Consider this: A young woman enters
the workforce at age 25 and is automatically enrolled in a defined
contribution (DC) plan at 3% of pay. The plan automatically escalates
her deferral by 1% until the woman is deferring 10% of pay annually.
When you add to this a safe harbor match and give the participant 7% per
year returns, she theoretically retires by age 60 a wealthy woman.
great, right? However, as John Lowell, partner and retirement actuary
with October Three, who is based in Atlanta, notes, this is rarely
reality. What if the woman gets married and has children and stops work
to take care of the children? Or, what if the woman has a period of time
where paying for child care costs, a mortgage or health care urges her
to reduce her deferrals or to take a loan from her DC plan? What if she
involuntarily loses her job? In addition, Lowell says DC plan
participants should understand that 7% per year returns is not a reality.
is the problem with retirement savings models, says Drew Carrington,
head of Franklin Templeton Investments’ U.S. large market institutional
defined contribution (DC) business, who is based in San Mateo,
California. “It is also partly a more generalized problem in the
[retirement] industry to oversimplify the retirement challenge,” he
Almost all of these assumptions are wrong, he
says. People change jobs every five or so years; many new hires will not
be fresh out of college and have probably saved somewhere else. Models
simplify decisions about retirement, including when a person will retire
and when they will claim Social Security. “These are usually household
decisions, but models are for individuals,” he notes.
that every time you throw market volatility in the mix, even if it has a
mathematical average equal to the assumption, it will bring the outcome
down. As a simple example, Lowell says, if the woman in the example has
a zero return in year one, then a 14% return in year two, the
cumulative return is not 7% compounded, it’s less. NEXT: Adjusting for reality