I used to love a certain cinnamon bun. I would buy it often when I went shopping.
But it can help, too.
Thanks to the 2009 Credit Card Accountability Responsibility and Disclosure Act (Card Act), maybe you no longer just make the minimum payment on your credit card. This law required issuers to disclose how long it would take customers to eliminate their debt if they chose to make only minimum monthly payments.
Let’s say you owe $10,000 on a card with a 17 percent interest rate. If you continue to make the minimum payments, it will take you more than 30 years to pay off this debt. The total interest paid will be more than $21,000.
Disclosure, as the theory goes, helps people make better decisions. The more you know about what you’re eating or spending, the more likely you’ll think twice about consuming too many calories or racking up too much debt.
The Setting Every Community Up for Retirement Enhancement Act of 2019 (Secure Act) is bringing this theory to defined contribution plans such as 401(k)s. A new rule would require plan sponsors to provide workers with an annual disclosure showing what their monthly (and lifetime) income would be if they converted their plan savings to an annuity with a guaranteed stream of income. The law is designed not necessarily to push people into buying annuities but to illustrate how their funds will need to stretch over their lifetime.
“It is really as important for plans to get people thinking about income rather than just accumulation because you’re going to get much better results if you switch over to having people understand that at some point they’re replacing their paycheck,” said Dan Keady, chief financial planning strategist for TIAA.
People hear that they have to accumulate a lot of money for retirement. As time goes on and their 401(k) balances increase, they become overconfident that they have enough money to retire. But, Keady says, “They need to begin asking themselves: ‘What would it produce in income down the road?’ ”
TIAA provided an example of what someone around age 39 might see on his or her statement. Let’s say as of June last year the worker had $87,851 saved. Based on a monthly contribution of $420 that increases each year with inflation, and a number of other assumptions such as rate of return, at 65 the person is estimated to have a balance of $829,150 (or $382,585 in today’s dollars).
The hypothetical annuity payment would be $4,586 (or $2,116 in today’s dollars). This assumes a single life annuity with a 10-year guarantee period and 4 percent interest rate.
But what if your 401(k) account has just $200,000 when you retire?
Keady says if such a person annuitizes $200,000 at 65 this might produce a hypothetical payment of $13,274 a year, or $1,106 per month based on a 6.6 percent payout rate (including interest rate and return of principal based on life expectancy). Although, the actual annuity payment will depend on current interest rates when annuitized, he said.
The 6.6 percent income rate means that for every $100,000 annuitized, the annualized income will be $6,600, Keady said. The 4 percent interest rate is used in the calculation of the annuity factor to come up with the payment amount. With a lifetime immediate annuity, which is what would be used for the illustrations under the Secure Act, the payout rate is different from the rate of return. The actual realized return depends on how long a person lives, beyond the guarantee period.
As you can see, there are a lot of assumptions that go into the lifetime income stream estimate.
The Secure Act also dictates that there would be disclosure within the example to make sure workers understand that the calculations depend on numerous factors that can affect the estimates they are given, Keady pointed out.
The Labor Department is required to issue rules instructing plan administrators on the assumptions that will be used to estimate a lifetime income stream. The illustrations would estimate retirement benefits that might be paid as a life annuity to a retirement account holder and a survivor annuity over the life of the participant’s surviving spouse, child or dependent. The plan administrators would assume the plan participant and a spouse were the same age, and a single-life annuity would also be shown.
Done right, this new requirement could be a useful reality check. Rather than focusing just on your total balance, which could give you a false sense of financial security, this lifetime income illustration could bring clarity to how you view retirement savings. Keep in mind your money may have to last you several decades in retirement.
This might shift people’s behavior and help them realize they need to save more for retirement.
Have a question about retirement or personal finance? Join Michelle for an online Q&A every Thursday at noon Eastern. Readers may write to Michelle Singletary at The Washington Post, 1301 K St. NW, Washington, D.C. 20071 or michelle.singletary@washpost.com. To read previous Color of Money columns, go to http://wapo.st/michelle-singletary.
