Are You Ready for Retirement Readiness?
As a recent Profit Sharing Council of America Survey indicates, the issue of retirement readiness has become one of increasing concern among plan sponsors. In fact, the study reveals that nearly 90% of respondents now measure participant outcomes in achieving retirement readiness. In this article, we will examine the issue of retirement readiness and how advisors and recordkeepers can provide valuable assistance.
Retirement Readiness | The Basics
Retirement Readiness is actually not a new concept; those of you who have worked with retirement plans for many years may know the concept by it is former not-so-sexy name, gap analysis. To determine a participant's retirement readiness, a calculation is performed to determine the participant's income needs in retirement. Then, a calculation of a participant's anticipated retirement income stream (including pension, Social Security, and other defined contribution retirement plans) is performed. The difference between the two figures is the retirement "gap" or the degree to which a participant is or is not ready for retirement.
For some participants, their retirement income stream will actually exceed their retirement income need. In this situation, there will be no "gap," as the participant's degree of retirement readiness will be high. This can be true of participants with generous pension benefits and/or those who have worked with advisors and other plan professionals to save and invest in a fashion that ensures retirement readiness. However, most participants have some sort of "gap," ranging from small to cavernous.
Many plan recordkeepers provide automated calculation tools to determine the degree to which each participant in a retirement plan is ready for retirement. However, as is the case with most calculations, the "garbage in, garbage out" rule applies; the tools are only as effective as the input data. In addition, calculation assumptions regarding the precise level of retirement income needed for a particular participant can vary widely. Thus, whether the actual calculations for each participant will prove to be correct at retirement is questionable. Regardless of accuracy, the retirement readiness calculator is viewed as a possible motivator of positive participant behavior, since most participants will have "gaps" that can only be filled by behavioral changes.
Retirement Readiness | The Concern
Why has retirement readiness become an increasing concern for plan sponsors? While gap analysis has been performed for many years, the transition from a traditional pension system to a defined contribution model has resulted in an increasing number of individuals with insufficient retirement savings. This was especially apparent as the "baby boomer" generation reached retirement age. Many of these individuals had to work past their normal retirement date, in some cases for several years, in order to secure sufficient retirement income. This, in turn, blocked other individuals within the organization from advancing into their positions, ultimately affecting employee retention.
At organizations where traditional pensions exist, the effect has been less pronounced. However, as traditional pensions are reduced, or even eliminated, for new hires, retirement readiness will decrease as well. Moreover, the impact on a public entity can be more pronounced than at a private tax-exempt, since the result of individuals working years beyond their scheduled retirement can directly affect the budget. For example, the replacement of a civil service retiree would, in most cases, be hired at a lower pay scale. And, due to the time value of money, the time to take action for such individuals is NOT at retirement age, but early on in their working careers.
Retirement Readiness | The Solution
If plan sponsors could wave a magic wand and fill the income gap of their retirees they would clearly do so. But of course, there is no "magic bullet," and the methods for increasing retirement readiness involve changing participant behavior in an area where participant inertia is the norm. Automatic enrollment and other automated strategies such as auto-deferral increase and QDIAs, can assist with retirement readiness, but are no panacea. Furthermore, auto-enrollment can be difficult to implement for public and church plan sponsors whose plans are not subject to ERISA (though some such plans utilize the similar employee mandatory contribution strategy).
Where inertia is a powerful motivator, it can be difficult to affect the participant behavioral changes that can impact retirement readiness. However, some plan recordkeepers have commenced the process by using available data to identify those who have retirement income gaps and isolating the cause. With this knowledge, recordkeepers can work with participants to implement solutions. For some participants, the solution may be as simple as the reversal of making inappropriate investment decisions with their account (such as buying high and selling low), but for many, tougher choices are required, such as foregoing additional income to increase savings for retirement.
While readiness itself is not a new concept, the measurement of retirement readiness improvement initiatives is not a well-mined area; though there are some case studies where successful initiatives have been implemented. The active involvement of the plan sponsor, recordkeeper, and advisor in a coordinated, customized education campaign to improve participant retirement outcomes may be worth the effort.
The problem of retirement readiness is a significant one, and there are no simple solutions. However, it would appear that the ability to "move the needle" and positively impact participant retirement readiness is yet another plan metric to which the prudent plan sponsor will devote time and effort.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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