying the account balance in your 401(k) and/or IRA by 4% was and is the simplest way to do that. So, for instance, if you had $1 million in your retirement account you could expect that to generate $40,000 a year in today’s dollars.

This, of course, is a very simplistic example. It doesn’t really take into account contributions, investment returns, date of retirement, inflation rates, and so on. But it is a rough-cut way to determine how much income your retirement accounts would generate.

And now the Labor Department wants to make that calculation even easier, though it plans to use different math. As the rule is currently proposed, plan administrators would show participants how much income they could expect from their ERISA-governed retirement account first, as a single life annuity; and second, as a qualified joint and survivor annuity that factors in a survivor benefit.

These monthly income illustrations would use prescribed assumptions such as the participant’s marital status and assumed age at the start of the annuity, the Labor Department noted in its fact sheet.

Current account balance

$125,000

Single life annuity

$645 a month for life, assuming Participant X is age 67 on Dec. 31, 2022

Qualified joint and 100% annuity

$533 a month for participant’s life, and $533 for the life of spouse following participant’s death, assuming Participant X and her hypothetical spouse are age 67 on Dec. 31, 2022.

According to the Labor Department, the interim final rule “requires various explanations about the estimated lifetime income payments that plan administrators must provide to participants. These explanations will help participants understand, among other things, how the plan administrator calculated the estimated monthly payments and, importantly, that these estimates are illustrative only and are not guarantees.”

What’s more, the Labor Department cites two benefits to its lifetime income illustration rule: One, it will encourage those currently contributing too little to increase their plan contributions, and two, it should help participants learn how prepared or unprepared they are for retirement.

But while it’s a good start, it’s not perfect. There are limitations that plan participants need to consider. What’s more, the lifetime income illustrations might even be inferior to some of the existing tools that plan sponsors are already providing plan participants.

Read Opinion: DOL punts on SECURE Act lifetime income illustrations.

So, what are some of the limitations?

Well, the interim rule doesn’t include future contributions, future earnings, or the account’s performance growth. In other words, it’s not necessarily a realistic projection. It’s a static number.

In fact, plan administrators must assume that a participant is age 67 on the assumed commencement, which is the Social Security full retirement age for most workers, or the participant’s actual age, if older than 67, and they are retiring with their current balance. “There’s not a lot of flexibility around the standardized illustration,” said Carrington.

And that could be problematic, especially for those still saving for retirement. By making no assumptions about future savings or the future value of an account it might in fact discourage plan participants from saving more if they view the amount of income their current balance produces as incredibly low, according to Carrington.

It also means that when you switch employers the illustrations you get will reflect only the savings in your new employer’s 401(k).

The proposed rule also assumes that a plan participant would immediately start drawing down their 401(k) balance at age 67 using an annuity. Again, this doesn’t quite reflect reality. Some people retire at 67, some before and some after. Some start drawing down their retirement accounts when they retire while others don’t. And most plan participants hardly ever purchase an annuity to generate income retirement.

What’s more, a retiree hardly ever has 100% of their assets in any one investment. So, using a lifetime income illustration tool that uses only an annuity doesn’t reflect reality either. “The likely optimal answer for most folks is some sort of partial allocation to annuities, not a 100% allocation nor a 0% allocation,” said Carrington.

The methodology for the calculation may be concerning as it may overstate or understate what future income the individual may have and also may not appropriately account for inflation, Schnaus said.

And those limitations have plan sponsors working overtime to make sure the sophisticated interactive lifetime income tools they already provide (or plan to provide) to plan participants are viewed as educational in nature and not viewed as fiduciary advice.

Those tools, among other things, let a plan participant play what-ifs with savings rates, retirement dates, investment returns, and the like. Some even let plan participants incorporate accounts outside of their 401(k) — IRAs, Roths, taxable accounts, a spouse’s retirement accounts — into the plan sponsor’s retirement income illustration tool, said Carrington.

“People get a much richer picture,” he said.

A richer — no pun intended — is certainly what those saving for retirement deserve.

But that picture may have to wait for the next version of the SECURE Act, which experts like Jack Towarnicky, a researcher with the American Retirement Association and author of Discordant Disclosures, say could allow for other “disclosure options,” and improve upon what is a good, but really only a good enough start.



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‘Greed is rearing its ugly head and killing brotherly love’: My husband and his brother are at war over an inheritance from a beloved neighbor. What can we do?

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Dear Quentin,

When my husband and his only (younger) brother were growing up, a childless neighbor was very kind to them and treated them as if they were her “nephews.” They even called her “Aunt Hilda.” They also treated her like family; my husband has visited her regularly over the years. But greed is rearing its ugly head and killing brotherly love.

When my husband was away in the army 30 years ago, Aunt Hilda gave a house and a piece of property to my husband’s brother when she decided to move to another state to care for her future mother-in-law, with the written legal condition that she had a lifelong ability to return and live in the house as well, should she want to or need to.

The brother decided he didn’t really like those terms, and after living in the house for a couple of years, used the “collateral” of the property to borrow money to buy a plot of land elsewhere and build another house. The “old” house has sat vacant for 20 years, but he does the minimum to keep it from disaster. She does not stay there because it is not maintained. He has stated that he doesn’t want to do anything that will encourage her to move back into the house.


‘At first, she discussed splitting her property 50/50, then she recalled that she had already given the brother the other house and land.’

Recently, the husband of Aunt Hilda died. She is 80, and decided that she wants to write a will to leave her money and property to my husband and his brother. At first, she discussed splitting her property 50/50, then she recalled that she had already given the brother the other house and land (current value is about $400,000, no small sum).

Now Aunt Hilda says since she has already given the younger brother the other house and the land, that should be taken into consideration. The brother is sending lengthy emails to my husband trying to convince him and Aunt Hilda that the previous “early inheritance” should not be taken into consideration “because it cost him so much trouble and work.”

It is of course up to Aunt Hilda how she wants to divide up the property, and whatever that is, everybody should respect her wishes. But if she asks the brothers how to do it fairly, what do you recommend? She is 80, but she might live another 15 years and any value assigned to the brother’s house today would likely change.

There is much more that could be added as to my brother-in law’s attempts to gain more than his brother, none of which reflects well on his character. My poor husband is heartsick over his brother’s greedy behavior, especially when he should be focusing on the welfare of Aunt Hilda — who just lost her husband — and grateful that she considers to leave them anything.

Should we intervene?

The Wife

Dear Wife,

Your brother-in-law is a lot of work and his inherited property is a lot of work. In that sense at least, as God made them, he matched them.

Your brother-in-law could be less self-centered and more compassionate, and it wouldn’t do any harm if he had one charitable bone in his body. But that is not who he is, and trying to wish him to be someone other than himself is an exhausting and ill-advised endeavor. Accept him for who and what he is, and you will both enjoy more peaceful nights as a result.


Remember, if one crazy person wants to have a fight with you, and you finally relent, there are two crazy people in that fight rather than one.

Your husband regards Aunt Hilda as a beloved relative and her estate as a gift, while his brother sees her estate as a lemon that can be squeezed time and again. What would I say to his brother? “The property required a lot of work over the years, and you have benefited from the property over the same amount of time. You chose to accept this inheritance early, and it has worked out very well for you.”

If he continued to make waves? I would feel compelled to tell him that it’s just plain unreasonable to constantly push for more. The love and care he lavished on his own property has been in direct proportion to the lack of care and duty bestowed upon Aunt Hilda’s home, and for all the years he enjoyed this property, she did not. You have to be prepared to stand up for what you believe is fair.

And remember, if one crazy person wants to have a fight with you, and you relent, there will be two crazy people in that fight rather than one. For that reason, advise Aunt Hilda to hire an estate attorney to draw up the papers fairly and squarely. Lawyers are paid well to deal with difficult personalities, and they have a duty to make sure their client’s wishes are upheld.

You can email The Moneyist with any financial and ethical questions related to coronavirus at qfottrell@marketwatch.com

The Moneyist: ‘Warren Buffett and Harry Potter couldn’t get those two retired early’: Our spendthrift neighbors said our adviser was ‘lousy.’ So how come WE retired early?

Hello there, MarketWatchers. Check out the Moneyist private Facebook
FB,
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 group where we look for answers to life’s thorniest money issues. Readers write in to me with all sorts of dilemmas. Post your questions, tell me what you want to know more about, or weigh in on the latest Moneyist columns.



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Opinion: Higher interest rates could mean more cash for seniors

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Here’s a common complaint I hear from seniors all the time: Interest rates are so low that it’s impossible to earn enough cash to supplement Social Security.

“Certificates of deposit don’t earn anything,” writes MarketWatch reader Camille: “Until the mid-2000s, you could easily earn 4% on a certificate of deposit (CD). Today, your money does not earn anything, which penalizes small savers and seniors.”

She’s right. Based on rates as I write this, if you put $500 into a one-year CD, you’d get back about $502.76 in 12 months. Wow! Two whole dollars and 76 cents! Probably enough for a loaf of bread or a gallon of gas, but not much else.

Low interest rates are a double-edged sword. If you’re borrowing money, it’s obviously good, but if you’re trying to make a few bucks, no. And this isn’t likely to change in any significant way, given the Federal Reserve’s recent announcement that it plans to keep its key “Fed Funds” rate low until the economy and jobs market picks up steam.

Since things like money-market funds and certificates of deposits are tied to the Fed, that’s tough news for anyone hoping to squeeze more out of their savings.

Meantime, those paltry returns stand in contrast to things that keep shooting up, like the cost of healthcare. I recently reported that drug prices, for example, are rising much faster than inflation, and much faster than the cost-of-living adjustment that seniors typically get from Social Security.

This one-two punch—more money going out and less coming in—is punishing seniors, pushing many closer to, if not into, poverty.

The need to earn more has nudged some seniors into the stock market, which in and of itself isn’t necessarily bad; financial advisers typically say that given the possibility of decades in retirement, even seniors should have some exposure to equities. But with stocks at nosebleed levels—the price-to-earnings ratio on the S&P 500
SPX,
+1.14%

 is up 80% from a year ago—caution abounds. As usual, I’ll emphasize that how much a retiree should have in stocks depends on factors like age, risk tolerance and so forth, and is best discussed with a trusted financial adviser.

It’s often tempting when rates are super low like now to put cash into things with fat dividends, but “you have to be very careful,” cautions Andrew Mies, chief investment officer of 6 Meridian, a Wichita, Kansas-based wealth management firm. “Saying I’m going to go buy a high dividend-paying stock or MLP (master limited partnership, an investment vehicle common in capital-intensive businesses, like the energy sector) were disasters in 2020. Buying high-dividend stocks was one of the worst performing strategies you could have had last year, and some MLPs were down 30-40%.”

In other words, what’s the use of buying something that pays a dividend of 8%, 9% or more—only to see the stock itself plunge by a third? One market strategist, the late Barton Biggs of Morgan Stanley, once said “More money has been lost reaching for yield than at the point of a gun,” and he was right. Echoing that is none other than Warren Buffett, who has called reaching for yield “stupid,” but “very human.”

So what to do?

Mies urges something that many people have trouble with: Patience. That’s because rates, all of a sudden, appear to be moving higher, and if you can wait a bit, you just might be able to find safer investments that yield more than you might be able to get now.

He’s right. As of Friday, the yield on the 10-year Treasury bond stood at 1.34%, hardly robust, but up from 1.15% for the week. Two things to remember here: When bond rates go up, bond prices go down; higher bond yields can also make stocks less attractive on a relative basis as well.

Mies thinks rates will continue to climb. “I think you’re going to have a chance in the next 12 months to put money to work at higher interest rates.” Buying or selling are choices, but so is doing nothing, so “I do think that not getting aggressive right now is probably the most prudent action.”

And after rates go high enough, he thinks municipal bonds could become more attractive, corporate bonds could, Treasurys could. “There will be pockets of opportunity that pop up.”

You may want to consider what have long been considered so-called “widow and orphan” stocks: utilities. “Utilities have been trading as if the 10-year (Treasury) is significantly higher than it is. That could be a spot worth dipping your toe in.” Possibilities to consider—preferably in consultation with your financial adviser—include the Standard & Poor’s Utilities Select Sector Fund
XLU,
-1.17%

and iShares’ Global Utilities ETF
JXI,
-0.54%
.
XLU currently yields 3.3%, while JXI yields 2.78%, certainly more than those measly rates found in CDs or money-market funds.



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Opinion: Few 401(k) participants changed portfolio allocation when market tanked

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The rumor has been that 401(k) participants took little action when the stock market declined by more than 30% in February and March 2020. A Morningstar study provides some numbers to back up the lore.

The data come from a major record-keeper for defined-contribution plans. The starting point was snapshots for two dates: Dec. 31, 2019 and March 31, 2020. To be included in the analysis, the participant had to show up in both samples. That is, they had to be enrolled on or before Dec. 31, 2019 and still in the plan March 31, 2020. This construct ensures that observed changes reflect active decisions by participants as opposed to the sponsor replacing one fund with another. The final sample consisted of 635,116 participants across 509 plans.

The important finding is that only 5.6% of participants enrolled as of Dec. 31, 2019 changed their portfolio allocation during the first quarter of 2020. Participants who adjusted their portfolios changed their equity allocations. Most of these changes were relatively small, with an average equity reduction of about 10 percentage points. However, older participants who changed their accounts made larger changes than younger participants, particularly if they were invested more aggressively.

Much of the report goes on to look closely at the 5.6% who did move their money. For this exercise, the report identifies four types of participants: self-directing their accounts, using a target-date fund, defaulted into a managed account, and opted into a managed account. The pattern across participants shows that those with professionally managed solutions — target-date funds or managed accounts — were much less likely to change their allocation.

On balance, this report seems like good news. Buying high and selling low doesn’t end well.



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