Leading defined contribution pension plan sponsors are shifting their focus from building account balances to building income adequacy. This outcomes-based approach means plan sponsors need to help members understand how their current savings level will translate into retirement income — and do it while members are in their prime saving years instead of waiting until they’re closing in on retirement.
Fortunately, there’s no shortage of tools available to help members project the income provided by their defined contribution account balance. Virtually every reputable financial institution in the country has developed its own. But not all retirement income calculators are created equal. Here are three things to keep in mind when shopping the market:
1. Garbage in, garbage out
Generally speaking, the less information members need to input, the better — for two reasons. First, for most employees, retirement planning is about as fun as visiting the dentist. So employers need to make it as painless as possible. Members will be more inclined to use a calculator that does as much of the work as possible for them.
Second, asking plan members to make a judgement call — whether it’s how long they think they’ll live or the rate of return they expect to get on their investments — increases the chances of getting a misleading result. The best tools keep member-driven inputs to a minimum number of straightforward questions, such as age and income. This hands-off approach will improve the accuracy of the projection and keep user frustration at bay — improving the likelihood that members will use the tool in the future.
2. Assumptions and biases
Plug the same inputs into two projection calculators and the outputs can vary by many thousands of dollars depending on assumptions, including rates of return, asset mix, annuity rates and longevity. Assumptions programmed into the tool should be well-researched, realistic and defensible. They also need to be free from biases or hidden agendas, such as increasing assets under management.
3. Level of detail
Many factors can influence retirement income needs and expectations, such as spouse’s income and pension coverage, as well as other savings or assets. The more of these factors that can be incorporated into a projection, the better.
Keep in mind that for most employees, knowing how much income their savings will generate is just the first step. To really understand if they’re on track to retire, they also need guidance on how much income they’ll actually need to replace. This can range from as little as 50 per cent to as much as 90 per cent of final earnings, depending on age, health, location and family status, among other things.
The table below compares results from two calculators: one developed by the government and one developed by a large insurance company. The first row shows results based on expert assumptions for longevity and investment returns. The second uses the average life expectancy and median investment return cited by members in Benefits Canada‘s 2015 CAP Members Survey.
- Age today: 45
- Current salary: $60,000
- Retirement age: 65
- 10 per cent annual contribution
- Current account balance: $177,000
- Includes government benefits
The retirement income projections generated by these tools can go a long way toward improving member engagement with their plan and improving outcomes. But for that to happen, the tool needs to be user-friendly and the information needs to be accurate. Plan sponsors need to be prepared to ask the right questions when looking for a tool — and be comfortable with the assumptions that are built into the calculations.