Are Saving More and Working Later the Only Options to Improve Retirement Readiness?

Researchers from State Street Global Advisors suggest policy changes that could improve retirement readiness for younger workers and late savers.

In a Pension Research Council working paper, Catherine Reilly, senior investment strategist, defined contribution, at State Street Global Advisors (SSGA), and Alistair Byrne, head of investment strategy, European defined contribution, at SSGA, state that expected low market returns paired with increasing longevity will make it tougher for future retirees to have sufficient income replacement rates in retirement.

After performing an analysis based on certain assumptions so that only the effect of lower expected market returns is measured, the researchers find that a hypothetical individual currently 60 years old and who retires at age 65, having been saving since age 22, could expect to achieve a 211% replacement rate from his defined contribution (DC) savings alone. In addition, he can expect to receive Social Security and may well have some defined benefit (DB) plan benefits as well. The paper authors note that while few 60-year-olds may have been in a DC plan since the age of 22, they could have made contributions to a retirement savings account by themselves.

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By contrast, an individual currently 25 years old and who employs the same saving strategy could expect to achieve a 27% replacement rate from his DC plan if he was to retire at age 65. Furthermore, the younger individual is unlikely to have any DB entitlements and faces more uncertainty regarding the amount of Social Security that he will receive. The researchers note a 45-year-old individual can expect better outcomes than the 25-year-old but is also disadvantaged compared to the 60-year-old.

The researchers contend that the most obvious tactics that younger workers could adopt to improve their situation are to contribute more and to work longer. For example, a 25-year-old could reach a 40% replacement rate by contributing about 13.5% and working until age 65; by contributing slightly above 10% and working to age 70, or by contributing about 7% and working to age 75. A 35- or 45-year-old benefits from stronger historical returns, so either can achieve the target replacement rate at slightly lower contribution rates. The researchers also note that individuals who start the retirement saving journey late face more challenges, yet they can also significantly improve their retirement readiness with a disciplined approach to saving and by postponing retirement.

However, this assumes consistent savings behavior during the entire working life, no career breaks, and no leakage from retirement savings.

NEXT: Suggestions to Improve Retirement Readiness

The researchers suggest policy changes that could improve retirement outcomes for younger individuals and/or late savers. One alternative policy would be to allow individuals to take out partial Social Security benefits rather than obliging them to always take the full benefit. For example, the paper notes, in Sweden, people who have reached the minimum age of eligibility for Social Security (62) can take a 25%, 50%, 75%, or 100% benefit, and modify this percentage when desired at an actuarially fair rate. There is also no maximum age by which full payments must start. Another option would be to give people a choice to defer the start of Social Security benefits beyond age 70, to make the most efficient use of Social Security’s cost-efficient longevity insurance. “This would make it possible to use Social Security as a longevity backstop providing the main source of income in late life, rather than a steady source of income throughout retirement,” the paper says.

As an example, the researchers note that in Australia, eligibility for the Age Pension is based on an asset test, reassessed annually, rather than retirees’ age. People are not eligible for the Age Pension until they have drawn their assets down to a minimum level, after which they receive a flat rate Age Pension for the rest of their lives.

Other than Social Security policy changes, the researchers suggest mandating automatic enrollment in DC plans and automatically escalating contribution rates would be effective for improving retirement outcomes. In addition, they note that matching contributions encourage voluntary employee contributions up to the match threshold. Reducing retirement plan leakage would also be helpful.

The researchers note that although some people may not be physically able to work full-time past retirement age, part-time work may be feasible for many.  A question the researchers posed, but did not address fully is how employers will facilitate and value older workers.

The full working paper is available here.

Participants Prefer Personalized On-Demand Advice

When asked how they would like to receive advice, respondents reported preferences for receiving advice as often as they have questions and through channels like email and 1:1 sessions, according to a new study by Betterment.

Most 401(k) participants prefer to receive advice on their retirement investments through email and one-on-one counselling sessions, according to a survey by Betterment for Business, the technology-focused 401(k) provider. 

The “most preferred cadence” for advice was “as often as a question arises” (28%), suggesting a need for personalized, on-demand advice. The study also identifies room for improvement in terms of how advisers are interacting with current and potential clients. 

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In fact, most participants surveyed (53%) say they receive no advice on their retirement investments at all. This statistic is of particular concern considering separate studies projecting low returns for the long-term and participants’ common misconceptions about retirement savings.

Nonetheless, the Betterment study finds that financial advisers remain the most utilized source for retirement advice among those who seek it. Of these, 65% work with a financial adviser, as opposed to other potential sources of guidance, such as a bank or an insurance agent. Most say they either fully trust or place a lot of trust in their financial advisers.

Betterment notes that this data arises as news around the Department of Labor (DOL) fiduciary rule reveals to many consumers that the financial advice they received on retirement investments could be subject to conflicts of interest. However, the firm’s survey found that fiduciary awareness is still just taking hold. Only 42% of respondents correctly identified what a fiduciary is in the retirement planning context. Moreover, 27% did not know what a fiduciary was at all, and 20% believed financial adviser and fiduciary were synonymous.

Of those aware of the details of the changing fiduciary duty, 84% still have taken no action, such as asking whether their personal advisers are fiduciaries. But of those that did take action, 48% decided to find a new adviser.

“The recent fiduciary ruling developments have spurred conversation around what credible advice should look like, and many advocates of the rule have hoped that investors would demand accountability from their financial professionals,” observes Jon Stein, CEO, Betterment. “All savers have the right to sound, reliable and personalized advice on their retirement investments, and as people demand and exercise that right, retirement outcomes can improve.”

In addition, the Betterment survey shed light on how participants are saving. Consistent with previous reports, it noted that automatic features seem to be boosting participation. The survey found that 94% of participants with auto-enrollment continue contributing to their plans. Half even increased their contributions. Most (78%) also didn’t opt out of auto-escalation. Betterment notes, “Millennials seem to like auto-escalation—but in practice, might not be using it most effectively, further underscoring the need for relevant, timely advice and education.”

Betterment for Business’s Consumer Retirement Advice Report was produced with data from 1,051 consumers who work at small and medium-sized businesses and currently contribute to their employer-sponsored 401(k) plans.

For more information, visit BettermentforBusiness.com.

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