How plan sponsors can help participants save for longer lives - and extended retirements
Over the past few decades, the shift from pension plans to defined contribution (DC) plans has made workers, instead of employers, responsible for funding retirement. Now the American employee is on the hook to not only save enough, but also to anticipate, prepare for and wisely execute on a myriad of issues before and during retirement, often without the skills or knowledge to do so. Leading this disconnect is the “Longevity Challenge,” as Americans still underestimate their life expectancy: Only 37% of women and 32% of men think they will live to age 85.1 Americans are woefully unprepared for this burden, despite the efforts plan sponsors have taken to address five key challenges facing many plan participants today.
1. Rising life expectancies, with increasing risk of outliving retirement savings
Baby Boomers, a significant segment of the population, have started to enter retirement and will soon be increasing the number of elderly adults to record levels. Experts are warning that the United States is unprepared to handle such large numbers of seniors, especially as the life expectancy of older people continues to rise.2 According to census data, roughly 31 million Americans will be older than age 75 by 2030 — the largest such population in American history,3 further straining a system already in crisis.
When employees retire at age 65 or 67, they have a significant chance of living 20, 25 or even 30 more years. Employees need to save more money today than was needed in prior generations, as it has to last longer. In addition, there is a combination of factors that, taken together, can cause retirees to run out of money at a time when they have little chance of replacing it (in their 80s or 90s, for example).
Beyond longevity risk, employees must factor in replacement income risk, inflation risk, sequence-of-return risk, withdrawal rate risk, cognitive risk and more as part of their long-term planning.
The implementation of auto-features has made a significant positive impact on DC plan participation, deferral and savings rates. In fact, plans that offer both auto-enrollment and auto-escalation have more than twice as many participants with retirement savings rates exceeding 15% as plans that do not offer both (14% vs. 6%, respectively).4 However, American employees are still apprehensive:5
- Three out of four Americans with jobs don’t expect to live as well as their parents did in retirement.
- About 30% worry their savings will run out just 15 years into retirement.
- 50% think their money will be gone within 25 years.
The National Institute on Retirement Security estimates that the median retirement account balance for all households near retirement was $14,500. For all households, it was a meager $2,500.6 As a result, more Americans expect to work later in life, either by choice, or because they cannot afford to retire. In a 2015 Gallup Poll of non-retired Americans: 7
- 37% expect to retire after age 65, up from 31% in 2009 and nearly three times the 14% who said this in 1995.
- 32% expect to retire before age 65; this is the first time this figure has topped 30% since 2009, but it is still down considerably from the 49% in 1995 who said that they expected to retire before age 65.
Currently, according to the Bureau of Labor Statistics, 32% of Americans age 65 to 69 are in the labor force (working or looking for work), up from 21% two decades ago. The percentage of older workers in the labor force has increased, even as the percentage of younger workers has decreased.8
Among pre-retirees who expect to work in retirement, 81% say they need the money to make ends meet, and 74% want to keep health insurance or other benefits.9 But not everyone who wants to work in retirement is able to — in fact, current retirees often stop working before planned, five years earlier on average.10
While employees who are able to continue working beyond age 65 offer valuable experience to their companies and gain positive financial and psychological benefits for themselves, 88% of plan sponsors said that employees choosing to work longer would have a negative impact on their business, due in large part to higher healthcare costs.11 However, by 2024, the number of workers aged 65 and older is projected to grow much more rapidly than the total labor force, challenging employers across the nation.
2. The struggle to make ends meet, with competing priorities for retirement savings
An uptick in savings rates is promising, most likely due to the rise of auto features in DC plans, based on a survey of 4,650 households with at least $20,000 of annual income:12
- Workers aged 35 to 50 are now socking away 8.2% of their income, up from 7.7% in 2013.
- The oldest workers, aged 51 to 69, are saving 9.7%, up from 8.1%.
- Millennials between the ages of 25 and 34 are saving a median of 7.5% of their pay for retirement, including matching contributions, up from 5.8% in 2013, the largest jump among all age groups.
However, for many employees, the pressure of day-to-day living still impacts their retirement savings, putting it low on the list. In fact, 10% of working Americans haven’t contributed to retirement funds at all in 2015 or 2014.13 Competing priorities include paying down debt, savings for their children’s education, helping an aging parent, insurance premiums and general living expenses, among other things. Only 37% of Americans report they can live comfortably and save an adequate amount for retirement or other needs, and a significant number even dip into their retirement savings or reduce retirement plan contributions to cover other expenses:14
- Nearly half (46%) say they can get by every month, but find it difficult to save and invest, whether for retirement or other purposes.
- 15% find it hard to make ends meet every month.
- Nearly one-third (32%) report that in the past 12 months, they have withdrawn money from savings or pension funds to make ends meet.
- 30% reduced contributions to a 401(k) or other pension or retirement fund.
Also, 45% of working-age U.S. households, and 41% of near-retirement households, have saved exactly nothing — zero — in retirement accounts.15 Despite the great strides taken across DC plans over the past 10 years, it’s clear that even more needs to be done to include, guide and help employees save for their retirement future.
NON-RETIREES OVERESTIMATE THE ROLE OF SOCIAL SECURITY WHEN PROJECTING FUTURE INCOME
Source: Gallup Poll Social Series: Economy and Personal Finance, April 9-12, 2015.
3. The fear of uncertain financial futures with a diminished expectation of Social Security support
Americans are fearful of outliving their money in retirement. Just 20% of workers nearing retirement — those aged 45 and older — have saved more than $250,000, and only 12% are confident of being able to afford long-term care expenses.16
Retirement readiness lost considerable ground during the financial downturn of 2008, which wiped out trillions of dollars of household wealth, and is still struggling to regain a solid footing. Although headlines show stock market and housing recovery since the recession, the Federal Reserve Bank of St. Louis points out that the recovery has been uneven across American families, with stock market and housing gains accruing mainly to the wealthy.17
According to a AICPA PFP Trends Survey of CPA Financial Planners,18 more than half (57%) cited running out of money as the top retirement concern for their clients, followed by the uncertainty on how much to withdraw from retirement accounts (14%) and healthcare costs (11%). When asked about the top three sources of clients’ financial and emotional stress about outliving their money, financial planners — many of whom work with high-net-worth individuals — cited healthcare costs (76%), market fluctuations (62%) and lifestyle expenses (52%) as the primary issues. Additional causes for financial stress were unexpected costs (47%), the possibility of being a financial burden on their loved ones (24%) and the desire to leave an inheritance for children (22%).
Almost 42 million retired workers are collecting Social Security retirement benefits,19 with more than one-third (43%) deriving 90% or more of their income from Social Security,20 and almost a quarter (24%) reporting it as their sole source of income.21 In 2017, the average monthly Social Security benefit is just $1,360, or $16,320 a year — not nearly enough to cover basic needs in retirement.21
There has always been a disconnect between future retirees’ expectations of how much they will rely on Social Security and current retirees’ actual reliance on it, compared to other income sources. While 49% of pre-retirees expect a self-funded 401(k), IRA, Keogh or other retirement savings to be their major source of income, a recent Gallup Poll showed Social Security as one of the top three major sources — and the nymber one minor source — of income expected in retirement.
Government-funded entitlements, such as Social Security, have become strained in their sustainability and adequacy as longer life expectancies and medical advancements mean more people are receiving government benefits for longer timelines. The Social Security Administration is projecting to deplete its reserves in 2033 without an injection of new revenue (such as increased taxes), benefit cuts or some combination of the two.22 At some point something is going to have to be done, yet there are no attractive options, including:
- Increase contributions: Individuals save more, combined with increased taxes and contributions to Social Security, Medicare and Medicaid, or
- Reduce eligibility: Extend mandatory retirement age and delay eligibility for benefits, resulting in individuals working longer and a phased retirement, potentially coupled with reduced pension benefits.
Today, only about 10% of participants in DC plans annuitize their savings when they retire. And the total amount is even more modest: In 2012, sales of individual fixed immediate annuities were just $7.7 billion, but households transferred $301 billion to IRAs from employer-sponsored plans.23
Beyond saving more in DC plans or other retirement savings vehicles, there are strategies that employees can take, such as working longer, delaying filing for Social Security benefits until age 70 and cutting down on fixed household and other expenses, to reduce the risk of outliving their assets. For pre-retirees, gaining individualized financial planning and investment advice through DC plans — through the use of managed account services — is one avenue to provide employees with the expertise and knowledge needed to help.
4. A lack of understanding of what healthcare in retirement will really cost
Less than half of employees (48%) have even bothered trying to figure out how much they need to retire comfortably.24 Beyond that, few are prepared for the increasing costs of healthcare as they age: On average, a couple both age 65 and who retired in 2016 can expect to spend an estimated $260,000 on healthcare during their retirement, excluding nursing home and long-term care expenses, up rom $245,000 in 2015.25 And, based on longer life expectancies, saving approximately $16,000 more at retirement than men do, just to cover general medical expenses (Medicare premiums, prescription drug costs, co-payments).26 Alarmingly, in a recent survey, nearly half (48%) of consumers believe that the total amount they’ll need to spend on healthcare in retirement won’t exceed $50,000.27
After age 65, retirees are eligible for Medicare coverage. While this government- provided medical insurance covers many healthcare expenses, it was never designed to cover them all. Future retirees may have to pay for a greater percentage of their medical expenses due to Medicare’s challenged financial position, exponential growth in medical costs and projected increases in Medicare premiums. Unfortunately, Medicare does not cover long-term care; most nursing home care is considered custodial care.28
THE COST OF LONG-TERM CARE
Long-term care costs can run anywhere from $45,000 to $92,000 per year once needed, over a period of 4.7 to 5.8 years.29 If both spouses need care, the lifetime cost of long-term care could be $1 million or more.30 For nursing home care alone, the average annual costs for a semi-private room range from almost $48,000 to an astronomical $271,000, depending on the state. Long- term care insurance, which can help pay for at-home or in-nursing-home care, is a possible solution, but prices and coverage vary, making policies difficult to compare. And prices are rising: In 2015, overall costs for new long-term care insurance increased 8.6% compared to the prior year: 31
- A healthy 55-year-old man can now expect to pay, on average, $2,075 per year for $164,000 in initial benefits, up from $1,765 in 2014.
- The cost for a healthy, single woman of the same age is higher: Her average premium is $2,411, up from $2,307. Insurers take gender into account when pricing long-term care policies, since, statistically, women live longer and are more likely to need long-term care.
5. The increased need for segmented education and personalized advice
Plan participants face distractions and challenges that can undermine their retirement readiness. To address this alarming concern, there is a growing trend in DC plans toward specifically helping participants (segmented by demographic) consider and address all aspects of their financial health to help them grow and manage their savings to, and through, retirement. Millennials, Generation X and Baby Boomers are all at different stages in their financial lives and need segmented guidance, with broad education for all.
More plan sponsors are offering Financial Wellness education programs that cover holistic financial wellness topics such as budgeting, debt management, saving for life stages (especially retirement), understanding the impact of inflation, basics of the financial markets, financial planning and health planning.32 Programs can be customized based on the specific needs of the employee base, and offered through multiple platforms (including the Web, mobile devices, webcasts, call centers, one-on-one guidance and more).
According to Financial Finesse’s 2015 Year in Review of their Fortune 1000 clients, of the employees who participated in the financial wellness program, repeat users scored 20% better than employees who only attended one workshop or logged into the financial learning center one time. Companies that take a multi-channel approach by offering employees the opportunity to engage with a financial planner online, over the telephone or in person, do a better job of overcoming employee stagnation in financial wellness.
Of those who interacted with a certified financial planner five or more times as part of the financial wellness program during the year:
- 80% had a handle on their cash flow compared to 66% of online-only users;
- 72% had an emergency fund, compared to 50% of online-only users;
- 98% contributed to their retirement plan, compared to 89% of online-only users;
- 48% felt they were on track for retirement, compared to only 21% of online-only users.
Financial wellness programs, customized by the varying needs of different age groups, can leverage behavioral finance and planning strategies to reduce plan leakage, narrow the gender gap in financial wellness, help employees tackle debt and finally — save for a secure retirement.
The State of Retirement for Women
Steps plan sponsors can take to tackle the longevity challenge
To help participants with the looming retirement crisis tied to longevity, plan sponsors should check their plan against the following list, and consider working with their retirement plan advisor or consultant to implement DC plan best practices:
- Implement or increase auto-enrollment to (at least) 6%. While a 3% auto-deferral rate is a baseline minimum, it’s widely accepted that employees with a deferral rate lower than 5%-6% are unlikely to achieve retirement security through their DC plan alone.
- Review the plan’s maximum auto-escalation percentage and consider increasing to up to 10% or more. While a 1% annual increase is often used as the step-up rate, many firms implement higher percentages in line with the goals of the plan.
- Offer a well-designed employer match for incentive. Ideas include an employer match of 50% of employee contributions for the first 6% of salary, a straight match up to a certain limit, or a dollar-for-dollar match on all contributions.
- Implement re-enrollment campaigns to sweep non-participants into the plan, and (older) participants who joined the plan prior to auto-enroll, into the Qualified Default Investment Alternative (QDIA).
- Consider adding a managed account service as an opt-in, especially for older participants (age 45+) with complex financial situations and increased assets.
- Include Retirement Income Projections on quarterly statements and all interactive platforms.
- Execute a segmented communications plan broken out by specific issues by demographic (Millennials, Generation X, Baby Boomers) and time horizon to retirement. Make sure the plan’s education efforts and tools address the unique needs of each life stage, while focusing on the longevity challenge in retirement.
- Implement a Financial Wellness Program to help with competing savings priorities, and broader education about the financial needs in retirement.