HEW Hewitt Associates

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 U.S. employees need in order to maintain their standard of living in retirement and what their employer programs are projected to provide. But according to new research from Hewitt Associates, a global human resources consulting and outsourcing company, employees who contribute to their 401(k) plan and who are willing to make small 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 percent of their final pay at retirement�significantly more than the traditional targets of 70 to 90 percent 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, less than one in five (19 percent) will be able to meet 100 percent of their estimated needs in retirement. On average, employees are projected to replace just 85 percent of their income in retirement, compared to the 126 percent they need. In other words, assuming inflation of 3 percent and a retirement age of 65, an average 40 year old with 10 years of service and earning $83,000 at retirement in today�s dollars would have saved enough to provide just $70,500 per year in retirement in today�s dollars�a $34,000 annual shortfall. In fact, more than 1.2 million employees (67 percent) are expected to have less than 80 percent of their projected needs at retirement. The scenario becomes even more serious for employees who do not contribute to their 401(k) plans. Employees who contribute an average of 8 percent of pay to their 401(k) plan can replace 96 percent of their preretirement income at age 65, providing approximately 80 percent of what is needed to provide the same standard of living during retirement. That number drops to just 54 percent for those employees who do not contribute, which equates to less than 40 percent of projected needs. Even employees who have a pension plan may expect to replace just 62 percent of their income at retirement if they do not contribute to their 401(k) plan, compared to 106 percent for those who do contribute. Recent Hewitt research shows that more than a quarter (26 percent) of employees do not participate in their 401(k) plan, and of those that do, most (61 percent) contribute less than 7 percent a year. �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,� said Alison Borland, defined contribution consulting practice leader at Hewitt Associates. �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.� Retiree Medical and Longer Life Spans Significantly Impact Success 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 percent of final pay if they are saving in their 401(k) plan. In other words, a worker earning $100,000 a year at the time of retirement will have $12,000 less per year than what he or she needs to maintain their preretirement standard of living. This number doubles to 25 percent�or $25,000 per year�for employees with only access to coverage and no employer subsidy, and jumps to 87 percent for employees with low retiree medical coverage who do not contribute to their 401(k) plan. �For many employees, access to employer-sponsored retiree health care is a key factor in determining whether they can afford to retire, and retiree medical costs vastly complicate the picture,� added Borland. �While the availability of Medicare�including the new Medicare prescription drug coverage�represents a substantial asset available toward meeting postretirement medical needs, medical inflation and declining employer subsidies for retiree health benefits can quickly erode the retirement income level generated by 401(k) and pension plans.� As an example, an individual retiring last year should have accumulated an average of $86,000 in savings just to pay for future expected medical expenses not covered by Medicare. Hewitt research shows that the median plan balance for employees age 60 and older is just over $34,000. While some of those employees have access to a pension plan, there is a clear�and significant�gap. Complicating the problem is the fact that people are living longer, which would thus require increased savings. If we assume employees need to prepare for a longer life span�approximately 10 years beyond the expected lifetime of 84 years old for someone age 65�the average shortfall increases by 80 percent. In other words, employees who retire at age 65 and who are earning $100,000 per year would generally need to accumulate an additional $200,000 when taking into account the increase in life expectancy. This suggests the need for an alternate solution to protect against that longevity risk. Small Changes Can Yield Big Results Not surprisingly, Hewitt�s research revealed that the longer employees work and save for retirement, the greater the impact on increasing their percentage of retirement income. Most, however, 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 just 2 years later�at age 67�and saving 2 percent more a year (an average of 10 percent total contribution) boosts projected retirement income replacement from 85 percent to 107 percent of final pay. Beyond contributing more and working longer, the following strategies can help employees boost their retirement savings�often by tens or hundreds of thousands of dollars over the course of their careers: Participate in the 401(k) plan. Failing to participate in a 401(k) plan may mean leaving money on the table in terms of an employer matching contribution. According to Hewitt research, more than 90 percent of large companies offer an employer match, with the most common formula being a match of $0.50 for every dollar up to 6 percent of pay per year. Employees hired before the ages of 25�35 who have more than 30 years of service at retirement can generally replace over 100 percent of their final pay at retirement if they contribute, on average, 8 percent of their pay each year throughout their career. Starting early, and saving more, has a dramatic impact on long term success. Invest smarter. Take advantage of advice and target date funds, diversify with an appropriate risk tolerance and do not invest too much in company stock. Pay attention to fees. Hewitt�s study finds that additional annual expenses of 0.25 percent�the difference between the typical institutional fund and retail mutual fund portfolio�can reduce projected retirement income adequacy substantially over time. For younger employees, these higher costs can erode 401(k)-related retirement income levels by nearly 6 percent in retirement. �When employees learn how much they need to save in order to maintain a comfortable standard of living in retirement, the numbers seem overwhelming and unattainable,� said Borland. �But small, incremental changes to saving and investing habits can truly have a big impact. Workers need to begin saving as early and as much as they can�and they need to take advantage of the plans and features their employers offer. Automatic contribution escalation can painlessly increase savings over time, and automatic rebalancing and target funds can very effectively maintain the targeted asset allocation. Even something as simple as switching to a lower cost investment fund can mean an increase of thousands of dollars by the time an employee reaches retirement age. And every little bit counts.� 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 dianareace@hewitt.com. About Hewitt Associates For more than 65 years, Hewitt Associates (NYSE:HEW) has provided clients with best-in-class human resources consulting and outsourcing services. Hewitt consults with more than 3,000 large and mid-size companies around the globe to develop and implement HR business strategies covering retirement, financial and health management; compensation and total rewards; and performance, talent and change management. As a market leader in benefits administration, Hewitt delivers health care and retirement programs to millions of participants and retirees, on behalf of more than 300 organizations worldwide. In addition, more than 30 clients rely on Hewitt to provide a broader range of human resources business process outsourcing services to nearly a million client employees. Located in 33 countries, Hewitt employs approximately 23,000 associates. For more information, please visit www.hewitt.com.