401(k) plans are seen as savings and investing vehicles. However, they should also be viewed as retirement plans.
If employers and employees take that view, some needed changes will follow.
When viewed as retirement plans, employees must make three fundamental decisions. Should I join the plan? How much should I contribute from each paycheck to have enough money for retirement? How should I invest that money?
The answer to the first question is obvious. Yes, you should join the plan. I will save the investing question for another day. I want to focus on the hardest question to answer–how much to contribute—or “defer”—out of each paycheck.
Here are some thoughts about that.
First, employees should always contribute enough to get the full employer match. That may not be a perfect answer, but it’s good advice. When your employer is willing to match your deferrals, it is “free money.” For example, if an employer is willing to match 50 cents to ever dollar deferred, up to 6% of deferrals, employees should almost always defer 6% of pay.
While that’s a good answer, it is overly simplistic. The better answer is that employees should save enough to have a reasonably secure retirement. In other words, a participant’s account balance at retirement should have enough money to generate the monthly income needed for a comfortable retirement, taking into account social security and other savings. But, how much is that?
To calculate the amount that’s needed, you need to make assumptions about investment earnings in your 401(k) account, future inflation rates, retirement date, life expectancy in retirement, and so on. Those are actuarial calculations based on assumptions about the future. It’s not realistic to expect people to know how to do that.
If that won’t work, what will? Here are some answers. These are best practices; they aren’t legal requirements.
Employers should provide, at the least, these four services to their employees:
Retirement Income Projections
Employees should be given an annual statement of projected retirement income based on their account balances and an estimate of their social security retirement benefits. Most 401(k) providers already offer this service. These projections won’t be perfect, but they are a lot better than not knowing at all.
Gap analysis looks at the projection of retirement income and whether an employee is on schedule or behind schedule, based on a reasonable goal for retirement income. If an employee is behind schedule, gap analysis suggests an increase in the amount of deferrals needed to close the gap or, in other words, to get back on schedule.
A Website Calculator
To the extent that an employee, or an employee’s spouse, has other assets, a website calculator allows the employee to include other information and make a more individualized projection. It also allows employees to change the assumptions, for example, the assumed retirement age, and to see how that changes the outcome. Most providers already offer this service. However, employers should make sure that the employees know about it
Most 401(k) plans offer, through their advisors and providers, 401(k) education for participants. That education focuses on saving and investing, rather than retirement income. That needs to change. While education about saving and investing are important when an employee starts participating, it doesn’t fill the need. For the latter part of an employee’s participation in a plan—let’s say for employees 50 and older, the education should focus on retirement income. Older employees can be given guidance about the amount of savings and income needed for retirement, based on the employee’s individual circumstances.
The key is for employers to understand that employees need these services, to know that they are available, and to ask their providers to offer the services to their employees.
Obviously, if your employer offers those services, you need to take advantage of them. It’s up to you to review and understand the information, to make decisions, and to implement those decisions. Your employer and the service providers can only go so far.
However, if those services are not available, or if you don’t know if they are, you should ask your employer to talk to the 401(k) provider about offering them.
In the 401(k) world, the burden is ultimately on the employee. However, employers and service providers can take steps to make that job a little easier.
View Original Post