Retirement Reality

Without question, the 401(k) plan has come a tremendously long way since its inception more than three decades ago. It has been transformed by automatic enrollment, automatic escalation, target-date funds (TDFs), fully-engaged investment committees, education and advice.

But a look at balance averages and the percentage of people who will actually be able to retire with an 80% or higher income replacement—the generally agreed-upon statistic for a comfortable retirement—makes it obvious that plan advisers have far more work ahead of them to steer plan sponsors and participants to successful outcomes. Experts agree that advisers need to convince sponsors to raise automatic defaults and escalation, educate participants about how even a 1% increase in savings can make a difference, and help participants convert their retirement savings account balances into a monthly retirement income figure.

The most alarming data come from the Employee Benefit Research Institute (EBRI)’s 23rd annual Retirement Confidence Survey, released in March. The EBRI report found that only 66% of individuals and/or their spouses have begun saving for retirement, 57% have less than $25,000 saved, and 28% have less than $1,000.

Figures from Fidelity Investments paint a more optimistic picture but still come up short. The average 401(k) balance administered by Fidelity reached $80,900 at the end of the first quarter of this year, up 8.4% from $74,600 in the first quarter of 2012 and 75% higher than the market low of $46,200 in the first quarter of 2009. For workers ages 55 and older who have been with their current employer for 10 years or longer, the average balance in the first quarter of this year reached $255,000—nearly double the market low of the first quarter of 2009 when balances dipped to $130,700.

If one were to convert the $80,900 balance into retirement income at the recommended annual 3% withdrawal rate, that would yield $2,427 per year, notes John Bucsek, managing director with MetLife Solutions Group in Cranford, New Jersey. The $255,000 balance would generate $7,650. “If you have a $1 million 401(k) balance, you may think you are all set, but that produces $30,000 a year,” Bucsek says. “To replace a $100,000-a-year lifestyle in retirement [not including Social Security], you would need $3 million.”

“Retirement Security Across Generations,” a report that The Pew Charitable Trust released in June, indicates that procrastination and debt are hobbling investors, putting only 50% of Generation X, 59% of late Boomers and 82% of early Boomers on track for a comfortable retirement (see chart, “Retirement Income Replacement,” on page 50). It is no wonder, then, that a Lincoln Financial Group survey found that a mere 18% of those on the doorstep of retirement—investors between the ages of 55 and 64—say they feel “very prepared” for the next stage of their lives.

“The fact that such a large percentage of Americans closest to retirement say they feel ill-prepared is alarming,” says Dennis R. Glass, president and CEO of Lincoln Financial Group in Radnor, Pennsylvania. “It is important, now more than ever, that people be empowered to take charge by viewing financial concerns through a lens of opportunity, not through one of insurmountable challenge.”

‘Make 6% the New 3%’

The best way to help employees and plan participants, many in the industry agree, is to simply take them out of the equation. Therefore, plan designs such as auto-enrollment, auto-escalation and re-enrollment are the underpinnings for improvement—aids that advisers should encourage plan sponsors to use far more aggressively, says Beth McHugh, vice president of retirement thought leadership at Fidelity Investments in Boston. “Six percent should be the new 3% for the initial default, with 2% annual escalations up to a ceiling of 15%,” McHugh says. “We cannot emphasize this enough: You need to save—and save at meaningful rates. The younger you start saving at a higher rate, the better off you will be, no matter how the market performs.”

This is borne out, McHugh notes, by the average $255,000 balances in the 401(k) plans of those investors who remained committed to their plans over the past 10 years. These investors deferred an average of 10.3% of their salaries. With an average employer match of 4.5%, their total contributions were 14.8%. McHugh calls this record average balance “encouraging” but acknowledges more work needs to be done.

As plan sponsors witness only a fraction of their employees opting out of higher defaults, and as advisers point out significant increases in the percentage of employees on track for a successful retirement, sponsors are becoming more receptive to higher standards, McHugh says. Retirement plan advisers must continue to advocate that sponsors raise the bar, as well as to help them gauge costs and reconfigure their matches, she continues.

“You cannot underestimate the impact of plan design,” McHugh says. “When you set an ‘auto’ default at 3%, it will take someone a very long time, even with an annual 1% escalation, to get to 10%. Our data has consistently shown that, if you set the default at 6%, you are not going to see an opt-out, so why not set it at a higher rate along with 2% escalation? You need to help people get to [total] savings of 15% or higher.”

Getting sponsors to up the ante is evidently going to take concerted effort by retirement plan advisers. While adoption of automatic features is gaining traction among plan sponsors, it is not the choice for the majority, data from PLANSPONSOR’s annual Defined Contribution (DC) Survey show. Automatic enrollment appeared in 41.7% of all plans in 2012, up from 33.4% in 2011, and automatic escalation was employed by less than one-third (29.6%) of all plans in 2012, up from 16.7% in 2011. The most common deferral rate for automatic enrollment is 3%, used by nearly half (45.6%).

Further, according to the PLANSPONSOR data, sponsors primarily rely on participation rates (65.2%) and employee satisfaction surveys (17.7%)—rather than increases in deferral rates (8.7%) or projected retirement income (3.3%)—to gauge plan success.

The emerging concepts of retirement readiness and plan health will, hopefully, change this, experts say. In fact, investment companies and recordkeepers have begun offering advisers tools they can use to show plan sponsors how prepared their work force is for retirement and to prompt them to reassess their plan design to improve such data. The Principal, for instance, launched a retirement readiness initiative in July that features customized “Retirement Readiness Reports” to help employers understand how well participants are saving for retirement and how plan design features can help increase savings rates. ADP recently introduced the “Plan Health Review” to provide plan sponsors with details about participation rates, deferral percentages, investment usage, loans and withdrawals.

“When you talk with sponsors about their plans’ aggregate retirement readiness and discover that only 10% or 15% or 20% of their employees are on track to be ready for retirement, it’s a powerful motivator,” says Michael Preisz, an adviser with Preisz Associates in Portland, Oregon. “We provide new clients with a baseline and, each year, data on improvements on balances, savings rates and projected income. Only 13% of one new client’s employees were on track for retirement. After we got [participants] to increase contributions, we got them to 21% in one year and to 42% in the second year. Next year, we will be well over 50%.”

Revealing the overall financial wellness of a sponsor’s retirement plan gives advisers the leverage “to help them redesign the plan and show incredible, tangible value to their plan sponsor clients,” agrees Kevin Crain, head of institutional retirement and benefit services for Bank of America Merrill Lynch in Hopewell, New Jersey. “The majority of our plan sponsor clients are offering some combination of auto-enroll, auto-increase and advice. From that, we are seeing significant lifts in employees’ financial security. In the past four years, balances in our book of business have grown 40%.”

Meaningful Communication

Many people delay saving for retirement until they have raised a family and seen their children graduate from college, Bucsek says. “If a 62-year-old suddenly realizes he has a big savings gap, he is limited,” he says. “To really address the problem, we need to talk to people in their 20s and 30s to help them understand [that] the dollar that is going to help them is the dollar they put away today. Younger people should be required to attend education meetings to learn about the benefits of compounding.”

At enrollment meetings attended by younger participants, Jeff Gitterman, CEO of Gitterman & Associates Wealth Management in Iselin, New Jersey, enlists employees in their later 20s to talk about the importance of retirement savings. No matter how modest their salary, Gitterman says, “by showing them how starting at 20 rather than 25 results in hundreds of thousands of dollars, we try to convince them that it is not futile to save and that other financial goals should not get in the way.”

With younger savers, for whom retirement is a far-off concern, Preisz says, “You have to talk about broader financial wellness and discuss other issues, such as saving for a house or paying off education or credit card debt. Those are more pressing issues for them, but we have found that if we can provide a holistic approach, it results in a higher retirement plan savings rate, as well.”

Even an “additional 1% ­contribution can make a huge difference, depending on what the participant was contributing before,” Gitterman continues. “If you were only contributing 1% and go to 2%, that’s double what you were saving. If you were saving 3% and add another 1%, that’s 33% more you’ll have in retirement.”

Retirement plan advisers wield considerable influence over savings rates, says Rick Mason, president of corporate markets for ING U.S. Retirement in New York. “According to a recent study, ‘Adviser Value,’ commissioned by the ING Retirement Research Institute,” Mason says, “individuals who work with an adviser are more likely to participate in their employer-sponsored retirement plan, and at higher contribution rates—10% vs. 8% for those who do not work with an adviser. They also have $62,000 more in total retirement savings and are more confident about their preparedness for retirement [77%] than those who do not work with an adviser [43%].”

Advisers must work with participants to get them to take an interest in their retirement preparedness, Crain says. “People have to understand that these 401(k) programs are their primary resource for retirement. They cannot rely on Social Security. Through seminars, webinars, mobile communication, calculators, education and advice, advisers can get them to take an interest.”

A Tangible Figure

“We really need to drive engagement, to get individuals to take the time to evaluate where they are with respect to where they need to be,” McHugh says. One way to do this is to tell people how many multiples of their salary they should have saved at various ages, she says.

Another way is to convert a person’s balance and savings rate into projected monthly income at retirement, Preisz says. “Converting a person’s balance into income makes it tangible. People can see they are not doing very well and that they need to do better,” he says. “It definitely changes their savings behavior and improves outcomes. Otherwise, retirement planning is a vague number for most people.”

J.P. Morgan puts the participants’ retirement income replacement number front and center on their online accounts, and the number is embedded in every communication that participants receive concerning their retirement accounts, Carol Waddell, head of product and marketing at J.P. Morgan Retirement Plan Services, said at the 2013 PLANSPONSOR National Conference. J.P. Morgan’s call center also mentions the number to participants during every conversation.

Retirement income conversion could even become a requirement, as the Department of Labor (DOL) is considering a rule that would require defined contribution (DC) plans to provide benefit statement estimates of the monthly annuity that participants’ account balances could buy.

“There’s so much focus on returns. The question should really be, ‘What do I need to save?’” Bucsek says. “The adviser’s role is to sit down with the employers and employees and do everything he can to encourage them to save as much as they can in their 401(k) plan.” Getting people to maximize their savings will take time, Bucsek says, “but if advisers provide this education, their businesses will grow at a much faster rate because they are doing the right thing. That is the awesome responsibility—and opportunity—we have as advisers.”

Health Care Costs

Retirees will face steep health care costs, and retirement plan advisers must include this fact in their conversations with plan sponsors and participants, experts say. Fidelity Investments projects that a 65-year-old couple retiring this year will need $220,000 to pay for health care throughout their retirement years, not even including the cost of long-term care such as a nursing home.

Based on 401(k) average balance data, “that $220,000 cost doesn’t leave you a lot of discretionary spending throughout retirement,” notes Fidelity’s Beth McHugh. “Individuals really need to think about how healthy they are likely to be in retirement and how much they need to save in their health savings account [HSA]. They should view it as a long-term health care savings vehicle rather than just a health spending account.”

As more Americans become aware of their longevity risks, health care costs have become a necessary component of a retirement plan adviser’s participant education. Fifty percent of people have discussed longevity with their doctor, 40% with a spouse or partner, 34% with their children and 21% with a professional adviser, according to a survey released in March by Bankers Life and Casualty Company’s Center for a Secure Retirement.

“Health care cost is the biggest question we get from clients in their 50s and 60s,” says Jeff Gitterman of Gitterman & Associates Wealth Management. “We also talk about long-term care and rising longevity, which is only going to make matters worse. It is a difficult yet critical conversation.”

Luckily, investment companies have begun providing tools to help plan participants estimate health care costs. Putnam Investments, for instance, recently introduced the Putnam Health Cost Estimator, which provides 401(k) plan participants with a personalized estimate of what portion of their expected future monthly income will be needed to cover health care costs in retirement. The estimator asks participants about their habits and any pre-existing conditions, such as high blood pressure or Type 2 diabetes, and provides itemized insight on medical, dental and pharmaceutical expenses at different age points.

Likewise, ING U.S. has created retirement income practice management guidance for advisers that includes information about health care and longevity, and software firm HealthView Services has launched a platform called HealthWealthLink. It enables retirement plan advisers to generate personalized reports on projected life expectancy and health care expenses in retirement, as well as how an individual can maximize Medicare and Social Security to help meet these costs.