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CCH® PENSION — 7/23/08

Hewitt Study Reveals Widening Gap Between Retirement Needs And Employee Saving Behaviors

From Spencer's Benefits Reports: Rising medical costs, lengthening life spans, and the declining prevalence of pension and retiree medical benefits continue to highlight the gap between the amount of savings that U.S. employees need in order to maintain their standard of living in retirement and what their employer programs are projected to provide. However, according to recent research from Hewitt Associates, employees who contribute to their 401(k) plans and who are willing to make minor improvements to their saving and investing habits can make a significant impact in lessening the gap and increasing their future income potential.

When factoring in inflation and increases in medical costs, Hewitt predicts that employees will need to replace, on average, 126% of their final pay at retirement—significantly more than the traditional targets of 70% to 90% pay replacement. According to Hewitt's study, which examined the projected retirement levels of nearly 2 million employees at 72 large U.S. companies using actual employee balances and behaviors, only 19% will be able to meet 100% of their estimated needs in retirement. On average, employees are projected to replace only 85% of their income in retirement, compared to the 126% that they need.

Importance Of Employee Contributions

According to Hewitt, the scenario becomes even more serious for employees who do not contribute to their 401(k) plans. Employees who contribute an average of 8% of pay to their 401(k) plan can replace 96% of their preretirement income at age 65, providing approximately 80% of what is needed to provide the same standard of living during retirement. That number drops to only 54% for those employees who do not contribute, which equates to less than 40% of projected needs. Even employees who have a pension plan may expect to replace only 62% of their income at retirement if they do not contribute to their 401(k) plan, compared to 106% for those who do contribute.

“Full-career employees who actively save in their 401(k) plans from an early age and have both pension plans and subsidized retiree medical coverage are in good shape for retirement, but employees in this situation—or who will be in this situation in the future—are a very small minority,” noted Alison Borland, defined contribution consulting practice leader at Hewitt. “Without changes in behavior, most workers will either need to significantly reduce their spending or work longer in order to have enough to last through retirement. The good news is that people can take small actions in several areas and make a big difference. Gradual increases in savings rates, smarter investing, lower fees, and delaying retirement can have a significant impact and enable most people to achieve a much more comfortable standard of living once they retire.”

Hewitt’s study found that employer-subsidized retiree medical coverage has a dramatic impact on an employee’s ability to achieve adequate retirement savings levels. Employees who are offered a high level of employer subsidy—typically covering half of total costs not covered by Medicare—will see a projected retirement income shortage of only 12% of final pay if they are saving in their 401(k) plan. Complicating the problem is the fact that people are living longer, which thus would require increased savings.

Hewitt’s research revealed that the longer employees work and save for retirement, the greater the impact on increasing their percentage of retirement income. However, most employees do not have to make drastic changes in these areas in order to make a significant impact. For employees who contribute to their 401(k) plan, retiring only two years later—at age 67—and saving 2% more per year (an average of 10% total contribution) boosts projected retirement income replacement from 85% to 107% of final pay.

Copies of the complete report, Total Retirement Income at Large Companies: The Real Deal, are available for $600 by contacting the Hewitt Information Desk at (847) 295-5000 or via e-mail at dianareace@hewitt.com.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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