Retirement Readiness: Employee or Employer Responsibility?

There is a growing debate as to what role, if any, employers should play in their employees’ quest for retirement readiness. We clearly live in a defined contribution world now, which puts employees in the driver’s seat when it comes to responsibility for their own retirement readiness. Most employees, however, need some assistance with planning the route they should take and identifying their intended destination.

Increasingly, employers are realizing the significance retirement readiness can have on managing their workforces and the consequences of delayed retirements. A number of them recognize that helping employees navigate through the maze of issues related to retirement readiness can be mutually beneficial.

Saving More for Retirement May Not Be Enough

When it comes to saving for retirement, a 401(k) or defined contribution plan is usually the means and lifetime income is the end. Many employees, however, focus too much on the means and fail to recognize the end.

Plan participants have been encouraged to save for retirement, monitor their investment returns closely, and even seek professional investment guidance offered through their employer. The name of the game for most employees is asset accumulation. More is always better and the rates of return on investment funds are often their primary focus. Employees typically contribute enough to their 401(k) plan to maximize their employer’s match, but they are really not sure if that amount is enough to achieve a secure retirement.

The end game should not be just attaining a maximum savings amount. Instead, the amount saved should be a means to an end with lifetime income being the ultimate goal.

Knowing the Right Questions to Ask – and Answer

For some reason, $1 million seems like a noble savings goal. After all, who doesn’t want to be a millionaire? Undoubtedly, that’s a lot of money and certainly enough to live on, right?

Well, maybe. Employees won’t know for sure unless they can confidently answer some questions, such as: Are they on the path to a secure retirement? Will they save enough to replace 80% of their pre-retirement income? What do they expect to earn on their investments? How long do they expect to live? How much can they afford to withdraw from their account each year during retirement? How long will their money last?

Lifetime Income = Retirement Paycheck

Lifetime income can be thought of as the “retirement paycheck.” After all, why do employees save for retirement in the first place? They want to be able to afford to enjoy a secure retirement without having to work. If they do work, it is by choice and on their terms, with income being a secondary consideration.

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So then, how much is enough? While there are no hard and fast answers, there are rules of thumb and guidelines employees can follow to determine how much they should save. Experts often suggest that about 80% of preretirement income should enable an employee to maintain a standard of living throughout retirement that is comparable to one’s working years.

How much does an employee need to save to replace 80% of pre-retirement income? When factoring in Social Security, the answer for most employees is around 12 times pay by age 65. In many situations, an employee needs to be on a savings path of about 12% to 15% of pay each year, which includes an employer’s 401(k) match, to reach that level of savings. Savings alert: a 6% employee contribution and 3% employer match (9% total) may be good, but it may not be enough. There are a number of other factors that may affect the amount an employee needs to save, including other savings and retirement plans as well as the earnings and savings of a spouse.

Drawing Down Without Running Dry

How much can an employee afford to withdraw every year without running out of money? The “four percent rule” suggests that if an employee withdraws four percent of savings once retirement starts, and adjusts that amount every year for inflation, then there is a good chance that the savings will last 30 years, but there are no guarantees.

Another way to look at it is that each $1,000 of lifetime income requires about $25,000 in retirement savings. So that $1 million in savings an employee may strive for should generate about $40,000 each year. Yikes! Maybe $1 million isn’t enough?

Fortunately, there are new investment options emerging that are designed to mitigate longevity risk, which is the risk of running out of money during retirement. One new type of investment that was recently approved for use in tax-qualified defined contribution plans is a qualified longevity annuity contract or QLAC. A QLAC is a type of deferred income annuity that must comply with specific requirements to be offered in a 401(k) plan.

The Means to an End

Some have suggested that saving 10 times pay or even less is sufficient to live on during retirement. Others maintain that the four percent rule is flawed, especially during periods of market volatility.

Remember, these are guidelines and tips. They are starting points, not laws of math or nature. Actual results may vary according to individual situations. Nevertheless, it is helpful to use these guidelines to help employees think about not only the means but also the end.

Retirement readiness is about people, not just their investments. It’s important for employees to become familiar with the concept of lifetime income, not just their 401(k) balances and investment return percentages. Saving more for retirement is good. Employees and employers need to make sure it’s enough.

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