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Retirement Income Adequacy –
“Too Much, Too Little, Too Late”
Session 9

Moderator: Rob Reiskytl, Hewitt Associates
Presenters: Alison Borland, Hewitt Associates; Bruce Schobel, New York Life Insurance Company
Recorder: Rob Reiskytl, Hewitt Associates

Retirement income adequacy is of increasing concern to some employers, as companies continue to shift their emphasis from defined benefit to defined contribution plans (while simultaneously reducing cost, in many cases). "Adequate retirement income" can be defined as being able to maintain the standard of living one was accustomed to just before retiring. Using the Report of the President's Committee on Pension Policy as a starting point, we begin with a 75%-80% target, then add 15% for post-retirement inflation, and then also recognize the cost of post-retirement medical care. The end result is that appropriate retirement income replacement targets are in the range of 106% to 115% (assuming access-only retiree medical coverage, and retirement at age 65).

There have been some confusing reports in the press, some claiming that "employees may be saving too much." The majority of the session was dedicated to analyzing the predicted retirement income adequacy of today's workforce. This was accomplished by using data from Hewitt's recordkeeping business, starting with current plans and employee behaviors, and predicting the outcomes under various future scenarios. The base case assumed retirement at age 65 based on initial data and account balances as of 12/31/2006, 7% annual nominal rate of return net of expenses, 3% annual general inflation, 4% annual pay increases, and annuity conversion at retirement using 94 GAR mortality and 6% interest. Data is available for 1.8 million active employees in Hewitt's database, all being eligible for 401(k) participation, with average employer size of 25,000 employees.

Projected retirement income pay replacement results in the following shortfall amounts (income falling short of needs at retirement) at age 65, assuming an access-only model for retiree medical (employee-pay-all):

• 41% shortfall for all employees
• 25% shortfall for contributing employees
• 18% shortfall for "full career employees" (20+ years)
• 87% shortfall for non-contributing employees

Results can be improved through actions such as delayed retirement, increased savings, or improved rate of return on assets. In addition, dramatic improvements can result from design structures such as automatic enrollment and savings rate escalation.

Social Security (SS) forms an important piece of the overall retirement income adequacy picture for many retirees. However, the future of the SS system remains uncertain. Possible solutions to the SS funding crisis include higher FICA taxes, reduced COLA, and/or higher NRAs. The problem is that the second and third solutions will result in a decrease in predicted retirement income adequacy, worsening the results described earlier. In addition, most individuals have failed to recognize that even without any of these changes SS is generally delivering decreased retirement income adequacy due to the rise in prevalence of two-income families. Examples were shown to illustrate this point. The bottom line regarding SS is:

• Reductions in the adequacy of SS benefits are inevitable
• We can't turn back the clock, and wouldn't want to even if we could
• Workers need to know what to expect, so they can make appropriate plans

In the end, it is clear that retirement income adequacy is an important issue, and current predictions reveal that many employees will need to either adjust their financial lifestyle during retirement, work longer than they had planned, or perhaps continue to work during at least some of their retirement years. Design ideas like automatic enrollment and savings rate escalation can help to some extent. The ultimate solution may require several of these components to come into play concurrently, as the next generations of employees move toward retirement.

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