Stronger market returns and continued retirement savings behaviours by employees over the past few years have helped U.S. workers make progress in closing the gap between the amount of money they need to meet their financial needs in retirement and what they are on track to accumulate, according to two new research reports by Aon Hewitt, the global human resource solutions business of Aon.
When factoring in inflation and postretirement medical costs, Aon Hewitt projects employees will need 11 times their final pay in retirement resources, such as company-provided plans and personal savings, to meet their needs in retirement beyond Social Security. Aon Hewitt’s analysis, The Real Deal: 2012 Retirement Income Adequacy at Large Companies, which examined the projected retirement levels of more than 2.2 million employees at 78 large U.S. companies (1), reveals that, on average, full-career contributing employees are on track to accumulate 8.8 times their final pay, leaving a shortfall of 2.2 times pay. This is a slight improvement over 2010 when the shortfall was 2.4 times pay. Employees who rely solely on a defined contribution plan to fund their retirement are making similar progress, reducing their shortfall from 4.3 times pay in 2010 to 3.8 times pay.
According to Aon Hewitt, two main factors contributed to closing the gap: continued savings by employees and strong return on assets. Aon Hewitt’s 2012 Universe Benchmarks report, which analyses the saving and investing habits of more than 3.6 million U.S. employees, shows 76 per cent participated in a defined contribution plan during 2011. While flat recently, this rate remains at a record-high.Â Participation among younger workers increased by two percentage points since 2009 to 54 per cent of eligible workers.Â In addition, the median annualized participant rate of return from 2009 through 2011 was a substantial 12 per cent.
However, Aon Hewitt’s research shows room for improvement. The average before-tax contribution rate remains nearly unchanged, at 7.2 per cent of pay. As a result, less than 30 per cent of full-career employees are currently “on track” to achieve adequate retirement income. Passive employee behaviour also is at an all-time high, with just 15 per cent of participants initiating a trade in 2011, down from 20 per cent in 2008 and prior years.
“It is encouraging to see that the continued efforts by employers and employees to increase retirement income security may be paying off,” explains Rob Reiskytl, leader of Retirement Plan Strategy and Design at Aon Hewitt. “To further improve results, employers should design their 401(k) plans in a way that harnesses inertia, such as matching at higher rates of savings and combining automatic enrolment with automatic contribution escalation for all employees. Ideal solutions will improve outcomes with little or no increase in employer cost.”
Among factors influencing retirement income adequacy, Aon Hewitt’s research revealed that, not surprisingly employee savings rates have the largest impact. For example, if not covered by a pension plan, an employee who begins saving at age 25 and targets 11 times pay at retirement needs a combined employer and employee contribution rate of 12 per cent to 18 per cent of pay each year (15 per cent on average) to build up adequate retirement income by age 65. This combined contribution rate increases if the employee does not start saving until later in life.
Aon Hewitt’s analysis shows the number of full-career contributors who can retire with sufficient retirement assets increases from 29 per cent to 46 per cent if they increase retirement contributions by as little as 1 per cent each year for five years. For an employee making $40,000 a year, this 1 per cent increase in contribution rates roughly equates to giving up purchasing one cup of coffee a day for a year.
Using Automation to its Full Potential
Aon Hewitt’s research shows that automation tools can have a dramatic impact on saving and investing behaviours. The participation rate among those subject to automatic enrolment is 83 per centâ18 percentage points higher than those employees who are not defaulted. The research shows employers that offer automatic enrolment have 15 per cent more employees on track to meet their needs in retirement than employers that do not offer automatic enrolment. Similarly, 53 per cent of employees who are enrolled in automatic contribution escalation programs are expected to meet their financial needs in retirement, compared to just 26 per cent of those who are not.
While automation has played a strong role in helping employees’ saving behaviours, Aon Hewitt’s research shows it also can be potentially detrimental if it is not leveraged effectively. Employees who are automatically enrolled in their defined contribution plan have an average savings rate of 6.7 per cent, which is a full percentage point below those not subject to automatic enrolment. Additionally, these workers are much more likely to miss out on employer matching contributions. Thirty-nine per cent of automatic enrolees save below the match threshold versus just 25 per cent of other savers.
“Automatically enrolling employees at a higher rate of pay and combining this with automatic contribution escalation can provide a strong foundation for adequate future retirement income,” Patti Balthazor Bjork, Aon Hewitt’s director of Retirement Research. Â ”Employers also should strongly consider sweeping in eligible non-participants periodically. Other alternatives include quick-enrolment tools and using education and communication opportunities to influence savings levels and highlight the availability of automatic escalation.”
Offering Investment Advisory Services
Aon Hewitt’s analysis shows that strong investment returns can have a positive influence on retirement income adequacy levels. A one per cent difference in average returns over a career and retirement period can result in a two-times-pay difference in retirement resources.
“Employers cannot influence market returns, but they can leverage their scale to reduce investment fees, which can have an impact on employees’ savings over time,” noted Reiskytl. “In addition, more employers are offering an array of investment advisory services like investment advice, managed accounts and pre-mixed portfolios. These tools can improve the diversification and efficiency of participants’ portfolios and help workers invest more effectively with very little effort.”
Aon Hewitt’s research shows that when available, 63 per cent of participants allocate to a premixed portfolio, up from 51 per cent in 2009. Among those who use a premixed portfolio, the average person held 65 per cent of their balance in premixed funds in 2011, up from 56 per cent in 2009.