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The big-picture view of a lump sum may tell investors little about how their total savings will or won’t adequately fund their retirement lifestyle. A $125,000 nest egg may sound like an ample amount to some savers, but may seem less so if they realize it translates into roughly $500 or $600 a month, for example.
“For the bulk of Americans, it’ll be a wake-up call,” Richard Kaplan, a law professor at the University of Illinois, said of the new disclosures.
But there’s good news: Many people, especially those with decades to retirement, have ample time to fix any shortfalls.
Lifetime income estimates provide a rough guide
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Many 401(k) savers will see the disclosures for the first time on their next quarterly statements, due to U.S. Department of Labor requirements. Those statements, issued by plan administrators, will arrive in the days and weeks after June 30.
The new policy is a result of federal legislation — the Secure Act — passed in 2019.
Workers should use the estimates as a rough guide instead of gospel or as a guarantee, Kaplan said.
In technical terms, they show how much approximate income you’d get per month for the rest of your life if you were to buy an annuity with your 401(k) savings at age 67.
There will be two estimates on your statement: One is for a “single life” annuity, which pays income to an individual buyer for life. The other is for a “qualified joint and survivor” annuity, which pays income for an individual and a surviving spouse for life.
The estimates are based on your current 401(k) balance. They don’t, for example, project how a 35-year-old’s savings will grow and how that future nest egg would translate into monthly income. As a result, their income may seem paltry at first glance.
The illustrations also don’t account for Social Security or any retirement savings outside of that 401(k) plan — which means the estimate is likely to be at least a slight underrepresentation. They also assume your full balance is fully “vested,” which may not be the case, especially for newer hires.
The estimates are likely to be most actionable for savers with many years to retirement instead of those near retirement age, since the former have more time to course-correct, Kaplan said.
“Most of this is directed at younger people, with this being a midstream correction,” Kaplan said.
Use estimates to rewire your thinking
Perhaps the most useful aspect of the new policy is how it helps people rewire their thinking around retirement savings, according to Philip Chao, principal and chief investment officer at Experiential Wealth, based in Cabin John, Maryland.
The typical person saves money with each paycheck without thinking of a future income goal. Savers should instead ask themselves how much of their prior salary they want to replace in retirement, Chao said.
Someone who earned $100,000 a year before tax may decide $70,000 or $80,000 a year in retirement would be adequate to fund their lifestyle.
Any 401(k) savings, pension income and Social Security payments would then aim to replace that monthly or annual income amount, Chao said. That income will generally satisfy two buckets: essential expenses (such as housing and food) or discretionary expenses (such as vacation). Financial planners generally recommend that individuals fund those necessities with guaranteed income sources such as Social Security, pensions or annuities, if possible.
“I think it’s very helpful for helping people start to think about outcome, and not emphasize the big pile of money,” Chao said of the new illustrations. “It’s really about how much money do I need to provide me a sustainable lifetime income. What is that number?”
Without going through this rough budgeting exercise, Americans may be saving too much or too little without knowing it.
“We should save enough for what we need, not go hog wild,” Chao said. “But what is enough? If you don’t know what is enough, how do you know you’ve saved enough?”
Unlike the new Labor Department requirements, many plan administrators offer online resources that help 401(k) investors gauge how their current account balances will fund their future income needs, by factoring in some assumptions about investment earnings and current contribution rates.
Other organizations, including AARP and the American Institute of Certified Public Accountants, also offer free online retirement-income calculators.
After getting a rude awakening from the new 401(k) income illustrations, savers can use an online calculator to get a better understanding of their situation and alter their contributions as needed, Chao said.
For example, investors might be saving 3% of their paychecks while their employer offers a dollar-for-dollar 401(k) match on up to 4% — which means the worker is effectively leaving free money on the table, he said.
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