Retirement readiness means having saved enough over one’s working years to convert those savings to a lifetime income stream that allows living comfortably throughout retirement.
It may seem like a simple proposition, but the path to get there isn’t always clear.
In the past, Americans counted on defined-benefit (DB) retirement plans, such as pensions, to provide income for life. However, while some workers—especially in the public sector—may have DB plans today, most don’t.
Instead, defined-contribution (DC) plans, such as 401(k) plans, have taken their place as the primary retirement savings vehicle.
The problem is, 401(k) plans were designed as supplemental accounts to be used in conjunction with guaranteed retirement income from a DB plan and Social Security payments—not as primary sources of income.
While DB plans have started disappearing from the marketplace, time spent in retirement has increased. Today, people are living longer, meaning they may need to stretch a lump sum of savings over a decades-long retirement (longevity risk).
In addition, there’s market risk, where market crashes or recessions may cause retirees to experience significant income declines. Also, as interest rates rise, fixed income values fall, so interest rate risk is of particular concern to people in retirement who typically shift assets toward fixed income investments.
Lastly, aging may impact the ability to make financial and other key decisions; this is known as cognitive risk.
These risks have heightened the need for more holistic retirement preparation and effective DC plan design.
The new role of DC retirement plans is to help ensure that people have the income they need throughout retirement. This includes replacing income traditionally provided by DB plans and planning to make up for any unanticipated shortfall in what Social Security provides.
This will require a new approach to retirement savings—a partnership between workers, employers, and plan providers to generate guaranteed retirement income through DC plans.
The not-for-profit sector may have lessons to share with the broader industry to improve outcomes in this regard.
For example, many NFP sponsors have relied on 403(b) plans—a type of DC plan that focuses on delivering retirement income—for decades.
Rather than serve a supplemental retirement savings plan, 403(b) plans were designed as a core retirement plan, with the goal of helping participants generate income for life.
What follows are four elements that are part of 403(b) plans’ comprehensive approach to helping their employees pursue retirement readiness:
1. Make retirement income the plan goal.
While most savers like to see their account balances grow, a better target for retirement savers is how much income they’ll need in retirement.
Planning decades into the future is an inexact science, but metrics such as income replacement ratios can help employees gauge their future needs and make adjustments like changing contribution rates or their asset allocation to stay on track.
By tracking income replacement at the plan level, plan sponsors can zero in on segments of employees that are falling short of income goals and need additional support.
2. Encourage savings rates to support stronger outcomes.
Too many plans—particularly in the 401(k)/for-profit world—feature savings rates that are below what is needed to build a proper retirement income.
In contrast, not-for-profit DC plans actively take an outcomes-focused approach.
Our clients have strong income replacement ratios on average, partially because of a robust combined employer and employee contribution rate which averages 14 percent. This is well within the industry-recommended savings rate of 10% to 15% of compensation.
3. Offer a diverse investment menu and actually consider your default investments.
Participants who take an active role in their retirement planning can benefit from a diverse investment menu that offers access to both growth potential and lifetime income options.
Participants who are less involved may benefit from having a default investment option that provides a lifetime income component.
This is especially true for the more than one-third of Americans who expect a target-date fund (TDF)—the most common default option—to provide a guaranteed monthly income check for the length of their retirement.
That isn’t what TDFs provide. We need to ensure plan sponsors and their consultants, as fiduciaries, can choose and offer income-oriented solutions for the retirement plan default options.
Especially since 70% of new hires choose—or actually more likely do nothing and default into—the default option in their plan.
4. Encourage participants to access education and advice.
Seventy-one percent of not-for-profit plan sponsors said engaging employees in their retirement plan is a significant challenge. But, participant research shows that providing professional advice may encourage participants to act.
Almost half of participants receiving our retirement plan advice either online or by working with a consultant chose to save more, adjust their portfolio allocation or rebalance. (This is from our advice analysis of 176,279 of our participants who received retirement plan advice online or working with a consultant and took action in the 12 months ending 8/30/16. The overall action rate of 48% included 11% who chose to save more, 32% changed their future allocations and 31.5% rebalanced their portfolio.)
Plan sponsors can also engage employees with digital tools that educate and motivate people to take action. For example, one way to reach plan participants on topics such as retirement, investing and savings is through gaming.
Contests and quizzes can help increase financial education by leveraging features like leaderboards and friendly competition.
Charting a course for the future
According to our latest Lifetime Income Survey, 73% of Americans are looking for certainty. They want their retirement plans to provide guaranteed money every month and to ensure that their savings will be safe, regardless of market conditions.
Looking to the future of retirement in America, the not-for-profit industry may have best practices to share. For decades, higher education institutions and others in the nonprofit world have offered retirement plans that include income security that is missing from other DC plans.
If a broader range of DC plans consider adopting 403(b) plan features, the path to retirement readiness may become easier to navigate for all American workers.
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