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A New Way to Measure Retirement Savings

Your IRA and 401(k) statements now forecast your future income. Here’s how to make sense of the numbers you see

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When we ponder our retirement savings, we tend to think in terms of a single number: I’ve got this many dollars socked away in my 401(k)403(b) or IRA. But though that number may be enough to spark some reassurance or anxiety, it’s not a very useful figure on its own. What really matters, financial planners will tell you, is how much monthly income your savings can generate over your retirement life.

Until now, estimating that income stream has been on you, whether or not you can run the math to calculate it or have looked online for a tool that can do the job for you. But as a result of legislation passed in 2019 and now in effect, a little more light has been shed on that mystery. As of June, the Department of Labor, one of the overseers of workplace plans, requires your plan’s administrator to include what’s been deemed a “lifetime income illustration” in your quarterly statement. So in addition to seeing how much your account is now worth and how it is invested, you’ll be seeing an estimate of how much monthly income your account could provide to you in retirement.

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“The Department of Labor wants to ensure that there is better awareness of how an account balance translates into monthly income,” explains Dennis Elliott, head of product and platforms for T. Rowe Price Retirement Plan Services.

The figure you’ll see is an estimate of what you’d receive each month if you emptied your account upon retiring and used all the funds to buy a life annuity — an insurance product that provides fixed payments for the rest of your life. The size of that monthly payment is determined not only by how much you give the insurer, but also by how old you are and how high interest rates are at the time of purchase. The older you are and the higher the rates are, the more you’ll get per month.

In fact, you’ll see two income estimates on a quarterly statement: a fixed monthly amount you could collect for the rest of your life, called a single life annuity, and a smaller sum you and your partner could receive monthly, known as a qualified joint and survivor annuity. If you died before your partner, this second type of annuity would continue to provide a fixed monthly amount to your partner for his or her lifetime.

Like any estimate, the lifetime income illustration can be misleading as well as helpful. “It’s like a beautiful cake,” says DeDe Jones, a Denver financial planner and CPA. “When you dig into the layers, you see how complicated it is.” To grasp what the numbers mean for your situation, you need to understand the assumptions that went into them.

Your age

If you’re 67 or older, the annuity’s monthly payout calculation takes into account your actual age. But if you’re 66 or younger — whether you’re 62, 52 or 42 — the calculation assumes you will begin taking payments at 67. If you start drawing down funds at an earlier age, your monthly payouts could be dramatically lower. Also note that for the joint and survivor annuity, the assumption is that your partner is exactly your age. If your partner is younger than you, the payout could be smaller; if older, the payout could be bigger.

Impact: Draw different conclusions depending on how old you are. If you’re far from retirement, look at the number as a starting line for making more retirement contributions, not as a forecast. “The number is more valuable the closer you are to 67 and retirement,” says Jill Gianola, a financial planner in Columbus, Ohio.

Your contributions

As a snapshot in time, the estimates consider only what you have saved up as of the last day of the benefit statement period. Future contributions and growth of your savings aren’t included. “They wanted to make sure it was simplified and standardized,” explains Craig Copeland, director of wealth benefits research for the Employee Benefit Research Institute. “But it’s not realistic, because it only tells you what you have now, if you never contribute another dollar.” If you are 50 and plan to retire at 65, you would have 15 more years to sock away more savings and for your current amount to grow.

Impact: Don’t despair if the number is low; get an estimate that takes into account expected future contributions and investment growth. Try AARP’s Retirement Calculator or any number of tools available from different financial organizations. (Do an online search for “retirement income calculator.”) Your quarterly statement might even include, along with the mandated standardized illustration, an additional estimate based on the plan administrator’s own methodology.

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The monthly payout number on your statement is assumed to stay constant over your lifetime. In other words, if the illustration for a 57-year-old is that she’ll receive $1,000 a month, that’s the expected amount she’ll receive when she’s 67 and when she’s 97. And because inflation eats away at purchasing power over time, she’ll be able to buy less with that $1,000 at age 67 than she can buy now, and probably much less at age 97.

In contrast, the benefits and estimates of benefits you receive from the Social Security Administration are adjusted for inflation. So if the SSA today tells a 57-year-old that her estimated monthly benefit will be $1,000 a month if she claims at 67, her benefit when she claims 10 years from now will be higher than $1,000 — increased by an amount intended to provide the same buying power as $1,000 in today’s dollars. And as she ages, the dollar amount of that monthly benefit will grow each year to stay abreast of inflation.

Impact: As you plan for retirement, keep in mind how valuable Social Security is as an inflation-adjusted annuity, and how you can make it even more valuable. Dan Danford, a financial planner in Lenexa, Kansas, points out that for each year up until age 70 that you delay claiming, your monthly benefit increases as much as 8 percent. Those inflation adjustments are added on top of that. You can buy inflation-adjusted annuities on the open market, but the initial payout will be far below the number you see in your lifetime income illustration.

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Your gender

The Labor Department requires the monthly income calculation to be gender-neutral — one figure to cover both women and men. And if an annuity is offered within a retirement plan (other than those for government workers or affiliated with a religious institution), men and women have to be offered equal terms. But women, on average, live longer than men, so insurance companies selling annuities on the open market will offer smaller monthly payments to female applicants than they will to male applicants of the same age paying the same amount.

Impact: Be aware that a growing number of 401(k)s and 403(b)s subject to Labor Department oversight are offering gender-neutral annuities within those plans. Women who buy those annuities might get a better deal than they would with gendered pricing.

Your withdrawal plans

The calculation assumes that upon retirement, you use 100 percent of the funds to buy an annuity. In reality, few people would do that. “It’s simply not optimal,” Cope­land says. To start, most people want to keep a large portion of the funds invested for growth, usually via stocks. Second, you likely want to have a fair amount of funds available to you in case of an emergency or large cash outlay. But once you put all your retirement savings in an annuity, Gianola points out, “if you have a big expense, you can’t get an advance.”

You may not need or want to buy an annuity at all. For one, there are other ways to create a stream of income. You may not want to tie any money up with a plain-vanilla annuity like the one incorporated into the illustration, and you may be turned off by the complexity or cost of other annuities on the market, such as variable annuities and fixed index annuities.

Impact: If you like the idea of supplementing Social Security or any pension you have with additional guaranteed income, consider using only a portion of your retirement savings to buy an annuity. If you’re afraid to do that all at once, you can divide up the money you’ve budgeted for annuities and buy one annuity in one year, another in the next year, and so on.

“That way you don’t invest everything in a low-interest-rate year,” Jones says. Alternatively, you can keep all your investments in a well-diversified portfolio — a mix of stock and bond funds that can help protect against both inflation and major market downturns. “You can build a strong case that it will do a better job,” Danford says. Then you can take withdrawals based on your own criteria, be they related to taxes, risk level or other factors.

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