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Brace Yourself

Kristine Hayes, 1:04 pm ET

PARTICIPANTS IN 401(K) plans will soon be getting estimates of how much income they might receive in retirement if their plan savings were spent purchasing an annuity. Under a new rule, plan providers are required to provide participants with at least two annuity estimates annually on their account statements. One would project the lifetime income from the purchase of a single-life annuity and the other from a joint-and-survivor annuity. A joint-and-survivor annuity extends payments over two lives, typically for a married couple.

I recently came across an article by CNBC that gave this example: Someone with a $125,000 balance in his or her 401(k) would receive $645 per month for life if the money was converted to a single-life annuity. If the same balance was converted to a joint-and-survivor annuity, it would provide $533 per month until the first death, and then that same amount would be paid to the surviving spouse for life. The estimates assume a retirement age of 67, typical longevity and an interest rate based on the current 10-year Treasury note yield.

The goal of providing the annuity estimates is to help 401(k) participants see if their accumulated savings can meet their desired income needs in retirement. My guess: Most people will be shocked to find out just how little income they’re estimated to receive.

The question I have is, how will people react when presented with the figures? Will it encourage them to increase their savings rate? Or will it discourage them, prompting them to throw in the towel?

Whichever the case, 401(k) account holders should start seeing the estimates sometime between this fall and fall 2022. The two estimates are required to be provided at least once a year under 2019’s SECURE Act, a federal law which modified many provisions of tax-advantaged retirement savings plans.

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Roboticus Aquarius
Roboticus Aquarius
1 month ago

I don’t know if there is a good way to deal with how people react, people carry so many wrong ideas about money.

If someone doesn’t expect the low size of the numbers quoted, I’m sure that they don’t realize they have a decent likelihood to multiply that number 8x with another 30 years of investing (assuming 60/40), due to the power of compounded returns. They will misjudge their potential income streams.

kristinehayes2014
kristinehayes2014
1 month ago

You make a great point. Perhaps the statements should also include a hypothetical estimate, i.e. “if you start saving $100 a month more now, your income in retirement could be as high as _______”.

Ormode
Ormode
1 month ago

Studies have shown that 80% of 401K and IRA holders don’t take any money at all until they are required to take an RMD, and then take only the minimum. It seems like many people must have other resources besides officially designated retirement savings.

kristinehayes2014
kristinehayes2014
1 month ago
Reply to  Ormode

Interesting. Do you have a reference for that?

R Quinn
R Quinn
1 month ago
Reply to  Ormode

I’d like to see where that stat comes from.

kristinehayes2014
kristinehayes2014
1 month ago
Reply to  Ormode

I have to say I’m surprised to read that. I would have thought a majority of 401k investors would start withdrawals prior to having to take RMD’s.

R Quinn
R Quinn
1 month ago

Good points. I actually forgot about the new statement. Interestingly though people will also see that the annuity will provide a greater (guaranteed) income than the 4% withdrawal strategy sans inflation adjustment.

An
An
1 month ago
Reply to  R Quinn

How does the annuity payout compare to 4% withdrawal strategy WITH inflation adjustments?

Roboticus Aquarius
Roboticus Aquarius
1 month ago
Reply to  R Quinn

+1.

Unfortunately, Not many people really know much about the Trinity study or think that way, so while many of us readers will go directly to that compare, I have a feeling most people don’t.

I was a little surprised at how low these quotes were. The single life annuity is only 5.16% (5 years ago I was getting quoted well over 7%, but I admit it was a sweetheart rate, so I’m not sure how much the real change has been.) The j&s quote above is 4.16%, so really it’s not much of a difference there vs a 4% withdrawal rate.

wtfwjtd
wtfwjtd
1 month ago

“My guess: Most people will be shocked to find out just how little income they’re estimated to receive.”

Yep. In addition, there seems to be widespread misconception about how a lump sum can be used: It can be used to generate income, OR principal can be spent down to meet immediate financial needs, but not both. Once that lump sum is gone, it’s gone–and so is the income that it could generate.
That million-dollar portfolio may not be nearly as impressive as many assume, and I agree that lots of people are in for a rude surprise when presented with this reality. Maybe that’s part of the reason why many people have such a hatred of annuities; it forces them to face this reality square-on, not allowing them to indulge the fantasy of being able to spend down their asset pile while continuing to use it as an income generator.

kristinehayes2014
kristinehayes2014
1 month ago
Reply to  wtfwjtd

Here’s an eye-opening stat: The average 401(k) balance is about $106,000. The median is just over $25,000. I imagine when people get their income estimates and realize they would get no more than $600 a month (and probably much less), it will shock them. But how will they react to the shock? Save more or just give up on saving completely?

wtfwjtd
wtfwjtd
1 month ago

$100k isn’t going to go very far in retirement. But giving up completely is even worse! It just re-enforces the importance of starting saving as early as possible, and learning at least the basics of investing. One without the other isn’t going to cut it for most of us, as there will be no big inheritances to save the day.
On a related subject, I also read something that I found interesting: Median income starts dropping after about age 75. I’ve seen various speculation about this, including how older people don’t spend as much because they’re home bodies, and the like. However, I strongly suspect it’s much more likely due to what we are discussing here–namely, not that people are intentionally spending less as they get older, but they are simply running out of money. Frankly, I don’t find that to be a very cheery thought, and use it as motivation to live more modestly now so that my older self won’t be so hard-pressed later on. It’s a pretty darn good reason to save as much as I can now, in my book.

Olin
Olin
1 month ago

The average for what age group?

kristinehayes2014
kristinehayes2014
1 month ago
Reply to  Olin

I believe that was the average over all age groups.

parkslope
parkslope
1 month ago

Average 401(k) by age: https://www.investopedia.com/articles/personal-finance/010616/whats-average-401k-balance-age.asp

Unfortunately, the median 401(k) balance is much lower than the mean balance:
“The average 401(k) balance is $106,478, according Vanguard’s 2020 analysis of over 5 million plans. But most people don’t have that much saved for retirement. The median 401(k) balance is $25,775, a better indicator what Americans have saved for retirement.”
https://www.businessinsider.com/personal-finance/average-401k-balance

Last edited 1 month ago by parkslope
Bob Wilmes
Bob Wilmes
1 month ago

The problem is most Americans have very little knowledge of the math of personal finance and retirement planning. There used to be popular TV shows like Louis Rukeyser and Wall Street Week that people could listen to to begin investing. Dr Robert Schiller points out that behavior has a huge impact on many people acting out good (and bad) financial habits. It would be wonderful if a guy like the Dirty Jobs guy (Mike Rowe) would do a show interviewing successful average Americans about how they saved for retirement, so others could model their behaviors.

kristinehayes2014
kristinehayes2014
1 month ago
Reply to  Bob Wilmes

I LOVE the idea of Mike Rowe hosting a show about the “average American”. I think he appeals to a wide swath of the population.

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