Retirement Readiness and Plan Reports for Healthcare Organizations
Providers and retirement industry insiders frequently use the term “retirement readiness,” but what does that expression actually mean? It generally indicates that a person has the financial resources to sustain them for the rest of their life without needing to work. So the question for a healthcare organization is, how does it know that the design of its program will lead to the retirement readiness of its staff?
That readiness result can be defined in several different ways. The goal of most retirement plans is to enable plan participants to maintain in retirement their pre-retirement standard of living. In a defined contribution style plan, the employer offers a retirement savings vehicle that allows employees to make pre and/or post tax contributions, and to select from an array of investment options. The employer may also contribute to that account, either through a matching contribution that requires the employee to contribute as well, or through a discretionary contribution, which does not necessitate employee contributions. The objective is to amass a sufficient level of annual income derived from a combination of all of these contributions, as well as the growth of the underlying investments and any amounts from Social Security. That level of income should allow the recipient to continue to live their lifestyle as desired, rather than being constrained by a scarcity of resources.
The projected annual amount is frequently referred to as “replacement income,” which is the amount of income replaced in retirement by the accumulated savings. That figure can be divided by the projected final working year’s salary to produce the “replacement ratio.” The retirement plan seeks to replace the final working year’s salary, because that projected salary is probably more representative of future lifestyle spending than the salary the person might be earning today.
Various methodologies address what level replacement ratio will enable participants to maintain an ongoing standard of living in retirement. Most of these approaches target around 80% of the final year’s salary. Note that the replacement ratio does not need to be 100% in order to maintain the same standard. The retiree may require less money for various reasons: the person is no longer saving for retirement, there is a reduction in transportation costs without the daily commute and people generally have lower housing costs, having paid off their mortgage by the time they reach retirement. Yet individual employee needs for retirement will vary dramatically, depending on personal circumstances and retirement goals. For example, someone who intends to travel in retirement will likely require significantly greater annual income than someone who will be staying close to home.
When healthcare organizations seek reports from their providers about the retirement readiness of their employees and the percentage that are on track to meet their replacement ratio target, they must still put the results in perspective. Just because the provider defines retirement readiness as an 80% replacement ratio does not mean that figure will be suitable for all employees. For instance, some people with projected replacement ratios of less than 80% may still easily meet their retirement needs. Furthermore, the information on which the projection is based is likely limited to the current plan, plus Social Security; in reality, the future income of the participants may also draw upon additional savings and accumulated assets, such as retirement plans from previous employers, outside IRAs or housing assets.
Some providers offer tools that enable participants to incorporate outside retirement plan information, such as data from a previous employer, or to enter website URL and password information, so the provider can pull the data from other sites (known as “scraping” technology). This background can help provide more detail about each person’s individual retirement picture, extending beyond the current employer’s plan. However, even if these tools are available, the participants still have to enter information into the provider’s website in order for this outside data to be included. Although the more engaged participants may take the time and effort to perform these actions, it is unlikely that a majority of participants will take advantage of this feature.
The retirement readiness report thus tends to reflect how well the current retirement plan is operating, assuming that participants only work for the one employer, regardless of the age at which they were hired. Employees who began with the healthcare organization at age fifty, for example, will probably not have a high replacement ratio.
Continuity is a key consideration. An employer cannot be expected to fund a person’s entire retirement, and have them on track toward meeting their replacement ratio targets, unless that person has worked for that employer for a significant portion of their career, typically twenty-five years or more. Accordingly, when the provider delivers the retirement readiness report, the healthcare organization should review the breakdown of participants in different age brackets, matched with years of service, to better assess whether or not the plan is achieving the goals for providing sufficient retirement income.
A crystal ball designed to pinpoint the future accumulated retirement savings for each person would make all of this planning much easier and more accurate. The tools that providers use to estimate these future amounts do continue to improve, by accounting for additional variables pre and post retirement. However, they are no more than estimates. If there were one correct formula, every provider would be using it. Absent of such an application, these calculations remain an inexact science.
Because they recognize these limitations, many healthcare organizations try to influence inputs over which there is more control, such as participation rates, contribution amounts and asset allocation. In that regard, behavioral finance economist Dr. Shlomo Benartzi speaks to the 90-10-90 principle. According to that theory, each plan should strive for 90% participation among employees, a 10% contribution rate, and an allocation of 90% of the assets towards diversified investments, such as target date funds, asset allocation funds or managed accounts. If a plan is meeting each of these target inputs, then the likelihood is much higher that the long term output will be that significantly more participants will achieve retirement readiness goals.
Of the three inputs above, the participation rate is the most important. The additional time for the compounding of investment gains and additional contributions outweighs the benefits of similar percentage increases in contribution rates and investment returns. Therefore, it is important to maintain careful scrutiny of the investment options, as well as a communication program to alert people to the program and get them enrolled (or an automatic enrollment process). Having the best investment options in the marketplace is obviously a plus for any retirement plan. Nevertheless, if the participants are not in the plan for a long enough period of time, additional returns from the investments will still not enable them to meet their goals.
Even the overall number of employees who are on track to meet their retirement needs is only a starting point. While it is an important gauge and a useful tool to plan evaluation, it must be carefully reviewed before taking action. Diving into the assumptions and recognizing what these analyses can and cannot measure is critical if a healthcare organization wishes to learn from the report and to consider any plan design or procedural adjustments to help the plan meet the employer and the employee goals.
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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