Introduction
The U.S. Department of Labor (“DOL”) on August 18, 2020, issued an interim final regulation (the “Regulation”) requiring the inclusion of lifetime income illustrations in the benefit statements provided to participants in defined contribution plans at least once every 12 months. The DOL anticipates that the Regulation will provide two primary benefits to plan participants: (1) strengthening retirement security by encouraging participants currently contributing too little to increase their plan contributions, and (2) saving some participants time in understanding how prepared (or unprepared) they are for retirement by making lifetime income information readily available.
As discussed in our previous OnPoint, the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE Act”) amended Section 105 of the Employee Retirement Income Security Act of 1974 (“ERISA”) to require that the benefit statements for participants in defined contribution plans must not only indicate the participant’s current account balance but must also provide two illustrations estimating how the participant’s account balance at retirement would convert into lifetime streams of payment or annuities. One illustration must reflect how the account balance would convert to a single life annuity form of payment and the other to a qualified joint and survivor annuity. Providing defined contribution plan participants with sufficient information about what income they can expect in retirement is highly dependent on a number of facts and assumptions, and plan sponsors and other investment professionals have faced challenges in the absence of clear guidance in not only selecting the “right” metrics, but also the possibility of fiduciary liability for picking the “wrong” ones. The Regulation not only offers much-needed guidance and protection, it also provides model language, discussed below.
Background
As noted by the DOL in a 2010 request for information concerning lifetime income options (the “ROI”),1 there has been “a trend away from sponsorship of defined benefit plans, toward sponsorship of defined contribution plans.” In contrast to traditional defined benefit pension plans, which provide retirees with a secure monthly income because the investment risk is borne by the sponsor of the plan, defined contribution plans, whose benefits are tied to the ultimate investment performance of a participant’s account, impose significantly more investment risk on participants to and through retirement. As the DOL said, “with the continuing trend away from traditional defined benefit plans to 401(k) defined contribution plans and hybrid plans, including the associated trend away from annuities toward lump sum distributions, employees are not only increasingly responsible for the adequacy of their savings at the time of retirement, but also for ensuring that their savings last throughout their retirement years and, in many cases, the remaining lifetimes of their spouses and dependents.”2
According to DOL statistics, as of 2017 there were 662,829 defined contribution ERISA plans covering 76.8 million participants. Consequently, more and more employees are required to take an active role in managing their retirement assets, both while employed and during their retirement years. However, both the DOL and policymakers have expressed concerns over whether participants’ expectations of retirement security will adequately be met under that model and whether they have the tools sufficient to appropriately make the decisions to guide their investment behavior. Among these concerns are whether defined contribution plan participants will accumulate sufficient plan savings to adequately fund retirement living expenses, whether participants can afford to assume the mortality and investment risks associated with managing sources of retirement income, and the false “illusions of wealth” that can sometimes arise when a participant views his or her accumulated 401(k) account balance in isolation.3
The ROI included questions on how best to disclose the income stream that can be provided from an individual account balance in a defined contribution plan. Eventually, in 2013, the DOL proposed a regulation that would have required including up to four lifetime income illustrations in defined contribution plan benefit statements: (1) a single life annuity based on the current account balance; (2) a qualified joint and 50% survivor annuity, if the participant is married, based on the current account balance; (3) a single life annuity based on a projected account balance (current account balance projected to normal retirement age, taking into account estimated investment returns, future contributions, and inflation); and (4) a qualified joint and 50% survivor annuity, if the participant is married, based on a projected balance.4
The proposed regulation languished until the passage of the SECURE Act. The DOL has now returned to the initiative, with the recent issuance of the Regulation.
Required Assumptions of The Disclosure
The Regulation provides the details and assumptions that must be used in order to convert a participant’s defined contribution plan account balance into a single life annuity and a qualified joint and survivor annuity for purposes of the required illustrations. Generally, there are four relevant factors that must be considered when converting a participant’s account balance into lifetime income streams: (1) the benefit commencement date and the participant’s age on such date; (2) the participant’s marital status; (3) the applicable interest rate; and (4) the expected mortality of the participant and spouse (if applicable).
The Regulation addresses the relevant factors by mandating the use of the following assumptions: (1) the assumed benefit commencement date must be the last day of the benefit statement period; (2) the assumed age of the participant at the benefit commencement date must be age 67; (3) the qualified joint and survivor annuity is assumed to provide a 100% survivor annuity; (4) the assumed rate of interest must be the 10-year constant maturity Treasury rate as of the first business day of the last month of the statement period; and (5) the assumed life expectancy must be determined by using the gender-neutral mortality table utilized for purposes of Section 417(e)(3)(B) of the Internal Revenue Code of 1986.
It should be noted that the Regulation’s required assumptions for converting a participant’s account balance into the lifetime income illustrations do not include an “insurance load” (i.e., the insurance company charges that would be applicable to the purchase of a lifetime annuity). In addition, the required assumptions do not make any adjustment for inflation.
Special rules are provided with respect to defined contribution plans that offer annuities through an insurance contract. Generally, such plans may base the lifetime income illustrations on the assumptions described above or on the actual terms of the plan’s insurance contract. In addition, there are also separate requirements for plans that offer participants the option of buying deferred income annuities which provide a specific dollar amount at retirement.
Model Disclosure and Liability Relief
The SECURE Act required the DOL to issue a model lifetime income disclosure that is written in a manner to be understood by the average plan participant. The model disclosure is required to explain a variety of topics, including the assumptions used to determine the lifetime income illustrations.
The Regulation addresses this requirement in two ways. First, the Regulation provides 11 brief model language inserts that may be integrated into a plan’s existing benefit statements in any manner determined by the plan administrator. Second, the Regulation provides a stand-alone model disclosure document that may be attached as an appendix to a plan’s benefit statements.
Limitations on Liability
The SECURE Act and the Regulation provide a limitation on liability for plan sponsors and plan fiduciaries related to the provision of lifetime income disclosures, if the benefit statements include the required assumptions and language substantially similar in all material respects to the model language. To qualify for this relief, the plan administrator must derive the lifetime income equivalents using the assumptions set forth in the Regulation and must use the Regulation’s model language, or language substantially similar to the model language, in participants’ benefit statements. While the use of the DOL’s model language is not mandatory, there would seem little incentive to deviate from the model language, as it is possible that fiduciary liability could attach outside of this prescribed “safe zone.”
Comment Period and Effective Date
The DOL has asked for comment on a number of important items, and has provided a 60-day comment period, after which a final rule is to be issued. The Regulation is scheduled to become effective one year after its publication in the Federal Register.
Footnotes
1) Request for Information Regarding Lifetime Income Options for Participants and Beneficiaries in Retirement Plans, available at https://www.federalregister.gov/documents/2010/02/02/2010-2028/request-for-information-regarding-lifetime-income-options-for-participants-and-beneficiaries-in.
2) Id.
3) See ERISA Advisory Council Report: Lifetime Income Solutions as a Qualified Default Investment Alternative (QDIA) –Focus on Decumulation and Rollovers, available at https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/about-us/erisa-advisory-council/2018-lifetime-income-solutions-as-a-qdia.pdf.
4) See 78 Fed. Reg. 26727 (May 8, 2013).
