Participant retirement readiness, demystified

Transcription

1 Participant retirement readiness, demystified Summary The key to participant retirement readiness is a simple proposition: save throughout your career and invest in a diversified mix of stocks, bonds and stable value. The simplicity often gets shrouded in complexity by the media, the fact the average participant is not financially sophisticated, and the reality most people see retirement as too far away to be interested at all. Engagement by plan participants, however, has to increase as the burden for securing a successful financial future in retirement has shifted away from the employer and the government and has fallen squarely on employees. In addition, the last market correction, which impacted people close to retirement, has dramatically changed that perspective for the DC plan. To ensure sufficient retirement income in the future, participants need to know two things: 1. Start saving early and save a meaningful amount. 2. Risk has a time and place. Save early, save enough When it comes right down to it, the bedrock of a healthy retirement savings account is the amount of savings put into it. Even a good market can only take an account balance so high. Consistent, long-term savings is an important factor to achieving retirement readiness. The fundamentals of adequate savings can include: As a general rule, participants need to save about 10% of their annual salary, which can be offset by employer match, to achieve an adequate replacement income at retirement. Time is an important factor in achieving retirement readiness. The 10% annual saving threshold, assumes the participant begins saving at age 25 and has 40 years of savings to reach at least 75% of pre-retirement income. Waiting just 10 years to begin saving at age 35 for retirement will require saving 15% to 18% annually to reach 75% of pre-retirement income. Waiting 20 years may jeopardize the chance of ever reaching the goal. Retirement Strategies

2 Participants need to accumulate approximately 8 to 10 times their at-retirement salary to achieve an adequate replacement income level at retirement Save well and take calculated risks Contrary to popular belief, increased risk in a participant s retirement portfolio does not necessarily translate to more income. In fact, where risk is concerned, there is a right time and place and many wrong ones. The fundamentals of an effective investment strategy include: There is 20 years or more until retirement, participants may experience an increase in retirement income with a change to a riskier investment portfolio. Contrary to popular belief, participants are not able to close the retirement income gap by investing in a riskier portfolio when they are 10 to 15 years from retirement. Investing in riskier portfolios closer to retirement may have a detrimental effect on account balance due to the volatility of the portfolio and the short time frame for recovery in the event markets go down. This paper explores both of these key points in detail, including the findings of extensive research MassMutual has undertaken on the topic. We will frame these key points through two different sample participants who are currently 65 years old. They plan to retire at age 67 and expect to need 75% of pre-retirement income, adjusted for inflation, throughout retirement. The only difference between the two participants is their current annual salary: Participant A s current annual salary is $75,000. Participant B s current annual salary is $150,000. The paper concludes with profiles of four successful retirement savers and the respective paths they have taken throughout their working careers. As part of the conclusion, the paper also explores some differences between male and female participants. The profiles can be used to help you educate and guide participants to specific actions they may want to take to have the best chance of being retirement ready. Save early, save enough All too often, the experts put too much emphasis on investing, investment fees and access to mutual funds in a retirement plan. While investments are important, the single most important factor in retirement readiness success is saving in an employer-sponsored retirement plan at a meaningful rate consistently over one s working career. For the purposes of this paper, we have defined a meaningful rate as annual savings of at least 10%. To understand why we have chosen 10%, see Exhibits 1 and 2. In Exhibit 1, both Participant A and Participant B would have needed to begin saving 10% annually when they were 25 years old to reach the desired 75% replacement income level at retirement age. Anything short of that amount would likely not have yielded the desired replacement income, as is shown in Exhibit 2. By starting at only 5% annually at ages 25 or 35, both participants will experience a further reduction of about 23% of their replacement income at retirement off what they would have been able to replace if they had started saving at 10% at these ages. Therefore, if we want to talk about how best to make meaningful strides toward retirement readiness, starting at 10% annually around the time one typically begins their working years will help put participants on a good path to a secure retirement.

3 Savings Rate Exhibit 1 1 Savings rate to achieve > = 75% pre-retirement income with no current account balance at age XX 30% 25% 20% 15% 10% 5% 0% 10.0% Age % 14.5% Age % 27.0% N/A Age 45 Participant A Participant B Note: N/A = 75% pre-retirement income is not attainable within current IRS contribution limits in a DC plan. Exhibit 2 2 Income achieved at retirement when saving begins at age XX 80% 75.0% If Participant A and Participant B waited until they were 35 years old to begin saving, they would need to save 14.5% and 18%, respectively, to achieve the same desired income level at retirement. Some participants find the thought of saving 10% daunting, but the fact of the matter is the longer a participant waits to begin saving, the more he or she will have to contribute annually to achieve the level of retirement income he or she wants at the age at which he or she wants to retire. To illustrate this better, take a look at Exhibit 3, which shows the impact of starting saving at the 10% rate at various ages. The 10 years of missed savings and returns between 25 and 35 years old equates to an 11% income reduction for Participant A and a 21% income reduction for Participant B (see Exhibit 3). If both waited to save until age 45, only Participant A would be able to achieve the desired income goal, but would have to save 27% annually to do so. Participant B would not be able to reach the desired goal with additional financial assets. As both participants wait longer to begin saving for retirement, there is an exponential 70% 60% 57.5% 59.5% Savings Rate 50% 40% 30% 20% 10% 45.5% 44.5% 36.5% 36.0% 32.0% 27.5% 28.0% Save 5% Save 10% Exhibit 3 3 Income achieved at age 67, when starting to save 10% at age XX 0% Age 25 Age 35 Age 45 Age 55 Age % 75.0% But saving at a meaningful rate is not the only important piece of the puzzle. Timing also plays a critical role in achieving one s retirement goals. When talking about Age % 40.0% 41.0% 49.0% 54.0% 63.0% Participant A Participant B retirement, the I have plenty of time to save later mentality can be crippling % 33.0% 3

4 reduction in income that each can achieve. Time and the power of compounding is another important piece of the puzzle to retirement readiness. The longer time period until the start of retirement, the better the chances a participant has to reach the desired income. Having a participant view the chances of replacing 75% of his or her final pre-retirement income in retirement is definitely something new for participants to grasp. Participants have grown accustom to measuring success in terms of account balance. However, without a context to give the balance some sort of significance relative to retirement, participants may think they are preparing themselves better than they are. both participants on track to be able to replace 75% of pre-retirement income in retirement. Tracking these milestones over the years, we can see that Participant A and Participant B are on a trajectory to accumulate about $621,000 and $1,533,000 respectively. This accumulation, we have found, generally needs to amount to about 8 to 10 times a participant s final pre-retirement salary to reach the desired outcome depending on salary. Exhibit 4 4 Account balance to reach > = 75% pre-retirement income saving 10% at age To help create this context, in Exhibit 4 we have mapped out the milestones each participant will likely attain in terms of retirement account balance over time. At age 45, for example, with consistent savings at 10% since age 25, Participant A would likely accumulate approximately $133,000 and Participant B would likely accumulate approximately $358,000. These figures keep Balance ($000) 1,800 1,600 1,400 1,200 1, , ,533 Age 25 Age 35 Age 45 Age 55 Age 65 Age Balance at age 67: Participant A, 8x final salary Participant B, 10x final salary Participant A Participant B Actions to consider 1. Save early: Get employees to participate in an employer-sponsored retirement plan as soon as possible. Consistent, long-term savings increases the chance of achieving desired retirement outcomes. 2. Save enough: Ensure employees are saving at an adequate level. Target a minimum of 10% annual savings, including both employer match and non-matched participant contributions. 3. Plan design: Consider setting automatic enrollment and automatic deferral increase rates at adequate default levels to help overcome participant inertia. Defaulting participants at the typical 3% annually only sets them up to fall short of retirement income goals. 4

5 Save well, and take calculated risks Appropriate investment allocation plays an important role in participant retirement readiness. Contrary to popular thinking though, investment allocation alone cannot make up for inadequate savings levels. So far, the examples used for Participant A and Participant B assumed both were invested in a conservative portfolio consisting of 29% equities, 14% bonds and 47% stable value throughout the entire period. For this next section and comparison to the conservative portfolio examples, we utilized a growth portfolio consisting of 71% equities, 14% bonds and 15% stable value. Exhibit 5 5 Income achieved based on investment portfolio 62.0% Participant A 70.0% 53.0% Participant B 61.0% Conservative Growth Given all that we have just discussed, we know that if both participants were saving only 5% annually, they will not be able to replace 75% of their final pre-retirement income at age 67. In Exhibit 5, it is estimated Participant A and Participant B would be able to replace 62% and 53%, respectively, investing in a conservative portfolio beginning at age 25. When both participants changed their investment allocations to growth portfolios, holding all other variables equal, they were only able to reach replacement rates of 70% and 61% of pre-retirement income, respectively. In this situation, both participants changing to a more risky portfolio does not close the income gap. It does get them closer, but a combination of savings and an appropriate risk level will put participants on a better track to reach their goals. Changing to a more risky portfolio can increase a participant s income generated at retirement, but only if done earlier in one s working career. But generally stating that more risk can generate more income is a trap that many participants fell into during the economic crisis in The precipitous drop of the markets exposed the risk many pre-retirees and retirees face when taking on more risk than needed. In Exhibit 6, we look at the difference in account balance a switch from a conservative to a growth portfolio would have for three different groups of participants: Under-funded: Participants who are projected to amass 75% of the required account balance to be able to replace 75% of their final pre-retirement income at retirement. On track: Participants projected to amass 100% of the required account balance to be able to replace 75% of their final pre-retirement income in retirement. Over-funded: Participants who are projected to amass 125% of the required account balance to be able to replace 75% of their final pre-retirement income in retirement. 5

6 Exhibit 6 6 Additional income generated with a change from a Conservative to Growth portfolio at age XX Age % 14.5% 12.4% Age % 11.4% 11.1% Age % 6.1% 6.1% Age 55 Age % 0.3% 0.7% -2.4% -3.0% -3.5% Under-funded On track Over-funded As expected, if participants increased their risk at age 25, age 35 or age 45, they do experience an increase in the level of income they would be able to generate at age 67. As we stated in the earlier section, time and compounding play a role in the outcome. If participants were to increase risk at age 55, they would not experience any significant increase in income level at age 67. In addition, if participants switch to an increased-risk portfolio at age 65, they are setting themselves up to have a reduced income level at 67. Why is this? Inherently, the growth portfolio has more volatility in returns than the conservative portfolio due to the higher exposure to equities. The 55 and 65 age groups do not have the luxury of time to recover from down market cycles. While risk can generate income when participants have 20 or more years until retirement, more risk may not make sense as participants get closer to retirement. In other words, more risk during this critical period will not close the income gap created by savings behaviors that were not optimal prior to this period. When talking with participants, the previous example can lead into a discussion around professionally managed funds as a means for helping direct participants toward good saving behaviors. Target date funds, online guidance and advice, or managed accounts provide the expertise that many participants need. A discussion around Exhibit 6 can also help illustrate for participants why they need to start saving at a meaningful rate early in their careers. Actions to consider 1. Save well: Changing investment allocation alone may not close the income gap. Guide participants in good savings behaviors first, and when good savings patterns are established, educate about investments as appropriate. 2. Take calculated risks: Encourage participants to use an age-appropriate asset allocation strategy. Taking on more risk does not necessarily generate additional income in all situations especially as participants get closer to retirement age. 3. Simplify participant investment decisions: Consider using professionally managed funds as a means to make it easier to manage investment behavior. Participants can focus on saving rather than on something they may not be at all familiar with or comfortable managing over the long term. 6

7 Profiles of participant retirement readiness At this point, we have looked at both savings behaviors and investing behaviors, and the effect each has on overall retirement readiness. But, these are not the only factors that come into play when planning for retirement. After all, when calculating how much will be enough in retirement, it is important to consider things like life expectancy and income from social security, for example. Let s take a look at two sets of participants and profile how they reached their goals. While all four participants have the same desired outcomes and savings behaviors, there are some interesting differences based on gender and earning potential. Assumptions for all: Currently 65 years old Their goal is to retire in two years at age 67 with 75% of pre-retirement income All are good savers and began at age 25 saving 10% annually Participate in their employer sponsored plan and take advantage of the company match of 50% of the first 5% Conservative investors and not interested in too much risk in the retirement investments Life expectancy for the men are 87 years old and for the women are 89 years old Experienced a 2% increase in salary over their working years Profile 1: Maria and Charles Maria Charles Occupation A floor supervisor at a large manufacturing Front desk manager at a small boutique hotel company Current Salary $75,000 Starting Age 25 $33,967 Desired Age 67 $57,375 annually $4,781 monthly Social Security $1,829 monthly 38% of total income Current DC Balance $575,000 $540,000 DC Age 25 $0 $0 DC Retirement $640, x final salary Cumulative Contributions $275,397 43% of total balance $601, x final salary $275,397 45% of total balance Cumulative Return 57% of total balance 55% of total balance 7

8 Profile 2: Samantha and Javier Maria Charles Occupation Radiology technician at a local hospital Financial representative at large regional bank Current Salary $150,000 Starting Age 25 $67,934 Desired Age 67 $114,751 annually $9,563 monthly Social Security $2,518 monthly 26% of total income Current DC Balance $1,450,000 $1,350,000 DC Age 25 $10,000 $0 DC Retirement $1,594, x final salary Cumulative Contributions $560,794 37% of total balance $1,485, x final salary $550,794 37% of total balance Cumulative Return 63% of total balance 63% of total balance Key findings: Maria and Samantha need to save 6.5% or $39,016 and 7.3% or $108,884 more in total assets, respectively, to maintain the same income for the two additional years of their life expectancies beyond their male peers. The same holds true as to why Maria and Samantha need a higher beginning account balance to achieve the same result as their male peers. Maria and Charles will have 38% of their retirement income derived from Social Security while Samantha and Javier need to accumulate about three times more in assets at retirement due to their higher salaries and the lower contribution to the total from Social Security (26%). The previous example assumes the four participants are all on track to achieving their desired income replacement rate. But what if they weren t? Given what we know about them, and what we have discussed regarding savings and investing behaviors, how could each participant change his or her behavior in meaningful ways to help arrive at an even better outcome? 8

9 Scenario 1: All four participants are age 35 and their DC balances are currently under-funded by 50%. Maria Charles Samantha Javier Current DC Balance $20,500 $16,000 $70,000 $58,500 Savings Rate 10% 10% 10% 10% Investment Allocation Conservative Conservative Conservative Conservative Projected Retirement Age 67 69% 68% 65% 64% Solution Maria Charles Samantha Javier Savings of 13% annually (+3%) or Savings of 12% annually (+2%) or Savings of 15% annually (+5%) or Savings of 14% annually (+4%) or Savings of 11% annually (+1%) and change to a Moderate portfolio (62% equities, 20% bond, 18% stable value) Savings of 11% annually (+1%) and change to a Moderate portfolio (62% equities, 20% bond, 18% stable value) Savings of 12% annually (+2%) and change to a Moderate portfolio (62% equities, 20% bond, 18% stable value) Savings of 12% annually (+2%) and change to a Moderate portfolio (62% equities, 20% bond, 18% stable value) Scenario 2: All four participants are age 45 and their DC balance currently under-funded by 75%. Maria Charles Samantha Javier Current DC Balance $93,750 $105,750 $283,125 $254,250 Savings Rate 10% 10% 10% 10% Investment Allocation Conservative Conservative Conservative Conservative Projected Retirement Age 67 68% 68% 66% 66% Solution Maria Charles Samantha Javier Savings of 15% annually (+5%) Savings of 14% annually (+4%) Savings of 17% annually (+7%) or Savings of 16% annually (+6%) and change to a Growth & Income portfolio (40% equities, 25% bond, 35% stable value) Savings of 16% annually (+6%) or Savings of 15% annually (+5%) and change to a Growth & Income portfolio (40% equities, 25% bond, 35% stable value) 9

10 Conclusion The lifecycle of a retirement plan participant can span more than 50 years from early career throughout retirement. The very simple act of saving at a meaningful rate throughout a career can put most participants on the path to succeed. While it may be too late for some of the older generation today, using the examples in this paper to help convince younger participants to take the basic steps of saving and selecting age/risk appropriate investment allocations over the very long term, you can significantly impact success of the younger generations of your participants. 10

11 MassMutual. We ll help you get there.

12 1 Source: MassMutual calculation using the RetireSmart Ready tool set for at least a 90% chance of success for both participants. Parameters: Participant A: Retire at age 67 with $57,375 annual income; Participant B: Retire at age 67 with $114,750 annual income 2% wage growth and invested in a conservative portfolio. 2 Source: MassMutual calculation using the RetireSmart Ready tool set fpr at least a 90% chance of success. Parameters: Retire at age 67, 2% wage growth and invested in a conservative portfolio. 3 Source: MassMutual calculation using the RetireSmart Ready tool set for at least a 90% chance of success. Parameters: Retire at age 67; Participant A: Final salary of $76,500; Participant B: Final salary of $153,000; 2% wage growth and invested in a conservative portfolio. 4 Source: MassMutual calculation using the RetireSmart Ready tool set for at least a 90% chance of success. Parameters: Retire at age 67; Participant A: Final salary of $76,500; Participant B: Final salary of $153,000; 2% wage growth and invested in a conservative portfolio. 5 MassMutual calculation using the RetireSmart Ready tool set for at least a 90% chance of success. Parameter: Retire at age Source: MassMutual calculation using the RetireSmart Ready tool set for at least a 90% chance of success. Parameters: Retire at age 67; Participant A: at age 65 salary of $75,000 and account balance of $278,750; Participant B: at age 65 salary of $150,000 and account balance of $700, Massachusetts Mutual Life Insurance Company, Springfield, MA All rights reserved. MassMutual Financial Group is a marketing name for Massachusetts Mutual Life Insurance Company (MassMutual) [of which Retirement Services is a division] and its affiliated companies and sales representatives. RS C: