Workplace savings and plan design keys to retirement readiness

Workplace savings and plan design keys to retirement readiness

Edmund F. Murphy III

Without access to a workplace retirement savings plan, many people just don’t save.

It’s that simple.

Today there are roughly 50 million Americans without access to a retirement savings plan at work. Closing this “access gap” is the most important step we need to take in solving America’s retirement challenge.

According to Empower Retirement’s 2015 Lifetime Income Score survey1, employees without access to a workplace savings plan are estimated to be on track to replace just 42% of their current income in retirement.

That’s a serious pay cut.

Even when including Social Security, these workers are looking at having their income slashed by approximately 60% in retirement.

The advantage for Americans with access to a workplace savings plan, meanwhile, is quite substantial. Those with access to a plan (and making regular contributions) are on pace to replace 74%2 of their income in retirement.

The driver is obvious, but worth stating: saving by payroll deduction is much easier than individual, self-directed, voluntary savings. Employees need that nudge to make the commitment to save.

A recent study by the Employee Benefits Research Institute found that 73% of moderate-income workers ($30,000 and $50,000) – with access to a workplace savings plan do save for retirement. For those without access to a plan, less than 5% set up their own Individual Retirement Account (IRA)3.

Plan design boosts participation

That said, it’s about more than just having access to a plan. The Lifetime Income Score survey found that plan design features, such as automatic enrollment and automatic savings escalation, play a significant role in raising participation and savings rates. Those auto-enrolled in a workplace savings plan are on track to replace 82% of income in retirement, while auto-escalation lifts median income replacement to 92%2.

Now we’re starting to get much closer to success.

The 10% goal

Across the industry, a 3% deferral rate is a common default for workplace plans that automatically enroll employees, according to the Empower survey. But when saving at this rate, workers are estimated to replace just 60% of their income in retirement.

The survey found that, overall, working Americans – at the median – are on track to replace 58% of their working income once they retire. That’s not going to be enough in retirement.

Workers who are able to defer 10%, including company matches, put themselves on track to replace 106% of their annual earnings. The good news is that approximately 30 million Americans are saving at a rate of 10% or more4. It’s important that 10% becomes the new norm for savings deferrals for all workers.

Many industry leaders have already embraced this goal. The Financial Services Roundtable, for example, recently announced its “Save 10” initiative to encourage employers to guide their employees on the path toward saving 10% of their income5.

The term “crisis” is used many times in describing the state of the retirement system in this country. In reality, we are facing a retirement savings challenge. And it’s a challenge that can be solved.

The solution begins with closing the access gap.

1 Empower Retirement, Lifetime Income Score V: Optimism and opportunity, March 2015.
2 The Lifetime Income Score represents an estimate of the percentage of current income an individual might need to replace from savings in order to fund retirement expenses. This income estimate is based on the individual’s amount of current savings as well as future contributions to savings (as provided by participants in the survey) and includes investments in 401(k) plans, IRAs, taxable accounts, variable annuities, cash value of life insurance, and income from defined benefit pension plans. It also includes future wage growth from present age (e.g., 45) to the retirement age of 65 (1% greater than the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), as well as an estimate for future Social Security benefits.
The calculations also take into account mortality rates for a variety of commonly diagnosed health conditions, including high blood pressure, high cholesterol, Type 2 Diabetes, cancer of any type, and cardiovascular disease of any type apart from high blood pressure. In addition, the model also takes into account the consistent use of tobacco on a household basis.
The Lifetime Income Score estimate is derived from the present value discounting of the future cash flows associated with an individual’s retirement savings and expenses. It incorporates the uncertainty around investment returns (consistent with historical return volatility) as well as the mortality uncertainty that creates a retirement horizon of indeterminate length. Specifically, the Lifetime Income Score procedure begins with the selection of a present value discount rate based on the individual’s current retirement asset allocation (stocks, bonds, and cash). A rate is determined from historical returns such that 90% of the empirical observations of the returns associated with the asset allocation are greater than the selected discount rate. This rate is then used for all discounting of the survival probability-weighted cash flows to derive a present value of a retirement plan.
Alternative spending levels in retirement are examined in conjunction with the discounting process until the present value of cash flows is exactly zero. The spending level that generates a zero retirement plan present value is the income estimate selected as the basis for the Lifetime Income Score. In other words, it is an income level that is consistent with a 90% confidence in funding retirement. It is viewed as a “sustainable” spending level and one that is an appropriate benchmark for retirement planning.
The survey is not a prediction, and results may be higher or lower based on actual market returns.
3 Source: Employee Benefits Research Institute (August 2013) estimate using 2012 Panel of SIPP (Covered by an Employer Plan) and EBRI estimate (Not Covered by an Employer Plan-IRA only).
4 Source: Household data estimated from the Current Population Survey and Bureau of Labor Statistics.
5 Source: Financial Services Roundtable, “Coalition Starts Drive to Get Employers to Push Workers to Save 10% of Pay”
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