The whole way that 401(k) savings are measured is about to
be turned on its head—if a new approach catches on. Under the new approach,
investors could get a clearer picture of whether they are nearing their
retirement-savings goals by focusing less on the dollar amounts they’ve
accumulated and more on how much income that money can generate in the future.
A lump-sum figure, the thinking goes, doesn’t tell you much
more than how well your portfolio has fared and how much you have saved. The
new approach—known as projected income—would show instead what your current
balance would pay out as income beginning at a certain age.
Projected income has some prominent supporters. Last year,
the Labor Department sought comments on proposed rules that would encourage
company plan sponsors to provide a projected retirement-income calculation for
their participants as well as information about current account balances.
The Total-Return
Fixation
John Rekenthaler, vice president of research at
investment-research firm Morningstar Inc., says projected income
could sit alongside more-traditional yardsticks such as total return in
measuring portfolio performance. Morningstar analysts are having internal
discussions about adding a projected-income calculation to the part of its
website that advisers use to analyze client portfolios.
Investors struggle to translate the lump sum of money they
see each quarter on their account statements. That is particularly true of
retirement savings, which accumulate over long periods. People tend to fixate
on total return and ignore the effects of inflation and interest rates on
future spending power. A projected-income calculation would show them how their
current balance translates into, say, an annuity that pays out starting at age
65, or set annual withdrawals beginning at that age.
A 35-year-old man with $50,000 socked away in a 401(k) plan
doesn’t have an easy way to understand what that quantity of money means for
him 30 years down the road when he hits retirement age. He might be tempted to
take a loan from the account today to pay for a car. If he could see not only
how much he has saved but how much income that translates into three decades
from now, he might forgo the loan and leave the money to grow in the plan
instead.
How It Plays Out
For a look at how projected income might play out, consider
some new offerings from BlackRock Inc. Last year, the New York
asset-management firm, with $4.5 trillion under management, rolled out a set of
indexes that were designed for those age 55 to 65 to track how much they need
to save now to produce $1 of inflation-adjusted annual income starting at age
65 and running the rest of their life. There are 11 indexes that follow each
retirement year of the current 55- to 65-year-old age group. A set of mutual
funds to track those indexes was introduced earlier this year.
Each index level reflects the performance of bonds picked to
mimic median annuity prices for each age, and their values change daily. For
example, as of Nov. 13, it would take a 65-year-old $20.54 of current savings
to generate $1 of annual retirement income beginning this year. But someone
retiring at age 65 in 2024 would need $14.54 of current savings to generate
every $1 of income, measured in 2014 dollars, starting 10 years from now.
BlackRock uses three variables for measuring projected
income: the portfolio value, current annuity rates and years remaining until
age 65. BlackRock factors in the effects of inflation, interest rates and risk,
too. The withdrawal rate is floating rather than the rule-of-thumb 4% fixed
amount because it adjusts daily to current annuity prices.
Say you are 61 years old and have $750,000 in savings. You
are going to retire in 2018. BlackRock’s index projects you will need $16.35 in
savings now to generate $1 of income starting at age 65. The projected annual
income off your savings is $45,871. That is a much higher number than the
$30,000 in annual income you would get from a $750,000 portfolio if you just
used the 4% formula to calculate income.
Quirks of Return
BlackRock’s process also shows how it is possible for a portfolio
to do well in terms of total return, but slip when it comes to projected
income.
That is because bond prices fluctuate and affect annuity
rates. If annuity prices increase faster than total return, projected income
will decline. Median savings for current 55-year-olds this year through
September rose 16.5%, to $271,620, BlackRock data says, boosted by market
gains. But the estimated cost of retirement income rose even faster, 18.5%.
This year a 55-year-old would need $15.12 to generate $1 in
annual income beginning a decade from now. A 55-year-old last year would have
needed only $12.76. Falling interest rates over the past year have made it
difficult to maintain spending power.
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