How Much Is Enough Anyway

 It can be complicated—the trick is helping participants create plans that work.

PLANSPONSOR.com
July 2012
Rebecca Moore


Illustration by Josh Cochran

The amount of income workers will need in retirement and how much they should save to reach that goal have gained more attention since the economic downturn of 2008 and 2009 depleted many retirement accounts. Before the downturn, service providers and researchers in the industry estimated that workers would need to replace between 70% and 75% of their preretirement income— i.e., what came from all sources. But even then, that estimate was being scrutinized.

Target income replacement ratios should be higher, the Retirement Advisor Council now contends. In a paper, the council says this is to account for the always increasing projected cost of health care in retirement, as well as other financial planning concerns workers face, such as children’s educational needs and the cost of caring for elderly relatives.




saving and spending (Photo credit: 401(K) 2012)

So, how much is enough, anyway? Josh Cohen, defined contribution practice leader at Russell Investments, says that while the appropriate replacement rate is different for each person’s situation, 80% is a good target, because studies have shown it is about the average amount needed to maintain current lifestyle.

When trying to arrive at the best income replacement rate for themselves, workers should use their imaginations, says Jason Scott, Ph.D., director of the Financial Engines Retirement Research Center. They should imagine continuing to do things postretirement that they did preretirement. Then they should consider expenses they will no longer have once they retire. … Some retirees can make it with a lower income in retirement, Scott believes, but, he notes, if individuals will travel or spend more in their free time, expenses they incur will offset the savings, meaning they may need more income.




Pension (Photo credit: Frederik Seidelin)

Cohen points out that this replacement rate comes from all potential sources, including Social Security and personal savings, in addition to defined benefit (DB) and/or defined contribution (DC) plans. …


Patricia Advaney, senior vice president of participant solutions at Diversified, says that because the standard

estimate replacement ratio of 70% to 75% may be inadequate, workers should think about increasing their goal. “It’s a moving target, with questions about Social Security, the rising cost of health care and longevity,” she says. The industry has shifted from trying to give an exact number for target replacement income to suggesting a minimum 10% savings for retirement, including both employee savings and employer match.

English: Proportion of pay to save. (Photo credit: Wikipedia)

The Retirement Advisor Council says, regardless of target income, a consistent contribution to 401(k) and 403(b) plans in the range of 10% to 16% of pay over a 30-year or 40-year career is needed to achieve the appropriate replacement retirement income.

In a research paper, “What’s the Right Savings Rate?”, Russell Investments contends that the total replacement income (TRI) 30 rule-of-thumb helps answer the question: “How much should participants save?” Saving 30% of the TRI rate each year—including personal savings, savings in an employer-sponsored retirement plan and any employer contribution—leads to about a 90% probability of meeting the income goal at retirement. This assumes a 40-year period of savings, Cohen notes.




English: Retirement savings rate as squirrel and nuts anaology (Photo credit: Wikipedia)

… Many who may want to retire early, Scott thinks, will find that their savings are much less than what they will need. But that figure also depends on exactly how early they want to retire. “It’s really hard to just look at savings in their 401(k) and determine whether they are hopelessly far behind,” he says.

According to the Employee Benefit Research Institute’s (EBRI’s) Retirement Security Projection Model (RSPM), 44% of Baby Boomers and Generation Xers are still projected to be “at risk” of running short of money in retirement. …

The trick is helping people figure out, wherever they are, how to create a plan that works, according to Scott. …

Workers should think about how they might boost savings by working longer, and therefore saving more, or being savvier about other benefits, such as claiming Social Security at a later age, Scott says.

A brief from the Center for Retirement Research (CRR) at Boston College concludes that starting early to save for retirement and working longer are more effective levers for ensuring retirement security than earning a higher return on savings. “How Much to Save for a Secure Retirement” said this strategy of saving longer is especially effective, given the greater risk that comes from chasing investment returns.




English: In the United States, Social Security benefits compared for younger vs. older workers. According to author Joseph Fried, this graphic uses information from: C. Eugene Steuerle and Adam Carasso, "The USA Today Lifetime Social Security and Medicare Benefits Calculator," (Urban Institute, October 1, 2004), from: http://www.urban.org/publications/900746.html. Note: The calculator does not include the value or cost of the Social Security disability program. (Photo credit: Wikipedia)

… Because Social Security benefits are actuarially adjusted, they are more than 75% higher when he is age
70 than age 62. As a result, they replace a much larger share of preretirement earnings if workers wait to apply—29% if they are 62 and 52% if 70, in the CRR’s example—reducing the amount they would need to take from savings­. And, by postponing retirement, people have additional years to contribute to their 401(k) and allow their balances to grow. Finally, a later retirement age means that people will have fewer years of dependence on their accumulated retirement assets. 

Plan sponsors can help with reporting, to show how far behind workers are, Cohen says. Then decisions can be made, …

“You can’t invest your way out of a savings problem. There may be different asset allocations that would be better, but, at the end of the day, investments can only do so much,” Cohen says. “It’s all about savings patterns, how long you work and reasonable expectations.”

According to Cohen, plan sponsors can set goals for partic­ipants and use the match formula as an incentive. For example, if a participant needs 15% put away each year and the company is willing to contribute 5%, the match formula would be 50 cents on the dollar, up to 10% of compensation. At the same time, plan sponsors can help participants get to that 10% by using automatic­ enrollment and automatic escalation.
“It takes a well-designed plan and the smart use of … auto-features and qualified default investment alternatives [QDIAs] [which], if implemented, [can give] the typical American worker … a very successful retirement,” Scott concludes.

Kristi Mitchem, head of global defined contribution at State Street Global Advisors, says workers today are in a much better position than before because the introduction of auto-enrollment has been incredibly powerful in getting participants of different income levels into retirement plans early and saving at an appropriate level. “We have put mechanisms into place to help people get on the right path and be successful,” she says.

Mitchem recommends plan sponsors auto-enroll at a 4% to 6% employee deferral range. They can pair that with auto-escalation up to 10%. And, as always, plan sponsors should communicate the importance of deferring substantial savings for retirement, according to Mitchem.

Advaney suggests retirement plan sponsors use service provider resources to help participants save more. …

“This is an incredibly important topic because the reality is, the biggest contributor of what you have in retirement is how much you put away,” Mitchem says. “So, getting people comfortable at an appropriate savings rate is the most important thing to ensure [they] have appropriate retirement savings.”

Everyone needs guidance on saving for retirement, but this is especially true for middle-income workers, says Kristi Mitchem, head of global defined contribution at State Street Global Advisors. While high-income workers will have less income replaced by Social Security, they presumably will have more personal savings to supplement their retirement income, and lower-income workers will have a higher percentage of income replaced by Social Security.




English: This is a chart outlining the historical personal savings rates in United States as compiled by the US Department of Commerce, Bureau of Economic Analysis (Photo credit: Wikipedia)

So, where does that leave middle-income workers? Sources of retirement income are important for this group. Baby Boomer and Generation X households that have a defined benefit (DB) pension plan accrual at retirement age are, overall, almost 12 percentage points less likely to be “at risk” of running short of money for basic needs and uninsured health costs in retirement, according to a report by the Employee Benefit Research Institute (EBRI). The report, “Retirement Income Adequacy for Boomers and Gen Xers,” finds that, while having a defined benefit plan is particularly valuable for those with the lowest income in both age groups, it also has a “strong impact” on reducing at-risk rates for those in the middle class: ...

More than any other group, middle-income workers­ should take advantage of all resources available, says Patricia Advaney, senior vice president of participant solutions­ at Diversified. … Middle-income workers need to start thinking about what they will need and should hold onto retirement paperwork until positive­ they can retire. Retirement plan advisers need to have conversations­ early enough for middle­-income workers­ to understand the implications of any decisions they will have to make.

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When It Comes To Retirement, 67 Is The New 55

NPR

by Alan Greenblatt

June 18, 2010

Looking forward to retirement? You may have to wait a bit longer. Financial pressures are pushing up retirement ages all over.

iStockphoto.com

William Reichenstein, who teaches finance at Baylor University, tells his students that they will have to save a lot more of their working income if they hope to retire as comfortably as their parents and grandparents, simply because they're going to live longer.

On Wednesday, … California's Republican Gov. Arnold Schwarzenegger announced a deal with four state public employee unions to raise the retirement age by five years for newly hired workers.

These moves follow several recent age increases across Europe and among U.S. states. Faced with one of the worst pension shortfalls in the country, Illinois in March lifted the retirement age for new state workers from as low as 55 all the way to 67.

The increases also anticipate the coming debate among members of the White House deficit commission over raising the eligibility age for Social Security benefits. …

The motivations driving all these various governments are similar. People are living longer and, therefore, are drawing retirement benefits for longer periods. …

Retirement Ages Around The World

View a sampling of official retirement ages around the world, according to a 2009 report from the Organization for Economic Cooperation and Development, based on data from 2002-07. France is among the countries listed that have already announced plans to raise their retirement ages in the coming years.

Adrienne Wollman/NPR

"If their parents are going to retire at 65 after working 40 years, they need to plan for about a 20-year [retirement]," [Reichenstein] says. "For my students' generation, with life expectancy going up about a month a year, in their cases they have maybe 25 years in retirement they have to plan for."

Another result of longer lifespans in the United States is that the ratio of people paying into Social Security, compared with those drawing benefits, is shrinking rapidly. "We know that in 2017, Social Security will begin paying out for the foreseeable future more in benefits than it collects in taxes," says Richard W. Johnson, director of the Urban Institute's retirement policy program.

The Social Security trust fund will be able to make up the shortfall for 20 to 25 years. "But that trust fund is now being used to offset other parts of the deficit," Johnson says. "Once we can no longer use that trust fund to fund other services, the deficit really balloons."

How Old Is Fair?

That's why President Obama's deficit commission is seriously considering raising the retirement age. … The full retirement age is set to rise to 67 for people born after 1960.

Raising the full retirement age by 2020, rather than 2027, would save $92 billion, according to the Congressional Budget Office.

"We have this huge problem we really have to address," says Steven Sass, director of the Center for Financial Literacy at Boston College. "We either have to cut benefits or increase revenues."

Sass points out, however, that raising Social Security's retirement age will disproportionately affect low- and moderate-income workers. People who work longer into old age tend to hold less physically demanding office jobs and are better educated. Those who are less educated or work in manual labor make up a greater share of people who are opting for the lower-paying early retirement benefits. Their numbers are increasing with the recession.

Because Social Security benefits are paid out on a sliding scale — you lose about 7 percent for every year you retire early — raising the full retirement age amounts to a de facto cut for those who are forced to retire early. "It's a terrible way to cut benefits," says Eric Kingson, a professor of social work at Syracuse University and co-director of Social Security Works, a coalition of unions and other groups that lobbies against benefit cuts.

"Life expectancy has improved, but not for all the groups," he says.

Enlarge Manu Fernandez/AP

People in Barcelona protest Feb. 23 against the Spanish government's plans to raise the retirement age. The marches were sparked by Prime Minister Jose Luis Rodriguez Zapatero's proposal that Spaniards delay retirement from 65 to 67 to ensure the long-term stability of the country's pensions.

Political Fallout Across Europe

There are fierce arguments looming over whether taxes should be raised or Social Security benefits should be cut, either outright or through an increase in the retirement age. These kinds of debates are already happening across Europe.

Greece, until recently, allowed workers in more than 580 job categories considered hazardous to retire with full pensions as early as age 50 for women or 55 for men. In response to its fiscal crisis, that country has raised the retirement age to 65 for most workers.

In Ireland, the government has proposed gradually raising the retirement age from 65 to 68. Hungary raised its retirement age in 2008 from 62 to 65 — one big reason why the ruling Socialists got trounced in parliamentary elections in April.

French President Nicolas Sarkozy is bound to experience blowback on his new plan, too — even though it won't erase even half the nation's projected pension funding gap.

Reichenstein, … says there is no other option. "The governments have promised more than they can meet," he says. "The reality is that they have to cut back."

More States Are Cutting

Reichenstein notes that things aren't quite so drastic — yet — in this country. For one thing, the U.S. federal debt — although climbing rapidly — is not yet as great as a share of GDP as debt in many European nations. Our median age is lower, too, thanks in part to immigration. The median age in the U.S. is just under 37, while it's right around 44 in Germany, Italy and Japan. And there are still some years left to find fixes for Social Security.

But state systems may be another matter. A study from the Pew Center on the States in February found that state pension systems were collectively running a $1 trillion deficit — and that was based on figures compiled before the 2008 stock market crash.

The California Public Employees' Retirement System announced Wednesday that the state needs to increase its pension contributions by $600 million a year.

Schwarzenegger's new agreement raises the retirement age for state workers by five years and requires current workers to contribute more of their salaries into their own retirement accounts. …

Several states have already done so, creating two-tiered systems that are much less generous for new hires.

"It's a correction long overdue," says Dowell Myers, a demographer at the University of Southern California. "Not only are people living longer but they're living way longer than they were when these programs were set up, and we have less money than we used to."

Generation “Hexed”?

PLANSPONSOR.com

PLANSPONSOR staff editors@plansponsor.com

Michael Barry

In the spirit of a modest proposal.

Retirement “benefits” are, in real life, income paid to people who aren’t working. … There are only two ways that can, for lack of a better word, “work.”

Alternative 1, prefunding. Current workers can prefund their benefit. … That’s how 401(k) plans, for instance, work.

Alternative 2, PAYGO. Current workers can pay for the benefits of retired workers. … This is generally called a “pay as you go” (PAYGO) system. … Generation 1 invests time and income raising and educating Generation 2—during a time when, because of youth, Generation 2 cannot take care of itself. Then, Generation 2 invests income (if not time) taking care of Generation 1—during a time when, because of age, Generation 1 cannot take care of itself.

…[A] PAYGO system—such as Social Security—works fine as long as each generation reproduces itself. However, when you have the situation we do currently—a declining population (in some European countries and Japan) or, at least, a significant decrease in population growth—you have a problem financing a PAYGO system. Fewer workers are supporting more retirees—which is hard on Generation 2.

So, why don’t we make explicit the premise underlying PAYGO (that each retiring generation will depend on the productive ability of its progeny)? If you don’t reproduce (defined as raising and educating children), you don’t get a Social Security benefit. If you (“you” being defined here as a couple) don’t have (e.g., naturally or by adoption) and provide for any children, then you’ll have to pay for your own retirement. If you only have one child, you can collect half your benefit.

There are all sorts of quibbles that could be raised about this proposal: What about children who don’t survive to majority? What about foster children? What about single parents? And so on. All of these problems are solvable.

Bottom line: In a PAYGO system, people who, for whatever reason (choice, disability, or even legal impediments), do not have and raise children are free riders. When they retire, they will be living off the productive capacity of children someone else paid to raise and educate. However, … they should have more discretionary income than a comparable person who did have kids. … [They] should be required to use some of that spare cash to pay for their own retirement. …

I would extend this proposal to any social welfare system that is not means-tested and is funded on a PAYGO basis. I kind of think it would fix the (modest) problem we have with our Social Security system and the (significant) problem we have with Medicare.

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Michael Barry is President of the Plan Advisory Services Group, a consulting group that helps financial services corporations with the regulatory issues facing their plan sponsor clients. He has had 30 years’ experience in the benefits field, in law and consulting firms.