Will employees have enough money to retire? According to our most recent study on this topic "Retirement Income Adequacy at Large Companies: The Real Deal 2010," the answer for many employees is "no" — at least not at a pre-retirement standard of living. Here, we will briefly summarize those results, and then provide you with some tactics employers can use now to improve employee behaviors in defined contribution plans.
Our research, conducted by projecting the retirement needs of more than 2.1 million participants in 84 large employers, indicates that employees will need about 15.7 times pay at retirement (on average) to maintain their preretirement living standards. About 4.7 times pay will be provided by social security, so employees will need to come up with about 11 times pay from personal savings and employer-provided retirement benefits. For our baseline scenario, we looked at employees that contribute to their savings plan over a full career, and they are projected to be about 2.4 times pay (15%) short of their retirement needs. Only 18% of the participants we reviewed are on track to meet their overall retirement goal.
Hewitt has worked closely with many organizations to address the retirement income adequacy gaps that exist within their plans, and we have identified a number of best practices that you can put in place within your plans as well. Following is a quick summary of these best practices.
We identified dramatic savings improvement in groups that were defaulted into automatic enrollment, and it is currently offered by about 60% of large employers. Unfortunately, most plans only default new employees, often because they are afraid that dropouts or negative feedback will occur if they change their system. In our experience, these outcomes are rare. If you aren't offering automatic enrollment to all your employees, we encourage you to do so and to "backsweep" current non-participating employees.
Contribution escalation is another best practice, which is also currently offered by about 60% of large employers. Automatic escalation now serves as a popular opt-in strategy, and it has had a positive impact on savings rates. If the average 30-year-old increases his or her saving rate by just 1% a year for five years, their retirement income gap essentially disappears. Many plans are now combining automatic enrollment and contribution escalation together to improve employee savings behaviors.
Plans that provide institutional funds lower their overall plan costs — and ultimately help employees save more. These funds can be 20–40% less expensive to administer, and over an employee's career, a 25-basis point savings can equate to another 50 cents on the dollar in company contributions.
Target date funds and managed accounts are another form of "help" that employers should consider implementing. These options make it simpler for employees to diversify their holdings, and they are often easier to understand. As you consider implementing them, just keep in mind the diverse needs of your employee population. Younger people, for example, tend to prefer simpler investment options when choosing target dates, while older participants tend to prefer managed accounts and customization options.
Many employees simply don't understand the substantial role that time and savings rate play in helping them to meet their retirement needs, and employers need to communicate these facts to them through awareness campaigns. By helping employees understand that they need to begin saving as early as possible (and that they may also need to consider retiring later), employers can help employee understand the impact of their decisions.
Employees also need education to understand the tradeoffs that they need to make as they balance future unknowns. Studies have shown that as people get closer to retirement, their investments become more conservative, because they realize the importance of preserving those assets. However, many fail to consider the impact those decisions have on their expected rates of return. Again, additional education helps to prepare employees as they attempt to make the right investment choices.
Now is ideal time for employers to take a more active role in helping their employees address retirement gaps. By implementing these best practices, employers can provide substantial benefits to their employees — at a nominal cost.