Legislation reintroduced recently in Congress is the latest attempt to push forward the reporting of lifetime retirement income in 401(k) plans and other defined contribution arrangements. I’ve been a long-time advocate of this idea.
Simple, meaningful and objective
Having been critical, six months ago, of the slow progress that the Department of Labor was making on this front, I’m happy to see the reintroduction of a bipartisan bill in the Senate which would mandate lifetime retirement income reporting.
Specifically, what I have long argued for is the addition of a lifetime income equivalent alongside the existing account balance. This would serve to focus attention on the purpose of saving in the first place: to provide income that will last throughout the retirement years. Only once this change of perspective takes place will participants have the information necessary to plan properly and to make appropriate decisions on saving rates, investment strategy and decumulation options.
A simple and objective way to calculate this lifetime income equivalent is by providing an estimate of how much income an individual’s current account balance would buy in the immediate annuity market at today’s interest rates for an older version of themselves who has reached retirement. I first proposed this calculation in testimony to a public hearing held jointly by the Department of Labor and the Department of the Treasury in September, 2010, and it continues to hold strong appeal.
This approach involves no projections and requires very little in the way of assumptions: the pricing of immediate annuities is based on prevailing market rates of interest and on assumptions about mortality experience that are well-documented.
It’s a meaningful and easily-understood number: the calculation described above automatically produces a result that is expressed in terms of today’s dollars.
It is an approach that can easily be standardized, so that the results would not depend on who does the calculation. The latest draft legislation would give power to the Secretary of Labor to “prescribe a single set of specific assumptions (in which case the Secretary may issue tables or factors that facilitate such conversions), or ranges of permissible assumptions.” A standardized calculation would have many advantages: it is simpler to perform the calculation, it reduces gamesmanship, it is easier to understand. There is no need to introduce unnecessary complication under this approach.
It’s reporting, not disclosure
Not everyone agrees that it is desirable to expand reporting, though. The objections that have been raised are worth addressing, because they demonstrate the importance of getting the details right.
One thing I’ve concluded from conversations with opponents of this legislation is that it’s better to think of this as reporting rather than disclosure. After all, disclosures can end up being just so much paperwork, changing little. But the account balance that is sent every quarter is not thought of as disclosure, and it’s rarely ignored. The lifetime income equivalent of that balance is an equally important statement of progress: it’s reporting, not merely disclosure.
Another objection that is raised is that reporting lifetime income equivalents does not address the coverage issue and does not directly produce a change in savings rates. However, while those are indeed the biggest issues currently facing the Defined Contribution system, they are not the only issues; the lack of lifetime income reporting facilitates inattentive and too often unsuccessful behavior from plan participants, and is much more easily addressed than those others. It’s worth making improvements where we can.
An objection that has been raised to the specific approach described above for calculating a lifetime income equivalent is that the results are likely to be volatile. Of course, the account balance itself is also volatile, but few would seriously argue that it is inappropriate to report it because of that. Likewise, a best estimate of what a given account balance will be able to purchase in the annuity market will vary considerably over time, and clear reporting must inevitably reflect that volatility.
Each of those points shows that there’s more to this than meets the eye, and that the details of the legislation will matter. But, ending this post with the same seven words I used to end the post last October: it’s time to get on with it.