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Employees Who Make Small Adjustments Can Dramatically Improve Future Retirement Income Potential
The average U.S. employee will need more than 15 times their final pay in retirement resources1 to maintain their current standard of living during retirement, according to a new analysis from Hewitt Associates, a global human resources consulting and outsourcing services company. While this estimate hasn’t worsened, meeting projected retirement needs has become a greater challenge for individuals, many of whom experienced decreases in their retirement accounts over the past two years. As a result, four out of five workers are still expected to fall short of meeting all their financial needs in retirement unless they take action to improve their savings habits or retire at a later age.
When factoring in inflation and postretirement medical costs, Hewitt projects employees will need 15.7 times their final pay in retirement resources to meet their financial needs in retirement, which is consistent with Hewitt’s prior projection in 2008. Of the 15.7 times final pay, Social Security is expected to provide 4.7 times final pay, leaving employees responsible for accumulating the remaining 11 times final pay from other sources such as company-provided plans and personal savings. Hewitt’s analysis, which examined the projected retirement levels of more than 2 million employees at 84 large U.S. companies2, reveals that just 18 percent of employees who contribute to a defined contribution plan and work a full career are expected to achieve this goal. On average, these employees are on track to accumulate 13.3 times their final pay (including Social Security) leaving a shortfall of 2.4 times pay. In other words, they’re expected to meet just 85 percent of their financial needs in retirement. Nineteen percent are expected to have a shortfall of five times final pay or more at retirement.
The situation is much bleaker for employees who are not covered by a defined benefit plan. On average, workers who rely solely on a defined contribution plan to fund their retirement are projected to meet just 74 percent of their needs in retirement—compared to 91 percent for employees who are also covered by an active or frozen defined benefit plan.
“Employees have been able to recoup a good portion of the retirement assets they lost due to market volatility, but unfortunately most workers are still falling significantly short of meeting their retirement needs,” explains Rob Reiskytl, Hewitt’s leader of Retirement Plan Strategy and Design. “This is a wake up call for employees. While retirement may be a long way off, workers need to start actively saving or be prepared to dramatically reduce their overall spending in retirement. Ultimately, they’re in control of most of the elements that will help determine their retirement outcomes.”
What Can Employees Do To Curb the Savings Shortfall?
Eliminating their savings shortfall may seem like a daunting task for most Americans. However, Hewitt’s analysis revealed that workers can significantly improve their situation by making a few small adjustments:
Start saving: According to recent Hewitt research3, 26 percent of eligible employees currently do not contribute to a defined contribution plan. Hewitt projects these workers will have saved, on average, less than half of what they will need by the time they reach retirement age. But workers who start investing at a young age and at a robust rate can reduce their shortfall. Hewitt’s analysis shows that a 25-year-old employee who makes $30,000 a year is expected to meet all of his/her retirement needs if he/she contributes, on average, 11 percent of his/her pay each year throughout their career (assuming he/she also receives an additional 5 percent employer contribution to his/her defined contribution account). If an employee waits until age 40 to join his/her defined contribution plan, he/she needs to save an average of 17 percent of pay per year.
“It’s a common perception that saving 10 percent of pay toward retirement throughout your career will get you where you need to be in retirement,” said Reiskytl. “Unfortunately, that old rule of thumb is no longer true given the general erosion of employer-provided retirement benefits and the reduction in employers providing subsidized retiree medical plans.”
Regularly increase your contribution rate: Hewitt’s analysis reveals that many workers who commit to increasing their retirement contributions by as little as 1 percent each year for five years will be on track to meet most of their financial needs in retirement. Under this savings rate escalation scenario, the number of employees in Hewitt’s study expected to retire with sufficient retirement assets doubles from 18 percent to nearly 38 percent, and almost a third (32 percent) will have a shortfall between one and two times pay. In other words, a total of 70 percent of employees are projected to have a shortfall of two times pay or less at age 65, making retirement income adequacy within reach for a significant number of employees.
For example, on average, a full-career, contributing employee who saves 7.3 percent of his/her pay and whose employer contributes 5 percent of pay to his/her defined contribution account is on track to meet 13.3 times his/her final pay in retirement—a shortfall of 2.4 times final pay. If that employee increases his/her contribution by 1 percent each year for five years and maintains this elevated savings rate, he/she will have reduced the savings shortfall to only 0.6 times final pay, accumulating 15.1 times his/her final pay retirement. “Small increases in saving levels can have a ery positive impact on retirement income adequacy for employees of all ages,” said Reiskytl. “Many employers make it easy for their workers to accomplish this goal by offering tools like automatic contribution escalation, which enables employees to automatically increase their contribution rate each year without having to proactively take action.”
Work longer: According to Hewitt’s analysis, employees who delay retirement to age 67 can significantly reduce their savings shortfall. For these workers, retirement needs drop from 15.7 times final pay to 14.4 times final pay. At the same time, their retirement resources increase from 13.3 times final pay to 14.2 times final pay, enabling them to meet 98 percent of their retirement needs.
“Workers who put off retirement for just two years have a much greater chance of retiring comfortably,” explains Reiskytl. “Social Security benefits are increased, there’s more time to accumulate retirement savings, and assets will be withdrawn for a shorter period of time. In addition, workers can continue to receive health care coverage under their employer—which can save employees a significant amount of money during that time.”
About Hewitt Associates
Hewitt Associates (NYSE: HEW) provides leading organizations around the world with expert human resources consulting and outsourcing solutions to help them anticipate and solve their most complex benefits, talent, and related financial challenges. Hewitt works with companies to design, implement, communicate, and administer a wide range of human resources, retirement, investment management, health care, compensation, and talent management strategies. With a history of exceptional client service since 1940, Hewitt has offices in more than 30 countries and employs approximately 23,000 associates who are helping make the world a better place to work. For more information, please visit http://www.hewitt.com.
1Sources of retirement income include Social Security, employer-provided defined benefit and defined contribution plans and employee savings
2Large companies in the Real Deal study have a median of approximately 15,000 employees
3Hewitt’s 2010 Universe Benchmarks Study
