Research by Aon Hewitt has found that U.S. workers may finally be making progress in closing the gap between the amount of money they need in retirement and what they are on track to accumulate, thanks in part to stronger market returns and better savings efforts by employees.
The study was carried out for U.S. employers and employees, but Canadian plan sponsors may also be interested in the results and implications, especially with respect to the pros and cons of auto features and investment advisory services.
Aon Hewitt projects that, factoring in inflation and post-retirement medical costs, U.S. employees will need 11 times their final pay in retirement resources in order to successfully meet their needs in retirement. However, Aon Hewitt’s report, The Real Deal: 2012 Retirement Income Adequacy at Large Companies, found that, on average, U.S. employees are on track to accumulate only 8.8 times their final pay. It’s bad news at first, as there’s still a shortfall of 2.2 times their final pay—but the good news is it’s also a slight increase from 2010, when the shortfall was 2.4 times their pay.
As well, according to Aon Hewitt’s 2012 Universe Benchmarks report, 76% of employees surveyed participated in a DC plan during 2011, and participation among younger workers increased by two percentage points since 2009 to 54% of eligible workers.
But even with the good news, there’s still plenty of room for improvement. According to Aon Hewitt’s research, the average before-tax contribution rate for U.S. employees remains nearly unchanged, at 7.2% of pay. As a result, less than 30% of employees are currently “on track” to achieve adequate retirement income. Passive employee behavior also is at an all-time high, with just 15% of participants initiating a trade in 2011, down from 20% 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,” said Rob Reiskytl, leader of retirement plan strategy and design with 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 enrollment with automatic contribution escalation for all employees. Ideal solutions will improve outcomes with little or no increase in employer cost.”
Use automation to its full potential
Automation tools help to encourage better saving and investing behaviors, according to Aon Hewitt’s research. The participation rate among those subject to automatic enrollment is 83%—18% higher than those employees who are not defaulted. The research also found that 53% of employees who are enrolled in automatic contribution escalation programs are expected to meet their financial needs in retirement, compared to just 26% of those who are not.
However, while automation can play a positive role in employees’ saving behaviors, it can also be detrimental if not managed effectively. Employees who are automatically enrolled in their DC plan have an average savings rate of 6.7%, which is a full percentage point below those not subject to automatic enrollment. Additionally, these workers are much more likely to miss out on employer matching contributions. According to the report, 39% percent of automatic enrollees save below the match threshold versus just 25% 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,” said Patti Balthazor Bjork, director of retirement research with Aon Hewitt. “Employers also should strongly consider sweeping in eligible non-participants periodically. Other alternatives include quick-enrollment tools and using education and communication opportunities to influence savings levels and highlight the availability of automatic escalation.”
Offer investment advisory services
“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,” said 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% of participants allocate to a premixed portfolio, up from 51% in 2009. Among those who use a premixed portfolio, the average person held 65% of their balance in premixed funds in 2011, up from 56% in 2009.