The most effective retirement plans help employees replace most or all of their working income. As life expectancies continue to increase, more people find themselves delaying retirement to ensure a sufficient level of income replacement. Meanwhile, those who retire before age 70 may face retirements of 30 years or more. In this environment, achieving a high level of income replacement takes on special urgency.
According to a new white paper from Empower Retirement, Americans are on track to replace 64 percent of their current income in retirement, on average. However, the study reports a much higher level of retirement preparation for employees who have established good planning habits. Not surprisingly, workers who plan actively and start saving early can expect to replace a higher percentage of their income. In addition, people who have a financial advisor are more likely to be on track to create adequate retirement income, with projected income replacement that is double that of people without an advisor.
While part of the responsibility for successful planning falls on employees themselves, employers have a critical role to play, too. By providing access to plan features that encourage habits of success, plan sponsors can help employees achieve their retirement goals. The following features are especially critical:
1. Automatic enrollment and auto escalation
Employees who currently participate in an employer-sponsored plan have a median income replacement percentage that is 25 percentage points higher than those who are eligible but not active in their plans. The level of contribution is also important. Plan participants who contribute 10 percent or more of their salary are on track to replace more than 100 percent of their working income in retirement, while those who contribute under 3 percent can expect to replace less than 60 percent.
One important way employers can drive plan participation is by instituting automatic enrollment. This feature can help employees overcome inertia, a major barrier for participation. Even among plan participants, automatic enrollment tends to generate better outcomes than opting into a plan. The Empower study found an 11-point difference in median income replacement percentages between participants who enrolled automatically (95 percent) and those who opted in (84 percent). The reason for this disparity is simple: Since automatic enrollment begins as soon as employees are eligible, they tend to start saving earlier.
Auto escalation optimizes the benefits of automatic enrollment, generating higher levels of income replacement than automatic enrollment alone. A plan that gradually increases the contribution from 3 percent to 10 percent of employee salary, for example, will generate substantially more retirement income than a plan that stays at 3 percent. In fact, employees who participate in a plan with auto escalation achieve a median retirement income replacement of 107 percent, 27 percentage points higher than employees without access to this feature.
2. Employer match
An employer match can boost employee saving in a few ways. The more obvious way is the match itself: An investment becomes more valuable when the amount invested is doubled. But matches also provide an incentive for plan participation. Since what they offer is effectively money for nothing, matches are hard for employees to pass up.
The Empower study reveals an added nuance to this logic: It’s not just the fact of the match that’s important, but the level of employee awareness regarding the match level offered by their plan. Of participants who know their match level, 73 percent set their contributions to meet or exceed it. Plan sponsors who educate employees about match levels can help drive more savings, and ultimately better retirement outcomes.
3. Income replacement planning tools
Employees who are confident in their planning tend to achieve higher income replacement. And among participants with access to an employer-provided plan, confidence is at a four-year high, at 79 percent.
Since confidence stems largely from awareness and knowledge, employers can encourage better retirement results by offering planning support and tools. Even conscientious savers may not know how much income they can expect to replace in retirement based on their current contribution levels. Tools that allow them to arrive at these figures can help them adjust their strategy to increase the probability of achieving their goals.
4. Accessible advice
Optimal savings strategies vary from person to person depending on income, age, family situation, health and retirement goals, among other factors. A one-size-fits-all retirement plan may not meet the specific needs of individual employees. For example, Millennials are projected to replace a higher percentage of their working incomes than early Baby Boomers — 75 percent vs. 55 percent. By the time Millennials retire, they will have spent several decades investing in their accounts, while many Baby Boomers lacked access to the same type of accounts until the middle or end of their careers. This disparity points to the need to leverage targeted solutions for different generations.
Managed accounts give employees the opportunity to work with an investment professional to personalize their plan. An investment professional can help with goal-setting, savings and investing strategies, tax optimization, as well as responding to economic changes. More than 80 percent of survey respondents found managed accounts somewhat or very attractive. Many plan sponsors are also employing a new investment strategy – a Dynamic QDIA – where participants are upgraded from a target date fund to more personalized, one-on-one advice when they’re closer to retirement.
Innovative plan design technology
Plan sponsors who update their plan design to include the above features can look forward to higher participation rates and more confident employees. Empower Retirement’s PlanVisualizerTM can help advisors dynamically preview how small plan design changes can improve results. It allows users to analyze a plan’s income replacement score, stretch match formulas, as well as estimate the cost of a plan upgrade and compare potential new designs with the current plan. Ultimately, PlanVisualizer helps strengthen benefits and drive higher participation and enrollment.
Providing access to a tax-deferred savings plan is a crucial first step for sponsors to give employees a better chance at a secure retirement. By incorporating key design features in their plans, they can make it even more likely that employees will replace most or all of their working income in retirement.
Source: Empower Institute, “Scoring the Progress of Retirement Savers,” April 2018.
The survey results are from a National Survey of 4,038 working adults (full-time, part-time, never retired) ages 18 to 65, conducted in conjunction with NMG Consulting. Respondents answered an online survey between December 18, 2017 through January 21, 2018.
The Empower Institute is brought to you by Empower Retirement and critically examines investment theories, retirement strategies and assumptions. It suggests theories and changes for achieving better outcomes for employers, institutions, financial advisors and individual investors.
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