In this issue, Jerry Patterson of Principal Financial Group talks to Confero about employee retirement outcomes.
Retirement readiness is a subject that is much talked about around the industry. Tell me about the resources that Principal is committing to this concept?
Retirement readiness is a shift in philosophy across the industry, and we are committed significantly improving outcomes for participants. We took our 70+ years of retirement experience plus industry expertise of behavioral finance leaders and digital experts, and created our holistic approach: Principal® PlanWorks.
This approach incorporates three key elements:
1. Retirement ready plan design,
2. An engaging participant experience –with tech savvy, engaging, easy-to-use tools and services
3. Strategic measurement – at both plan sponsor and participant levels
We’ve invested considerable resources to drive superior participant retirement outcomes. For example, we tapped into leading digital experts to help create a positive, distinctive digital experience that drives action and outcomes. Our approach to plan design is rooted in behavioral finance, and turns behavioral challenges into behavioral solutions. Reports and tools help plan sponsors and advisors understand the power of retirement readiness.
How does Principal define retirement readiness for defined contribution participants?
It is a participant’s ability (and continued progression) to meet and maintain income goals throughout retirement.
There seems to be a movement to push the conversation away from investments and fees and towards outcomes. Has the focus shifted at Principal and if so, can you tell me about those initiatives?
Yes, we have definitely shifted our focus from participant accumulation (participation/deferral) to improved participant outcomes. The push began in 2012 when we commissioned a study with Brightwork Partners LLC regarding financial professionals and their role in working with plan sponsors. As a result, we learned that retirement readiness showed as an important point to plan sponsors and was a top area for financial professionals to help illuminate for plan sponsors. (Brightwork Partners LLC Study Article (PQ 11627 M)).
Its been written that creating better outcomes for participants requires a commitment from both the plan sponsor and participant? Beyond saving more for retirement, what else should participants be doing to get closer to their retirement goals?
Well, in this case we are talking about a participants need to know more than just their account balance. They should have a retirement goal and know where they stand. Do they have a clear picture of how much income they’ll have on the day they switch from a paycheck to “mycheck”? Do they know how long their savings may last?
For many, that means saving more for retirement. They can take advantage of features/services that can help. For instance, sign up for automatic increases or be sure they’re receiving the full employer match.
Retirement savings isn’t one-and-done. They should periodically review their entire retirement picture (all their employer benefits, Social Security estimates, consolidation of previous retirement accounts, etc.). There are many planning tools and calculators available to review their overall picture.
Many people simply drift into retirement, failing to adjust their strategy as they get closer to retirement. For those approaching retirement, they need to be looking at creating an income that will sustain them throughout their retirement. A portion of their savings should be used to create guaranteed income to cover necessities. They should review their risk tolerance and determine how much they would be willing to keep in the market with additional growth opportunity. They should also consider their overall health and estimate their health care coverage and costs in retirement. Lastly, they should look at social security benefits and when would be the best time to elect them.
Those in retirement may want to look into the tax implications and may want to consider having both pre and post-tax assets.
In addition, everyone should take care of their physical and overall fiscal health to fully enjoy their retirement.
What does Principal believe are the main drivers to better outcomes? Both from the plan sponsor side as well as the participant side.
For plan sponsors, plan design is critical. It can help achieve improved participation, average deferrals, and average account balances.
For participants, it’s important to help participants make great decisions right away. Decisions around participating in the plan, setting deferral amounts and selecting investment allocation. Then it’s important to keep the momentum going to stay on track to and through retirement.
All of these rolled into an engaging participant experience can improve savings rates, account balances, income at retirement, and “on track” indicators.
Income replacement ratio comes up frequently when employee retirement readiness is discussed. Is there a general target employees should be aiming for?
In general, we have found that a participant may need to save at least 10 percent of their pay (plus any employer contributions) throughout their entire career to have enough income in retirement.1 This assumes they would need about 85 percent of pre-retirement income to maintain their current lifestyle after retirement.2 Each individual’s situation is unique, so savings and post-retirement needs may differ.
1Based on analysis conducted by the Principal Financial Group®, August 2013. The estimate assumes a 40-year span of accumulating savings and the following facts: retirement at age 65; a combined individual and plan sponsor contribution of 12 percent; Social Security providing 40 percent replacement of income; 7 percent annual rate of return; 2.5 percent annual inflation; and 3.5 percent annual wage growth over 40 years in the workforce. This estimate is based on a goal of replacing about 85 percent of salary. The assumed rate of return for the analysis is hypothetical and does not guarantee any future returns nor represent the return of any particular investment. Contributions do not take into account the impact of taxes on pre-tax distributions. Individual results will vary. Participants should regularly review their savings progress and post-retirement needs.
2Assuming pre-retirement annual gross income of $40,000. Aon Consulting’s 2008 Replacement Ratio StudyTM http://www.aon.com/about-aon/intellectual-capital/attachments/human-capital-consulting/RRStudy070308.pdf
Will there be impact to plan sponsors if not enough employees are close to achieving retirement readiness? Do you think this may come in the form of either regulation or legislation?
There are people in Congress that are trying to argue that the private retirement system is failing and needs help. I would argue that they could not be farther from the truth. I believe the private system is doing a good job of offering retirement solutions that will help employees achieve their retirement goals. The biggest challenge is changing the behavior of people. People by nature are not savers and go more for the immediate satisfaction – living for today.
I won’t say “never”, but I would be hard pressed to foresee the government mandating employers to sponsor retirement plans (I won’t say never because ObamaCare is very close to that on the health side). Currently, there is not a requirement for an employer to sponsor a plan and the fiduciary requirements if they sponsor a plan does not say that they have to cover everyone nor does it say it has to be a minimum level of benefit. It is still a voluntary retirement system.
There are employers that are interested in helping their employees achieve success and have made it a priority in their benefits package they provide to employees (having a plan design that would help employees achieve successful outcomes).
It seems that auto enrollment combined with auto escalation of deferral rates are important contributors to a more prepared employee. What are your thoughts and what are Principal’s with regards this concept?
We (both The Principal and I) agree with the importance of automatic enrollment with automatic escalation to help create better savers. Our retirement ready plan design features those two concepts along with a few others to help jump-start retirement readiness improvement. Others include:
• Automatic escalation of 1% annually up to at least 10%
• At least a one-time sweep of those non-participants and those deferring below the plan automatic enrollment default
Other approaches include conversations with plan sponsors about stretching employer matching contribution formulas to better incent participants to save more to receive the full match. There is also an opportunity to name a diversified investment option as a plan qualified default investment alternative. It gives the participant the ease of mind knowing that the plan sponsor has chosen a diversified, well-allocated investment line-up.
Plan sponsors are feeling maxed out when it comes to total employee benefit compensation. Are you seeing employers doing anything interesting when it comes to recharacterizing the match or other non-discretionary contributions?
Cost does not have to be an issue when it comes to designing a retirement plan that will enable participants to have more successful outcomes. Whatever the employer’s budget, a plan design can be created to help employees achieve their retirement goals.
One of the ways many employers have chose to encourage employees to save more is to stretch their match. For example, instead of a match of 100% on 4%, they stretch it to 50% on 8%. This encourages employees to save more which improves their outcomes.
Many employees need help getting started and increasing their savings. That is why many employers have also implemented auto enrollment and auto increases to get people into the plan and to make annual increases thereafter. The employers realize that their employees may not necessarily do these things on their own, but know they should to be able to have successful outcomes.
I have also seen employers give an employer contribution to everyone but also have a match to encourage savings by employees. The employer contribution can be the same for all or it could be different for different groups. It really depends upon the objective of the employer and who they believe needs the most help getting retirement ready.
1/2 Question: How many of Principal’s own employees are deemed to be retirement ready?
Periodically we prepare a retirement adequacy analysis which shows at what age our employees are targeted to reach a replacement ratio (adjusted to factor in the potential erosive impact of inflation) of 85% of their final projected compensation. Depending on the company-provided defined benefit pension formula the employee participates under along with the company provided 401(k) benefit (based on the employee’s current actual deferral rate projected forward) and estimated Social Security our employee population, as a whole, is projected to be retirement ready between ages 62 and 64.
Additional comments: The Principal has a 94% participation but that doesn’t necessarily mean everyone is retirement ready. We have a pension benefit in addition to our 401(k) benefit and when you add Social Security to the mix, I would be surprised if our number would be less than 75% on track. Not many employers have both a pension plan and a 401(k) plan today.n
Jerry Patterson is senior vice president, Retirement and Investor Services with the Principal Financial Group®. He is responsible for the retail and institutional annuity businesses, retirement income management strategy and overall accountability for the individual investor business of The Principal®.