Retirement Planning
Content
Retirement Planning – Are Today’s Employees Prepared for Tomorrows Retirement?
Jeff Chad – HR.com Senior Research Analyst - Benefits
AGENDA
• Define Retirement Planning, Life Planning and what are the steps involved and why it is so important • Income Replacement Ratio Targets • Where we are today?- The numbers tell the story • What Employers need to do to help and why
We’ll start today by conducting two polls to see where our audience is on a couple of Rules of Thumb one should be aware of when trying to prepare and plan for retirement.
Poll 1 – Rule of Thumb 1
• How long does it take to double your money considering compound interest? Remember this is an approximation Hint: Exact Formula would be: P (1+ i/100)x = 2P X = 1/i • X = 72/i • Other Response
The actual true calculation would be; if P is your principal, P x (1 + your interest rate as a percentage) to the power of x, where x is the term you want to determine equals to 2 times your principal. Results: Seventy-one percent of you have chosen the right answer as 72 divided by i. This is referred to as the rule of 72. So, the correct answer is (2). Remember this is only a quick approximation. For example, if i=12%, then 72/12 = 6; if i = 8% and 72/8 = 9.
Poll 2 – Rule of Thumb 2
• What Rule of Thumb has often been used as the percentage of your income that you should save? Less than 5% 5 to 9% 10% Greater than 10%
Results: Fifty-seven percent of you have chosen 10 and that is the actual response. Realistically, the answer depends on many issues including determining the lifestyle that you want to have on retirement. We will get more into this later, but for simplistic purposes, the Rule of Thumb is 10%, starting as early as possible, even in the 20' to give yourself more s, options.
Retirement Planning
• Definition: It can be defined as the process of gathering financial data, and life style information including leisure, volunteer work and full or part-time paid work.
So, what is retirement planning? It can be defined as the process of gathering financial data and lifestyle information including leisure, volunteer work and full- or part-time paid work. One needs to do this not just for the obvious reason of financial security and resource management, but also think about where you will be 5, 10 or 15 years down the road with your life. Retirement requires planning, commitment and an action. If one does not plan this trip of life’s journey before one starts, it will be too late to choose one’s destination. If you' re planning a vacation you usually choose the destination first and prior to, the day you want to go on vacation. Some people try and take last minute trips but they are not really keen necessarily on going to a particular place. Last minute you can go anywhere or not necessarily the place you want to go.
Questions to Ask Yourself
• • • • • • Where will you be living? Will your spouse be living and if so will you still be together? Will You be employed at the same job? Will you be in good health? Will you have the same friends and enjoy the same hobbies? Will your life have meaning, a sense of purpose?
Now before we go any further, let me give you another thought. I contend that successful retirement planning is just a byproduct of the development of a purposeful life plan and life planning is defined as an ongoing process of creating goals and setting objectives of every stage of one’s life cycle. The life planning goals are or should be focused on trying to balance one’s personal needs, family and work, and there are many obstacles one comes across in doing this.
Quick Poll 3
• What is the greatest transition that one will face in ones lifetime? Retirement Marriage Other
Response: The correct response is (1) Retirement as actually 70% of you have indicated. Although when you really think about it, death probably is, but we won’t ever truly know the answer to that. Now you may think that life planning is something only some of you like me with a project planning background would adopt and embrace. Many people only live for today and today’s task and never for retirement. They are in constant pursuit of
happiness. A quick message for those of you who aren’t aware of it yet, you don’t become happy by pursuing happiness. Your life must mean something for you to be happy. If you are not there now, you will be there at some point. If you get a financial reward like a bonus, some people would save this for retirement, others would use it for today’s living expenses. Everybody needs to set their own compass on one' life’s s journey and everybody has a unique destination in their lifestyle. Everybody needs to decide whether they want to go on this journey and whether they want to travel coach, business class, or first class.
Major Life Periods
Period Youth Focus Middle Years Leisure Pursuit Duration 16-25 years 30-35 years 20-40 years Main Activity Learning Working Balanced Lifestyle
If we look into the past, the average life expectancy at the start of the 20th century was approximately 48 years compared to today' where it’s the late 70’s for males and early s, 80' for females. Prior to the 20th century, one would work for their whole lifetime just to s survive. Today with the adoption of child work laws and mandatory education laws, we have on average three major life periods: the first 16 to 25 years of your life we call “youth focus,” and basically learning is your main activity; the middle years, which we call your "work years," and which last 30 to 35 years on average; and the last term or period of your life is considered "leisure pursuit," and lasts 20 to 40 years. That is where you are looking for a balanced lifestyle. The only thing different there is, more and more today, people will be working part-time longer or full-time longer into the leisure pursuit years as well. As you progress through the period of life, you should not just limp through life but rather take an approach that leads to progress, adventure, enthusiasm and joie de vivre. You need a balance in your life. You want and need physical health and wellness, personal growth, professional career, personal fulfillment, precious relationships and financial freedom. But say you only have the last one, financial freedom. If you look at some well-known entertainers, such as Marilyn Monroe, John Kennedy, Janis Joplin, and Mama Cass Elliot, all these known entertainers and celebrities died young, with lots of money, so they had their financial wishes, if you like, but they did not have a balanced lifestyle. All died from a form of substance abuse, although in two cases the substance abuse was actually overeating.
Hierarchy of Needs
Most of you have probably heard of if not studied about the famous psychologist named Abraham Maslow. One of the many interesting things Maslow noticed while he worked with monkeys early in his career was that some needs take precedence over others. For example, if you are hungry and thirsty, you would tend to try to take care of the thirst first. After all, you can do without food for weeks, but you can only do without water for a couple of days. Thirst is therefore a stronger need than hunger. Likewise, if you are very thirsty but somebody has put a choker on you and you can’t breathe, which is more important? The need to breathe, of course. On the other hand, sex is less powerful than any of these. Let' face it - you won’t die if you don’t get it. s Maslow took this idea and created his now famous Hierarchy of Needs. Beyond the details of air, water, food and sex, he laid out five broader layers of the psychological needs. The need for safety and security, the need for love and belonging, the need for esteem, and the need to actualize the self, in that order. Basically, the above stated needs must be satisfied before the next higher ones can be met. First thirst, then hunger and shelter, and then security and safety, then belonging, identification and love, then respect, prestige and self-actualization. The reason why it is in a pyramid shape is not everybody moves up to each level, and therefore on each level we go to we have less and less people and that’s why it’s pyramid-shaped. The most profound reason for living is to make it a purposeful existence. Now why did I bring up Maslow’s Hierarchy of Needs in the first place can be viewed because from this angle, retirement is not considered as days of personal decline, but rather an inclining movement into true maturity, wisdom, spirituality, opportunity and action to contribute. Now, most synonyms used for the word ‘retirement’ include resignation, departure, isolation, retreat, seclusion, solitude, withdrawal, progression, and non-productive years. In reality, all of these tend to drive a negative connotation, but as I am trying to stress on the Hierarchy of Needs, where retirement sits is moving upwards so it should be looked at in that regard.
Top Concerns /Activities
CONCERNS • Health • Money • Relationships ACTIVITIES • Leisure • Volunteer • New career or parttime work
So, how will you change your life in retirement? First of all, what will be your top concern or top three concerns and activities? Your concerns will be health, money and relationships. Activities would be leisure, volunteer and new career or part-time work. What am I getting at by mentioning that is everybody has lots of different concerns and they would do lots of different activities but these are the top three that pretty much all retirees of the future and the past are concerned about today.
Retirement Planning Exercise
What do you need and want for the future? Organize your affairs Seek all the data, information and help you need Attain financial fitness Determine if your income sources will meet needs 6. Will you be considering a change of occupation? 7. Are you considering starting your own business? 8. Are you considering starting partial retirement? 1. 2. 3. 4. 5.
What I am going to ask you to do now is to get your creative juices going and I am going to start a retirement planning exercise. So, if you think of any idea that I don’t come up with on the following three charts, please feel free to e-mail them to me after the session and I will make sure that I include it in future sessions. Put aside your daily demands and think about what you need and want for the future. You need to organize your affairs so you can see clearly. You need to seek all the data and information and help you need. In order to attain financial fitness and maintenance thereof, once reached, you need to do various things. You need to determine if your personal savings, investments,
pensions and the employer provided retirement vehicles will meet your needs of retirement. Will you be considering a change of occupation? Are you contemplating starting your own business? What about partial retirement?
Retirement Planning Exercise ctd
9. Are you contemplating early retirement? 10. Will you need to move? 11. Will you have a second or permanent home in a sunbelt area? Will you sell your home? 12. Do you wish to travel a lot? 13. What hobbies are you planning? 14. Are you in good health? Is your spouse? 15. Longevity in your family? Spouses family? 16. Have you determined your income needs?
Are you contemplating early retirement? A lot of people used to hear the term Freedom 55 but Freedom 55 is a dream that most of us will not be able to reach, not as we are today. Will you need to move? Will you need to move to a new house? Will you want a second home in a sunbelt area? Will you sell your existing home or buy a new home? Do you wish to travel a lot? What hobbies are you planning and are they costly hobbies? Are you in good health? What about your spouse? What about the longevity in your family and/or your spouse’s family? Have you determined what your income needs are?
Retirement Planning Exercise ctd
17. What are the various sources of income and options available? 18. Have you arranged your investments for inflation protection? 19. Have you determined/estimated your health costs? 20. Do you think you will meet your retirement goals and objectives?
What are the various sources of income? And are you upfront? Do you know what all the options available to you will be? Have you arranged your investments for inflation protection? And more importantly in these days, have you determined or estimated what
your health costs in the future are going to be? retirement objectives?
Do you think you will meet your
Retirement Sources
• Three-legged stool
Employee Savings
Social Security
ER Provided Pensions
Security is necessary to alleviate many of the concerns associated with retirement, but it will not cut it alone. You need to ensure a rewarding, challenging and satisfying lifestyle and there is no fixed price tag for a successful retirement, nor does it happen the day you leave the workforce. True financial planning consists of setting goals and objectives. Investments and taxation, income and life protection, wills and estate planning, pension and retirement, but it also means the development and affordability to pursue a meaningful interest including a second career, friends, family, hobbies, recreation, travel, further education, a sunbelt home, etc. The list goes on. You need to prepare for various roadblocks including boredom, loss of identity and self-esteem. Retirement thinking - old versus new. There has been a shift of responsibility from the 20th century to the 21st, where the employee now is assuming much of the responsibility for his or her own future. We have moved from the paternalistic employer, where the employer’s responsibility was first and the focus on everything involved the employer to a society, which is referred to as a survivalist, where the focus is on the employee and the employee responsibility. What do I mean by a survivalist mentality? I mean you need to be clear and concise with your retirement plan. You must accept responsibility and determine your goals for retirement. You must be prepared to work full-time as long as possible, and possibly part-time thereafter. I contend that it will not be the strongest nor the smartest that will survive but the ones who are the most adaptable to change. But from a pensions past to a pensions future, even the relative sizes might have changed. We are still looking at what I call a three-legged stool approach. Now all of you who are sitting on a stool of three legs know that it needs each of the legs to support you. So if one of those legs break, in other words, if the government gets rid of social security, your employee savings aren’t what they need to be or the employer provided pensions DB, DC, including IRA’s and 401K’s, etc. are not what they need to be. What' s going to happen to you? One of those legs will not be thick enough to support you and
you are going to topple over. It' still pertinent that your total income will consist of those s three things and as long as you have the ability to get your employees in on that, you need to as well. To prepare for retirement one needs to start not at age 65 or later but in your 30’s or even earlier, specifically if you plan to retire early. Developing what I refer to as a road map should not be full of unnecessary anxiety. Few people realize how little cash you need to put aside assuming you start early enough and follow it consistently. Remember the older you are, the greater your life’s expectancy. For example, your life expectancy at 60 is greater than it was at birth and the fastest-growing population on a percentage basis only are centurians (100 plus).
Income
DC, DB PT, FT Work Other Investments
Pretax Income
Social Security
Ret Investments
Home Equity
So, what are your expense and the income requirements? We will talk about it a little bit further later on but I am going to give you another Rule of Thumb. Count on needing somewhere between 70% to 80% of your last working year’s full income. The exact amount will depend on your desired realistic lifestyle, your personal commitments and responsibilities including financial help to your children, your sources of income. Remember retirees tend to slow their pace of life by about 70 or so. They drive less. They entertain less. If one never entertains during one’s working career, is it realistic to expect to entertain once they retire? You could expect that but your percentage ratio that you need to replace would obviously need to be higher in order to do so. The retiree has usually eliminated many personal expenses such as furniture, appliances, equipment and vehicles, completed home renovations and/or home is paid off, children moved out and their education complete, most outstanding debt is paid off. To retire you will generally have a reduction of cost to live in retirement other than health costs, which today unfortunately are generally increasing. So, let’s look at the various sources of income. Starting at the top we have your corporate pension, which includes your defined contribution, defined benefits plans, other investments, retirement investments, home equity if you are going to sell your house and use the equity out of it, government social security, part-time or full-time work and that in total will generate what we call your pre-tax income.
Expenses
Food Shelter Personal Care Personal Expenses Recreational Expenses Travel Expenses Discretionary Expenses Transportation Insurance Property Taxes Mortgage & Other Loans Estimated Income Taxes Estimated Health Costs Estimated COLA
What about expenses? Expenses - and there may be more than these - will include food and shelter, transportation and insurance, personal care, general health, personal expenses, property taxes, mortgage and other loans, recreational expenses, travel expenses, estimated income taxes, estimated health costs, discretionary expenses, and estimated inflation protection costs for a number of years. COLA stands for cost of living adjustments. At the end of the road after you have computed both your income and expense sheets you need to arrive at your summary and you will either have a surplus or a deficit. A surplus will mean your projected resources exceed your expense requirements with a buffer of X amount of dollars. A deficit would mean your projected retirement needs exceed your resources by X amount of dollars and the goal is to increase your net worth by saving and investing and reducing requirements. You as an employer can provide your employees with tools so that they can model what these deficit/surpluses are and try and do something about it. They need to determine when to actually start saving more, how much more they need to save and how they should be investing it. You need to schedule time to complete this annual financial fire drill, as I call it, to make sure you are on course with your retirement objectives. Use any of the available tools to model the forecast. How can you make up the deficits considered above?
How Much To Save each Year
Depends on the following: • How much capital you need • How much you have already saved • How long until you retire • How many years do you expect to live • Your expected net return after COLA
So, how much do we need to save each year? The amounts will depend on many different things but essentially it starts with how much capital you think you need. How much do you already have? How long until you retire? How many years do you expect to live? And what is your expected net return after cost of living adjustments? None of these is fixed in stone. It’s constantly changing and that is why you have to review this annually.
Compounding 1000/yr for 30 yrs
Interest Rate 0% 3% 6% 9% 10.5% 12% Approximate dollars (000s) $30 $58 $122 $270 $407 $615
Compounding interest has a huge effect and if we look at it just paying $1,000 a year into some saving vehicle for 30 years and your interest rate is 0%, i.e. you are earning no interest, it would be 30 times $1,000 and end up being $30,000. If we instead go to 1.5 % interest average return throughout that lifetime, you would have $41,000. On the other end of the scale if we go all the way up to 12% you are going to have $615,000. Now, imagine getting a total of $615,000 for just $1,000 a year for 30 years. Looking at it another way, if you invest $20 a week at 12% compounded monthly and started at age 25, you will have approximately $1.04 million at age 65. If you wait 10 years with the
same exercise - $20 a week - and you started at 35, you will have only slightly over $300,000, or a cost of waiting 10 years from 25 to 35 of over $700,000. So, the message here is that not only do you need to know this for yourself, but the idea of saving needs to start as soon as possible. So make regular contributions to the fund. Don’t wait till the end of the year to make it up.
Profile of a Retiree
• • • • • • • • Spends approximately 30-35% less his previous pay Uses one all purpose credit card Adventure travel is #1 Goal Watches much TV Loss of identity and/or self esteem Boredom common Walking #1 physical activity. Involved with family & friends
Now, let' look at the profile of a typical retiree. As I said earlier, this may be a s contradiction because individually everybody needs to choose their own realistic and attainable lifestyle; therefore, a typical profile may not be something that’s really out there. Generally, the typical retiree will spend approximately 30% to 35% less than the pre-retirement income he used to have. He will use one all-purpose credit card usually with cash back or travel points associated with it. Adventure travel will be his #1 goal. He will watch much TV. He will probably experience a loss of identity and/or selfesteem. Boredom may be common. Although walking will be the #1 physical activity, others include gardening, home maintenance, swimming, bowling, golf, and tennis. He will be involved with family and friends and to the exclusion of the neighborhood and community.
Income Replacement Ratio
Definition Amount of Income an Employee Requires from all Sources as a % of Final Pay Needed to Maintain Standard of Living
Let me quickly discuss an anecdote from a Time Management presentation. If you take a one-gallon jar and you take 12 fist-sized rocks and placed them one at a time into this jar until no more rocks can fit, is the jar full? No it' not. You can pour some gravel in s and shake the jar causing some of the gravel to find its way into the jar. Is the jar full yet? Again no, it' not. Take a bucket of water and pour it in until the jar is filled to the s brim. So what is the point of this illustration? Is it not if you really try hard you can fit more into your time schedule? No. If you do not put the big rocks in first you will never be able to get them in at all, so what are your big rocks in life? I am sure that health and your children are two of them, but I submit the retirement planning needs to be one as well. If you sweat the small stuff and you fill up your life with things that do not really matter you will have no room for the big stuff. We are going to talk very briefly about income replacement ratios. By definition it' the s amount of income an employee requires from all resources stated as a percentage of his final pay needed in order to maintain a pre-retirement standard of living. Now what are some replacement ratio targets? Again we talked about Rule of Thumb when we said approximately 75%. Let' give an example here. Assume an employee earns $60,000 s before retirement and he receives $45,000 between social security and all other forms of retirement income. His replacement ratio would be calculated as 45,000 divided by 60,000, which equals 75%. Remember, we said earlier that the Rule of Thumb was 70% to 80%. A retiree generally needs less because: taxes decrease after retirement, FICA deductions from wages stop, you no longer need to save for retirement, social security is partially or fully tax-free, and age and work-related expenses generally decrease with shelter usually paid off and transportation to work unnecessary. These outweigh some of the expected increases in healthcare cost to a large extent but that is one thing the employee of today has to be concerned about. With what has been happening with raising health costs in the past number of years, many employers have turned around and stopped their retirement medical plans. Where an average cost for health before was maybe 25% or 20%, now it is 50% to 100%.
Income Replacement Ratio
Replacement Ratio % For Average Employee 90% 75% 78% Earnings $20,000 $60,000 $90,000
Social security replaces a larger portion of pre-retirement income for the low wage earners. It redistributes, by design, income from the higher to lower paid so total replacement ratios are therefore higher for the lower paid, because they are getting a bigger part from social security but they pay less taxes and also usually save the least. If we look at the table above, the replacement ratio of someone earning $20,000 is as high as 90% and even if we factor in some of the rising healthcare costs, it may be well over 100%. If we go down to a level of $60,000, the average replacement ratio needed is 75% for the average employee, and again this is average. If you don’t contribute to a 401K plan, you can expect to replace as little as 50%. Considering that some may need to replace as much as 125% to meet medical and income needs, shortfalls that exist need to be made up. The numbers tell the story. Most workers have not even calculated how much money they will need to save for retirement. There are more workers who have not saved one penny for retirement than workers who are confident they have enough for retirement. A 2004 study conducted by Hewitt of 3,500 employees of large companies says that 49% of employees worry that they do not have enough for retirement. Approximately 40% of US employees are not currently saving for retirement at all. Only 40% have calculated their retirement saving needs; one in three workers does not participate in company 401K plans and planning for retirement has not only become more important but also more difficult to accomplish. The baby boomers'initial foray into the retirement venue has happened at a time when the stock market completed three years of decline, coupled with Congress’ review of the legality of cash balance plans and medical inflation causing the elimination and reduction of many employer-sponsored post-retirement medical plans.
Good News
Good News vi=very important % EEs who feel DB plans vi % EEs who feel ER plans vi % ERs who feel ER plans vi % ERs who believe 401K important to attract/retain % EEs who want bfts over pay 2005 61% 74% 85% 79% 58% 2004 46% 66% 77% 75%
There is some good news from a Trans-America study just released in October 2005. We have the following results: Employees who feel that their defined benefit plans are very important to them went from 46% in 2004 to 61% in 2005. The employees who feel the employer funding plans are very important to them went from 66% to 74% - not quite the same rate of increase but still it is an increase. The percent of employers who also feel their employer-funded plans are very important to their employees went from 77% to 85%. The percent of employers who believe their 401K plans are important to attract and retain employees has gone up slightly from 75% to 79%. The percent of employees who would exchange superior benefits over increases in pay is 58%, which is also good news.
Not So Good News
2005 % ERs who feel EE want benefits over pay % EEs who feel ok to retire at 65 % EEs who feel nest egg ok % EEs who spend >10hrs/yr % EEs who saved >100,000 22% 23% 20% < 33% < 25% 2004 34% 31%
Not so good news is if we look at this chart we see the employers who feel employees want better retirement benefits over pay; they have gone down from 34% in 2004 to now only 22% in 2005. The percentage of employees who feel confident that they can retire at 65 has gone down from 2004 from 31% to 23%. The percentage of employees who thought they have enough of a nest egg is only 20%. The percentage of employees who spend greater than 10 hours a year figuring out what their retirement income objectives
and amounts are is less than 33%. The percentage of employees who save greater than $100,000 to date is less than 25%. The percentage of employees who want to know more about reinvesting is 71%. I am not sure that it is bad news. Employees seem to appear to want more investment options; in the study 73% agreed to it. I am not sure where this comes from as to me the evidence shows that there is already too much choice and companies, if they are offering new options, should maybe eliminate some of the old options because employees are just faced with too much choice. Companies have started adopting lifecycle and lifestyle funds to accommodate this. Some other results from the Trans-Americas Center for Retirement Studies that are worth mentioning briefly: 82% of the employees agreed that the employer gave enough information to decide on return benefits to the employee; 53% agreed and 45% disagreed that the employees were building enough of a nest egg. With respect to the age where the employee is expected to retire, the mean of all that was 63 and the median was 65. For those of you who do not know what the mean is, mean is basically the average. So if we have five employees and we add up their five ages and divide by five, the median would be the amount right in the middle. So for the five employees the median would be the third number, whatever that would be. The age employees start saving was age 30 with a mean of age 28. The problem with some of the estimates that I am going to give you right now is how they were arrived at. How much of a nest egg will you need to retire? The total mean for both large and small employers was roughly $1.5 million for this question, so employees responded they think they need on average $1.5 million as a mean as a nest egg in order to retire from all sources. The median was roughly half that at $750,000. The large companies were slightly higher than that at almost $1.7 million, with smaller companies at $1.3 million. But the problem, I guess, is 35% of the employees that arrived at these estimates guessed, in fact only 22% actually calculated worksheets in order to come up with an estimate for these numbers.
Quotation from 1872 EE Manual
“ Every employee should lay aside from each pay a goodly sum of his earnings for his benefit during his declining years, so that he will not become a burden upon the charity of his better.” Mt. Corry Carriage & Iron Works in 1872
So you as an employer have to provide or should provide various ways to help the employee get into pre-retirement mode. I refer you to this quotation, which was taken out of an 1872 employee manual by the Mount Corry Carriage and Iron Works. “Every employee should lay aside from each pay a goodly sum of his earnings for his benefit during his declining years, so that he will not become a burden upon the charity of his better.” That quote would still hold today so if that company felt it was worthwhile doing
something on behalf of the employees back then it sure is still happening today and should be happening today.
Problems
• EEs make minimum contributions • Low participation • Don’t know plan • Don’t use education • Don’t know asset allocation • Little appreciation • HCEs get money back • Many EEs financially illiterate – leads to absenteeism, presenteeism, theft, lost productivity, high turnover
Now there are many problems out there. These problems are caused by different things, but basically many plan participants are only making minimum contributions, if at all, and thus not maxing out employer match. Everybody should even borrow money in order to max out the employer match because you are throwing money away. People do not know the plan. They do not understand the basic features of the plan. A high percentage of them never use the educational services available to them and we generally provide them with information as opposed to knowledge. Employees generally have or cannot pass a simple quiz on asset allocation methods. Employees do not appreciate the plan. Employees that are failing to plan are planning to fail. They are setting themselves up. Then there are the high compensated earners who, many times at the end of the year, get back some money because of top heavy rules when low participation results on behalf of the low incomers cause them to be having too much in the plan. Many employees are financially illiterate and the signs of this illiteracy include loans, wage garnishments, calls from banks and creditors, lost productivity, high turnover, theft, lost time dealing with problems, absenteeism, presenteeism costs, low participation plan and proper diversifications. The additional financial strife leads to undesirable consequences including safety and customer service problems. But is advice the answer? DC plan participants have little investment knowledge and are unable or unwilling to gain it. They are looking for others to provide the skills they lack. Should the plan sponsor delegate decisions to an advisor on their behalf, and if so, how to choose an advisor? What fiduciary responsibilities does the sponsor retain? What is the cost and who will pay for it? And what to do for participants who do not use the advice? Considering our new world has less retirement security, longer working lives and later retirement, it’s a world requiring high personal savings and smarter investing. At least in 2006 federally mandated defaults directing employers to deposit relative small amounts of $1,000 to $5,000 into IRAs takes effect.
Employers should be trying to educate their workforce. Research will confirm there are immeasurable benefits to an educated workforce. After financial education in the workplace, participants reported the following improvements: 45% increased contributions or deferral rate to a 401K plan 35% started contributing to the 401K plan 70% changed investment strategy to more diversification greater than average financial wellness and better health less financially stressful events occur less likely to have maxed out credit cards less likely to worry about money matters they owe instead of work issues financially literate employees often receive better reviews financially literate employees are often more promotable.
Why Employers Should Educate
Improve EE Retirement Readiness Improve Understanding
Reduce Turnover
Improve Utilization
Improve Productivity
Increase Participation
Increase Diversification
Increase Contributions
Now why should employers educate? Well for one thing it improves understanding. It improves utilization, increases participation, increases contributions, increases diversification, improves employee productivity, improves retirement readiness and reduces employee turnover. So, what is the ROI? The rate of investment on retirement planning ratio and what is it worth to you on behalf of your employees to make sure that they are better well off for retirement.
Tips to Employees
Fees < Manage Debt Do Inventory Save for Yourself Participate ASAP Keep Emergency Fund Plan for Life Events Prioritize Objectives Diversify Use Professional
Contribute More
Monitor Progress
Work Longer Look at tax Withholdings
Let' look at some tips to employees. First, you need to know what you have, so you s need to do an inventory, gather all your bank accounts, bills, statements, investment accounts, retirement accounts, figure out and calculate your net worth, save for yourself first, and no matter how little on a continual basis, participate and start and contribute as early as possible at an age and time of the year in order to maximize the compounding effects to your employer-provided plans and your personal saving accounts and also maximize your employer match into your 401K plans. Expect the unexpected and keep emergency funds. Plan for life events including weddings, births, home buying, education, etc. Prioritize your objectives and goals and be realistic in your goal setting in both how much you will have and how much you will need. Work with a professional advisor. Lower your debt where possible and lower interest rates by negotiating with another company and transferring balances, stop procrastinating, diversify, and monitor progress. Review income tax withholdings. Team up; speak to friends and colleagues in addition to the professionals. Consider working longer by at least two years. Consider contributing more where possible, an additional 2%, and try as much as possible to avoid high fees.
Tips For Employers
Online Retirement Calculators Match & Vest ASAP Financial Advice
Immediate Participation
Measure Results
Rollover Old 401(k)
Lifecycle Funds
Various Media
Tips for employers - Provide online retirement calculators for modeling shortfalls. Provide access to financial advice and educational tools. Stress to employees to roll over all 401K plans and benefits communication. Use a mix of media to reach your total audience. This includes general print material, personalized print material, personalized web including modeling, employee meetings and seminars. Try and improve communication and educate rather than give information only. Lifecycle funds boost participation. On average lifecycle funds also boost better returns. Allow immediate participation and automatic enrollment wherever possible. Match employee contributions and invest them immediately wherever possible and measure your results. See if the efforts are working.
Roth 401(k)
• • • • • • • Funded with after tax dollars Qualified distributions tax free Contributions $15,000/yr (20000 for 50+) Combo with 401(k) if offered Same hardship and loan rules Can defer as long as working Sunset provisions end 12/31/2010
Do we give our employees the Roth 401K option? As you know this starts January 1, 2006, and although there are many good things to say about it, the government probably likes it because it' paid with after tax contributions so the government gets your tax s upfront. One of things that you need to think about is that employers, in the last number of years, have been moving from DB plans to DC plans and one of the reasons for that has not just been cost. It has been the complexity of the plan. Try to simplify the plans and the Roth 401K plan is a more complicated plan. You have got to bring in to it not only tax today but future expected tax rates (which you don’t really know what they will be). So you are paying tax up front and if tax rates go down in the future you will have paid too much, not only have you paid too early, you have paid too much. Having said that, there are many things good about it. The Roth 401K plans are confusing so they may hinder overall participation. Remember, one of our problems is poor participation to start with. Let' go over the features of the Roth 401K plan. They are funded with after tax s contributions, with qualified distributions; contributions plus earnings are withdrawn taxfree. The qualified distribution means the five-year holding period including time with prior employer plans for rollovers. You are exempt if you are greater than 59-1/2, disabled, die with money transferred to a beneficiary or state. Your contributions are limited to $15,000 per year with $20,000 for workers per year of those 50 plus as a catch up. These numbers are both higher than the $4,000 traditional in the Roth IRA accounts, which rises to $5,000 for those greater than or equal to 50. If the employer provides a Roth 401K plan, the employee can choose the 401K plan, the Roth 401K plan, or both with separate accounts and $15,000 in total per year. Same hardship and loan rules apply. You can defer as long as you’re still working, at any age. The employee terminates with the Roth 401K plan. He can leave it with the former employer or if the plans roll it over into another Roth account - either a Roth 401K plan or an IRA Roth plan. The sunset provisions end December 31, 2010 unless Congress extends it, which they may do because they’re getting tax money upfront, and there is a good chance they will be extended if employees and companies want it.
Copyright 2005 HR.com - This document cannot be republished, replicated or reproduced in print or electronic format without the expressed written permission of HR.com. No part of this document is to be posted onto another website, company intranet or shared electronically. Contact HR.com at: [email protected] or toll free at 1877-472-6648.
Jeff Chad – HR.com Senior Research Analyst - Benefits
AGENDA
• Define Retirement Planning, Life Planning and what are the steps involved and why it is so important • Income Replacement Ratio Targets • Where we are today?- The numbers tell the story • What Employers need to do to help and why
We’ll start today by conducting two polls to see where our audience is on a couple of Rules of Thumb one should be aware of when trying to prepare and plan for retirement.
Poll 1 – Rule of Thumb 1
• How long does it take to double your money considering compound interest? Remember this is an approximation Hint: Exact Formula would be: P (1+ i/100)x = 2P X = 1/i • X = 72/i • Other Response
The actual true calculation would be; if P is your principal, P x (1 + your interest rate as a percentage) to the power of x, where x is the term you want to determine equals to 2 times your principal. Results: Seventy-one percent of you have chosen the right answer as 72 divided by i. This is referred to as the rule of 72. So, the correct answer is (2). Remember this is only a quick approximation. For example, if i=12%, then 72/12 = 6; if i = 8% and 72/8 = 9.
Poll 2 – Rule of Thumb 2
• What Rule of Thumb has often been used as the percentage of your income that you should save? Less than 5% 5 to 9% 10% Greater than 10%
Results: Fifty-seven percent of you have chosen 10 and that is the actual response. Realistically, the answer depends on many issues including determining the lifestyle that you want to have on retirement. We will get more into this later, but for simplistic purposes, the Rule of Thumb is 10%, starting as early as possible, even in the 20' to give yourself more s, options.
Retirement Planning
• Definition: It can be defined as the process of gathering financial data, and life style information including leisure, volunteer work and full or part-time paid work.
So, what is retirement planning? It can be defined as the process of gathering financial data and lifestyle information including leisure, volunteer work and full- or part-time paid work. One needs to do this not just for the obvious reason of financial security and resource management, but also think about where you will be 5, 10 or 15 years down the road with your life. Retirement requires planning, commitment and an action. If one does not plan this trip of life’s journey before one starts, it will be too late to choose one’s destination. If you' re planning a vacation you usually choose the destination first and prior to, the day you want to go on vacation. Some people try and take last minute trips but they are not really keen necessarily on going to a particular place. Last minute you can go anywhere or not necessarily the place you want to go.
Questions to Ask Yourself
• • • • • • Where will you be living? Will your spouse be living and if so will you still be together? Will You be employed at the same job? Will you be in good health? Will you have the same friends and enjoy the same hobbies? Will your life have meaning, a sense of purpose?
Now before we go any further, let me give you another thought. I contend that successful retirement planning is just a byproduct of the development of a purposeful life plan and life planning is defined as an ongoing process of creating goals and setting objectives of every stage of one’s life cycle. The life planning goals are or should be focused on trying to balance one’s personal needs, family and work, and there are many obstacles one comes across in doing this.
Quick Poll 3
• What is the greatest transition that one will face in ones lifetime? Retirement Marriage Other
Response: The correct response is (1) Retirement as actually 70% of you have indicated. Although when you really think about it, death probably is, but we won’t ever truly know the answer to that. Now you may think that life planning is something only some of you like me with a project planning background would adopt and embrace. Many people only live for today and today’s task and never for retirement. They are in constant pursuit of
happiness. A quick message for those of you who aren’t aware of it yet, you don’t become happy by pursuing happiness. Your life must mean something for you to be happy. If you are not there now, you will be there at some point. If you get a financial reward like a bonus, some people would save this for retirement, others would use it for today’s living expenses. Everybody needs to set their own compass on one' life’s s journey and everybody has a unique destination in their lifestyle. Everybody needs to decide whether they want to go on this journey and whether they want to travel coach, business class, or first class.
Major Life Periods
Period Youth Focus Middle Years Leisure Pursuit Duration 16-25 years 30-35 years 20-40 years Main Activity Learning Working Balanced Lifestyle
If we look into the past, the average life expectancy at the start of the 20th century was approximately 48 years compared to today' where it’s the late 70’s for males and early s, 80' for females. Prior to the 20th century, one would work for their whole lifetime just to s survive. Today with the adoption of child work laws and mandatory education laws, we have on average three major life periods: the first 16 to 25 years of your life we call “youth focus,” and basically learning is your main activity; the middle years, which we call your "work years," and which last 30 to 35 years on average; and the last term or period of your life is considered "leisure pursuit," and lasts 20 to 40 years. That is where you are looking for a balanced lifestyle. The only thing different there is, more and more today, people will be working part-time longer or full-time longer into the leisure pursuit years as well. As you progress through the period of life, you should not just limp through life but rather take an approach that leads to progress, adventure, enthusiasm and joie de vivre. You need a balance in your life. You want and need physical health and wellness, personal growth, professional career, personal fulfillment, precious relationships and financial freedom. But say you only have the last one, financial freedom. If you look at some well-known entertainers, such as Marilyn Monroe, John Kennedy, Janis Joplin, and Mama Cass Elliot, all these known entertainers and celebrities died young, with lots of money, so they had their financial wishes, if you like, but they did not have a balanced lifestyle. All died from a form of substance abuse, although in two cases the substance abuse was actually overeating.
Hierarchy of Needs
Most of you have probably heard of if not studied about the famous psychologist named Abraham Maslow. One of the many interesting things Maslow noticed while he worked with monkeys early in his career was that some needs take precedence over others. For example, if you are hungry and thirsty, you would tend to try to take care of the thirst first. After all, you can do without food for weeks, but you can only do without water for a couple of days. Thirst is therefore a stronger need than hunger. Likewise, if you are very thirsty but somebody has put a choker on you and you can’t breathe, which is more important? The need to breathe, of course. On the other hand, sex is less powerful than any of these. Let' face it - you won’t die if you don’t get it. s Maslow took this idea and created his now famous Hierarchy of Needs. Beyond the details of air, water, food and sex, he laid out five broader layers of the psychological needs. The need for safety and security, the need for love and belonging, the need for esteem, and the need to actualize the self, in that order. Basically, the above stated needs must be satisfied before the next higher ones can be met. First thirst, then hunger and shelter, and then security and safety, then belonging, identification and love, then respect, prestige and self-actualization. The reason why it is in a pyramid shape is not everybody moves up to each level, and therefore on each level we go to we have less and less people and that’s why it’s pyramid-shaped. The most profound reason for living is to make it a purposeful existence. Now why did I bring up Maslow’s Hierarchy of Needs in the first place can be viewed because from this angle, retirement is not considered as days of personal decline, but rather an inclining movement into true maturity, wisdom, spirituality, opportunity and action to contribute. Now, most synonyms used for the word ‘retirement’ include resignation, departure, isolation, retreat, seclusion, solitude, withdrawal, progression, and non-productive years. In reality, all of these tend to drive a negative connotation, but as I am trying to stress on the Hierarchy of Needs, where retirement sits is moving upwards so it should be looked at in that regard.
Top Concerns /Activities
CONCERNS • Health • Money • Relationships ACTIVITIES • Leisure • Volunteer • New career or parttime work
So, how will you change your life in retirement? First of all, what will be your top concern or top three concerns and activities? Your concerns will be health, money and relationships. Activities would be leisure, volunteer and new career or part-time work. What am I getting at by mentioning that is everybody has lots of different concerns and they would do lots of different activities but these are the top three that pretty much all retirees of the future and the past are concerned about today.
Retirement Planning Exercise
What do you need and want for the future? Organize your affairs Seek all the data, information and help you need Attain financial fitness Determine if your income sources will meet needs 6. Will you be considering a change of occupation? 7. Are you considering starting your own business? 8. Are you considering starting partial retirement? 1. 2. 3. 4. 5.
What I am going to ask you to do now is to get your creative juices going and I am going to start a retirement planning exercise. So, if you think of any idea that I don’t come up with on the following three charts, please feel free to e-mail them to me after the session and I will make sure that I include it in future sessions. Put aside your daily demands and think about what you need and want for the future. You need to organize your affairs so you can see clearly. You need to seek all the data and information and help you need. In order to attain financial fitness and maintenance thereof, once reached, you need to do various things. You need to determine if your personal savings, investments,
pensions and the employer provided retirement vehicles will meet your needs of retirement. Will you be considering a change of occupation? Are you contemplating starting your own business? What about partial retirement?
Retirement Planning Exercise ctd
9. Are you contemplating early retirement? 10. Will you need to move? 11. Will you have a second or permanent home in a sunbelt area? Will you sell your home? 12. Do you wish to travel a lot? 13. What hobbies are you planning? 14. Are you in good health? Is your spouse? 15. Longevity in your family? Spouses family? 16. Have you determined your income needs?
Are you contemplating early retirement? A lot of people used to hear the term Freedom 55 but Freedom 55 is a dream that most of us will not be able to reach, not as we are today. Will you need to move? Will you need to move to a new house? Will you want a second home in a sunbelt area? Will you sell your existing home or buy a new home? Do you wish to travel a lot? What hobbies are you planning and are they costly hobbies? Are you in good health? What about your spouse? What about the longevity in your family and/or your spouse’s family? Have you determined what your income needs are?
Retirement Planning Exercise ctd
17. What are the various sources of income and options available? 18. Have you arranged your investments for inflation protection? 19. Have you determined/estimated your health costs? 20. Do you think you will meet your retirement goals and objectives?
What are the various sources of income? And are you upfront? Do you know what all the options available to you will be? Have you arranged your investments for inflation protection? And more importantly in these days, have you determined or estimated what
your health costs in the future are going to be? retirement objectives?
Do you think you will meet your
Retirement Sources
• Three-legged stool
Employee Savings
Social Security
ER Provided Pensions
Security is necessary to alleviate many of the concerns associated with retirement, but it will not cut it alone. You need to ensure a rewarding, challenging and satisfying lifestyle and there is no fixed price tag for a successful retirement, nor does it happen the day you leave the workforce. True financial planning consists of setting goals and objectives. Investments and taxation, income and life protection, wills and estate planning, pension and retirement, but it also means the development and affordability to pursue a meaningful interest including a second career, friends, family, hobbies, recreation, travel, further education, a sunbelt home, etc. The list goes on. You need to prepare for various roadblocks including boredom, loss of identity and self-esteem. Retirement thinking - old versus new. There has been a shift of responsibility from the 20th century to the 21st, where the employee now is assuming much of the responsibility for his or her own future. We have moved from the paternalistic employer, where the employer’s responsibility was first and the focus on everything involved the employer to a society, which is referred to as a survivalist, where the focus is on the employee and the employee responsibility. What do I mean by a survivalist mentality? I mean you need to be clear and concise with your retirement plan. You must accept responsibility and determine your goals for retirement. You must be prepared to work full-time as long as possible, and possibly part-time thereafter. I contend that it will not be the strongest nor the smartest that will survive but the ones who are the most adaptable to change. But from a pensions past to a pensions future, even the relative sizes might have changed. We are still looking at what I call a three-legged stool approach. Now all of you who are sitting on a stool of three legs know that it needs each of the legs to support you. So if one of those legs break, in other words, if the government gets rid of social security, your employee savings aren’t what they need to be or the employer provided pensions DB, DC, including IRA’s and 401K’s, etc. are not what they need to be. What' s going to happen to you? One of those legs will not be thick enough to support you and
you are going to topple over. It' still pertinent that your total income will consist of those s three things and as long as you have the ability to get your employees in on that, you need to as well. To prepare for retirement one needs to start not at age 65 or later but in your 30’s or even earlier, specifically if you plan to retire early. Developing what I refer to as a road map should not be full of unnecessary anxiety. Few people realize how little cash you need to put aside assuming you start early enough and follow it consistently. Remember the older you are, the greater your life’s expectancy. For example, your life expectancy at 60 is greater than it was at birth and the fastest-growing population on a percentage basis only are centurians (100 plus).
Income
DC, DB PT, FT Work Other Investments
Pretax Income
Social Security
Ret Investments
Home Equity
So, what are your expense and the income requirements? We will talk about it a little bit further later on but I am going to give you another Rule of Thumb. Count on needing somewhere between 70% to 80% of your last working year’s full income. The exact amount will depend on your desired realistic lifestyle, your personal commitments and responsibilities including financial help to your children, your sources of income. Remember retirees tend to slow their pace of life by about 70 or so. They drive less. They entertain less. If one never entertains during one’s working career, is it realistic to expect to entertain once they retire? You could expect that but your percentage ratio that you need to replace would obviously need to be higher in order to do so. The retiree has usually eliminated many personal expenses such as furniture, appliances, equipment and vehicles, completed home renovations and/or home is paid off, children moved out and their education complete, most outstanding debt is paid off. To retire you will generally have a reduction of cost to live in retirement other than health costs, which today unfortunately are generally increasing. So, let’s look at the various sources of income. Starting at the top we have your corporate pension, which includes your defined contribution, defined benefits plans, other investments, retirement investments, home equity if you are going to sell your house and use the equity out of it, government social security, part-time or full-time work and that in total will generate what we call your pre-tax income.
Expenses
Food Shelter Personal Care Personal Expenses Recreational Expenses Travel Expenses Discretionary Expenses Transportation Insurance Property Taxes Mortgage & Other Loans Estimated Income Taxes Estimated Health Costs Estimated COLA
What about expenses? Expenses - and there may be more than these - will include food and shelter, transportation and insurance, personal care, general health, personal expenses, property taxes, mortgage and other loans, recreational expenses, travel expenses, estimated income taxes, estimated health costs, discretionary expenses, and estimated inflation protection costs for a number of years. COLA stands for cost of living adjustments. At the end of the road after you have computed both your income and expense sheets you need to arrive at your summary and you will either have a surplus or a deficit. A surplus will mean your projected resources exceed your expense requirements with a buffer of X amount of dollars. A deficit would mean your projected retirement needs exceed your resources by X amount of dollars and the goal is to increase your net worth by saving and investing and reducing requirements. You as an employer can provide your employees with tools so that they can model what these deficit/surpluses are and try and do something about it. They need to determine when to actually start saving more, how much more they need to save and how they should be investing it. You need to schedule time to complete this annual financial fire drill, as I call it, to make sure you are on course with your retirement objectives. Use any of the available tools to model the forecast. How can you make up the deficits considered above?
How Much To Save each Year
Depends on the following: • How much capital you need • How much you have already saved • How long until you retire • How many years do you expect to live • Your expected net return after COLA
So, how much do we need to save each year? The amounts will depend on many different things but essentially it starts with how much capital you think you need. How much do you already have? How long until you retire? How many years do you expect to live? And what is your expected net return after cost of living adjustments? None of these is fixed in stone. It’s constantly changing and that is why you have to review this annually.
Compounding 1000/yr for 30 yrs
Interest Rate 0% 3% 6% 9% 10.5% 12% Approximate dollars (000s) $30 $58 $122 $270 $407 $615
Compounding interest has a huge effect and if we look at it just paying $1,000 a year into some saving vehicle for 30 years and your interest rate is 0%, i.e. you are earning no interest, it would be 30 times $1,000 and end up being $30,000. If we instead go to 1.5 % interest average return throughout that lifetime, you would have $41,000. On the other end of the scale if we go all the way up to 12% you are going to have $615,000. Now, imagine getting a total of $615,000 for just $1,000 a year for 30 years. Looking at it another way, if you invest $20 a week at 12% compounded monthly and started at age 25, you will have approximately $1.04 million at age 65. If you wait 10 years with the
same exercise - $20 a week - and you started at 35, you will have only slightly over $300,000, or a cost of waiting 10 years from 25 to 35 of over $700,000. So, the message here is that not only do you need to know this for yourself, but the idea of saving needs to start as soon as possible. So make regular contributions to the fund. Don’t wait till the end of the year to make it up.
Profile of a Retiree
• • • • • • • • Spends approximately 30-35% less his previous pay Uses one all purpose credit card Adventure travel is #1 Goal Watches much TV Loss of identity and/or self esteem Boredom common Walking #1 physical activity. Involved with family & friends
Now, let' look at the profile of a typical retiree. As I said earlier, this may be a s contradiction because individually everybody needs to choose their own realistic and attainable lifestyle; therefore, a typical profile may not be something that’s really out there. Generally, the typical retiree will spend approximately 30% to 35% less than the pre-retirement income he used to have. He will use one all-purpose credit card usually with cash back or travel points associated with it. Adventure travel will be his #1 goal. He will watch much TV. He will probably experience a loss of identity and/or selfesteem. Boredom may be common. Although walking will be the #1 physical activity, others include gardening, home maintenance, swimming, bowling, golf, and tennis. He will be involved with family and friends and to the exclusion of the neighborhood and community.
Income Replacement Ratio
Definition Amount of Income an Employee Requires from all Sources as a % of Final Pay Needed to Maintain Standard of Living
Let me quickly discuss an anecdote from a Time Management presentation. If you take a one-gallon jar and you take 12 fist-sized rocks and placed them one at a time into this jar until no more rocks can fit, is the jar full? No it' not. You can pour some gravel in s and shake the jar causing some of the gravel to find its way into the jar. Is the jar full yet? Again no, it' not. Take a bucket of water and pour it in until the jar is filled to the s brim. So what is the point of this illustration? Is it not if you really try hard you can fit more into your time schedule? No. If you do not put the big rocks in first you will never be able to get them in at all, so what are your big rocks in life? I am sure that health and your children are two of them, but I submit the retirement planning needs to be one as well. If you sweat the small stuff and you fill up your life with things that do not really matter you will have no room for the big stuff. We are going to talk very briefly about income replacement ratios. By definition it' the s amount of income an employee requires from all resources stated as a percentage of his final pay needed in order to maintain a pre-retirement standard of living. Now what are some replacement ratio targets? Again we talked about Rule of Thumb when we said approximately 75%. Let' give an example here. Assume an employee earns $60,000 s before retirement and he receives $45,000 between social security and all other forms of retirement income. His replacement ratio would be calculated as 45,000 divided by 60,000, which equals 75%. Remember, we said earlier that the Rule of Thumb was 70% to 80%. A retiree generally needs less because: taxes decrease after retirement, FICA deductions from wages stop, you no longer need to save for retirement, social security is partially or fully tax-free, and age and work-related expenses generally decrease with shelter usually paid off and transportation to work unnecessary. These outweigh some of the expected increases in healthcare cost to a large extent but that is one thing the employee of today has to be concerned about. With what has been happening with raising health costs in the past number of years, many employers have turned around and stopped their retirement medical plans. Where an average cost for health before was maybe 25% or 20%, now it is 50% to 100%.
Income Replacement Ratio
Replacement Ratio % For Average Employee 90% 75% 78% Earnings $20,000 $60,000 $90,000
Social security replaces a larger portion of pre-retirement income for the low wage earners. It redistributes, by design, income from the higher to lower paid so total replacement ratios are therefore higher for the lower paid, because they are getting a bigger part from social security but they pay less taxes and also usually save the least. If we look at the table above, the replacement ratio of someone earning $20,000 is as high as 90% and even if we factor in some of the rising healthcare costs, it may be well over 100%. If we go down to a level of $60,000, the average replacement ratio needed is 75% for the average employee, and again this is average. If you don’t contribute to a 401K plan, you can expect to replace as little as 50%. Considering that some may need to replace as much as 125% to meet medical and income needs, shortfalls that exist need to be made up. The numbers tell the story. Most workers have not even calculated how much money they will need to save for retirement. There are more workers who have not saved one penny for retirement than workers who are confident they have enough for retirement. A 2004 study conducted by Hewitt of 3,500 employees of large companies says that 49% of employees worry that they do not have enough for retirement. Approximately 40% of US employees are not currently saving for retirement at all. Only 40% have calculated their retirement saving needs; one in three workers does not participate in company 401K plans and planning for retirement has not only become more important but also more difficult to accomplish. The baby boomers'initial foray into the retirement venue has happened at a time when the stock market completed three years of decline, coupled with Congress’ review of the legality of cash balance plans and medical inflation causing the elimination and reduction of many employer-sponsored post-retirement medical plans.
Good News
Good News vi=very important % EEs who feel DB plans vi % EEs who feel ER plans vi % ERs who feel ER plans vi % ERs who believe 401K important to attract/retain % EEs who want bfts over pay 2005 61% 74% 85% 79% 58% 2004 46% 66% 77% 75%
There is some good news from a Trans-America study just released in October 2005. We have the following results: Employees who feel that their defined benefit plans are very important to them went from 46% in 2004 to 61% in 2005. The employees who feel the employer funding plans are very important to them went from 66% to 74% - not quite the same rate of increase but still it is an increase. The percent of employers who also feel their employer-funded plans are very important to their employees went from 77% to 85%. The percent of employers who believe their 401K plans are important to attract and retain employees has gone up slightly from 75% to 79%. The percent of employees who would exchange superior benefits over increases in pay is 58%, which is also good news.
Not So Good News
2005 % ERs who feel EE want benefits over pay % EEs who feel ok to retire at 65 % EEs who feel nest egg ok % EEs who spend >10hrs/yr % EEs who saved >100,000 22% 23% 20% < 33% < 25% 2004 34% 31%
Not so good news is if we look at this chart we see the employers who feel employees want better retirement benefits over pay; they have gone down from 34% in 2004 to now only 22% in 2005. The percentage of employees who feel confident that they can retire at 65 has gone down from 2004 from 31% to 23%. The percentage of employees who thought they have enough of a nest egg is only 20%. The percentage of employees who spend greater than 10 hours a year figuring out what their retirement income objectives
and amounts are is less than 33%. The percentage of employees who save greater than $100,000 to date is less than 25%. The percentage of employees who want to know more about reinvesting is 71%. I am not sure that it is bad news. Employees seem to appear to want more investment options; in the study 73% agreed to it. I am not sure where this comes from as to me the evidence shows that there is already too much choice and companies, if they are offering new options, should maybe eliminate some of the old options because employees are just faced with too much choice. Companies have started adopting lifecycle and lifestyle funds to accommodate this. Some other results from the Trans-Americas Center for Retirement Studies that are worth mentioning briefly: 82% of the employees agreed that the employer gave enough information to decide on return benefits to the employee; 53% agreed and 45% disagreed that the employees were building enough of a nest egg. With respect to the age where the employee is expected to retire, the mean of all that was 63 and the median was 65. For those of you who do not know what the mean is, mean is basically the average. So if we have five employees and we add up their five ages and divide by five, the median would be the amount right in the middle. So for the five employees the median would be the third number, whatever that would be. The age employees start saving was age 30 with a mean of age 28. The problem with some of the estimates that I am going to give you right now is how they were arrived at. How much of a nest egg will you need to retire? The total mean for both large and small employers was roughly $1.5 million for this question, so employees responded they think they need on average $1.5 million as a mean as a nest egg in order to retire from all sources. The median was roughly half that at $750,000. The large companies were slightly higher than that at almost $1.7 million, with smaller companies at $1.3 million. But the problem, I guess, is 35% of the employees that arrived at these estimates guessed, in fact only 22% actually calculated worksheets in order to come up with an estimate for these numbers.
Quotation from 1872 EE Manual
“ Every employee should lay aside from each pay a goodly sum of his earnings for his benefit during his declining years, so that he will not become a burden upon the charity of his better.” Mt. Corry Carriage & Iron Works in 1872
So you as an employer have to provide or should provide various ways to help the employee get into pre-retirement mode. I refer you to this quotation, which was taken out of an 1872 employee manual by the Mount Corry Carriage and Iron Works. “Every employee should lay aside from each pay a goodly sum of his earnings for his benefit during his declining years, so that he will not become a burden upon the charity of his better.” That quote would still hold today so if that company felt it was worthwhile doing
something on behalf of the employees back then it sure is still happening today and should be happening today.
Problems
• EEs make minimum contributions • Low participation • Don’t know plan • Don’t use education • Don’t know asset allocation • Little appreciation • HCEs get money back • Many EEs financially illiterate – leads to absenteeism, presenteeism, theft, lost productivity, high turnover
Now there are many problems out there. These problems are caused by different things, but basically many plan participants are only making minimum contributions, if at all, and thus not maxing out employer match. Everybody should even borrow money in order to max out the employer match because you are throwing money away. People do not know the plan. They do not understand the basic features of the plan. A high percentage of them never use the educational services available to them and we generally provide them with information as opposed to knowledge. Employees generally have or cannot pass a simple quiz on asset allocation methods. Employees do not appreciate the plan. Employees that are failing to plan are planning to fail. They are setting themselves up. Then there are the high compensated earners who, many times at the end of the year, get back some money because of top heavy rules when low participation results on behalf of the low incomers cause them to be having too much in the plan. Many employees are financially illiterate and the signs of this illiteracy include loans, wage garnishments, calls from banks and creditors, lost productivity, high turnover, theft, lost time dealing with problems, absenteeism, presenteeism costs, low participation plan and proper diversifications. The additional financial strife leads to undesirable consequences including safety and customer service problems. But is advice the answer? DC plan participants have little investment knowledge and are unable or unwilling to gain it. They are looking for others to provide the skills they lack. Should the plan sponsor delegate decisions to an advisor on their behalf, and if so, how to choose an advisor? What fiduciary responsibilities does the sponsor retain? What is the cost and who will pay for it? And what to do for participants who do not use the advice? Considering our new world has less retirement security, longer working lives and later retirement, it’s a world requiring high personal savings and smarter investing. At least in 2006 federally mandated defaults directing employers to deposit relative small amounts of $1,000 to $5,000 into IRAs takes effect.
Employers should be trying to educate their workforce. Research will confirm there are immeasurable benefits to an educated workforce. After financial education in the workplace, participants reported the following improvements: 45% increased contributions or deferral rate to a 401K plan 35% started contributing to the 401K plan 70% changed investment strategy to more diversification greater than average financial wellness and better health less financially stressful events occur less likely to have maxed out credit cards less likely to worry about money matters they owe instead of work issues financially literate employees often receive better reviews financially literate employees are often more promotable.
Why Employers Should Educate
Improve EE Retirement Readiness Improve Understanding
Reduce Turnover
Improve Utilization
Improve Productivity
Increase Participation
Increase Diversification
Increase Contributions
Now why should employers educate? Well for one thing it improves understanding. It improves utilization, increases participation, increases contributions, increases diversification, improves employee productivity, improves retirement readiness and reduces employee turnover. So, what is the ROI? The rate of investment on retirement planning ratio and what is it worth to you on behalf of your employees to make sure that they are better well off for retirement.
Tips to Employees
Fees < Manage Debt Do Inventory Save for Yourself Participate ASAP Keep Emergency Fund Plan for Life Events Prioritize Objectives Diversify Use Professional
Contribute More
Monitor Progress
Work Longer Look at tax Withholdings
Let' look at some tips to employees. First, you need to know what you have, so you s need to do an inventory, gather all your bank accounts, bills, statements, investment accounts, retirement accounts, figure out and calculate your net worth, save for yourself first, and no matter how little on a continual basis, participate and start and contribute as early as possible at an age and time of the year in order to maximize the compounding effects to your employer-provided plans and your personal saving accounts and also maximize your employer match into your 401K plans. Expect the unexpected and keep emergency funds. Plan for life events including weddings, births, home buying, education, etc. Prioritize your objectives and goals and be realistic in your goal setting in both how much you will have and how much you will need. Work with a professional advisor. Lower your debt where possible and lower interest rates by negotiating with another company and transferring balances, stop procrastinating, diversify, and monitor progress. Review income tax withholdings. Team up; speak to friends and colleagues in addition to the professionals. Consider working longer by at least two years. Consider contributing more where possible, an additional 2%, and try as much as possible to avoid high fees.
Tips For Employers
Online Retirement Calculators Match & Vest ASAP Financial Advice
Immediate Participation
Measure Results
Rollover Old 401(k)
Lifecycle Funds
Various Media
Tips for employers - Provide online retirement calculators for modeling shortfalls. Provide access to financial advice and educational tools. Stress to employees to roll over all 401K plans and benefits communication. Use a mix of media to reach your total audience. This includes general print material, personalized print material, personalized web including modeling, employee meetings and seminars. Try and improve communication and educate rather than give information only. Lifecycle funds boost participation. On average lifecycle funds also boost better returns. Allow immediate participation and automatic enrollment wherever possible. Match employee contributions and invest them immediately wherever possible and measure your results. See if the efforts are working.
Roth 401(k)
• • • • • • • Funded with after tax dollars Qualified distributions tax free Contributions $15,000/yr (20000 for 50+) Combo with 401(k) if offered Same hardship and loan rules Can defer as long as working Sunset provisions end 12/31/2010
Do we give our employees the Roth 401K option? As you know this starts January 1, 2006, and although there are many good things to say about it, the government probably likes it because it' paid with after tax contributions so the government gets your tax s upfront. One of things that you need to think about is that employers, in the last number of years, have been moving from DB plans to DC plans and one of the reasons for that has not just been cost. It has been the complexity of the plan. Try to simplify the plans and the Roth 401K plan is a more complicated plan. You have got to bring in to it not only tax today but future expected tax rates (which you don’t really know what they will be). So you are paying tax up front and if tax rates go down in the future you will have paid too much, not only have you paid too early, you have paid too much. Having said that, there are many things good about it. The Roth 401K plans are confusing so they may hinder overall participation. Remember, one of our problems is poor participation to start with. Let' go over the features of the Roth 401K plan. They are funded with after tax s contributions, with qualified distributions; contributions plus earnings are withdrawn taxfree. The qualified distribution means the five-year holding period including time with prior employer plans for rollovers. You are exempt if you are greater than 59-1/2, disabled, die with money transferred to a beneficiary or state. Your contributions are limited to $15,000 per year with $20,000 for workers per year of those 50 plus as a catch up. These numbers are both higher than the $4,000 traditional in the Roth IRA accounts, which rises to $5,000 for those greater than or equal to 50. If the employer provides a Roth 401K plan, the employee can choose the 401K plan, the Roth 401K plan, or both with separate accounts and $15,000 in total per year. Same hardship and loan rules apply. You can defer as long as you’re still working, at any age. The employee terminates with the Roth 401K plan. He can leave it with the former employer or if the plans roll it over into another Roth account - either a Roth 401K plan or an IRA Roth plan. The sunset provisions end December 31, 2010 unless Congress extends it, which they may do because they’re getting tax money upfront, and there is a good chance they will be extended if employees and companies want it.
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