Article FOUR in a Mercer and Stanford Center on Longevity series Retirement income statements may help avert a looming crisis Authors: Amy Reynolds

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1 Article FOUR in a Mercer and Stanford Center on Longevity series Retirement income statements may help avert a looming crisis Authors: Amy Reynolds Partner, Retirement, Richmond Steve Vernon FSA Research Scholar, Stanford Center on Longevity

2 The anticipated retirement crisis is beginning to attract increasing media attention with President Obama and Congress. While they watch the policy debate gain momentum, many employers are recognizing the challenges that an aging workforce will bring and are looking for ways to encourage their employees to save more for retirement now. This article discusses one overlooked tool that employers can leverage more effectively: income statements for employer-sponsored defined contribution (DC) retirement plans, such as 401(k) plans. Regular quarterly statements can not only help employees keep track of the money they have saved but also help employees understand how much savings they will need to be able to retire. Indeed, research findings indicate a strong demand among employees for information on the income that their retirement savings are expected to generate (see Figure 1). Regular quarterly statements can not only help employees keep track of the money they have saved but also help employees understand how much savings they will need to be able to retire.

3 Figure 1 Employees Want More Information about Generating Retirement Income Percentage of employees who would find very valuable or somewhat valuable a statement about how much: Money to save to maintain their current lifestyle after they retire 91% Retirement income to expect from their current account balance 91% Retirement income to expect if they maintain current rate of saving 89% 0% 20% 40% 60% 80% 100% Source: Stanford Center on Longevity and Society of Actuaries. The Next Evolution in Defined Contribution Retirement Plan Design (September 2013), available at

4 The challenge with a traditional approach Plan sponsors provide DC participants with periodic statements that display current account balances, account activity, and the return on investment for the different funds. Increasingly, statements also project account balances at retirement if participants continue contributing at their current rate of savings. The challenge is that most participants do not have the financial acumen to estimate how that projected account balance will be converted into lifetime retirement income. Many may assume that a seemingly substantial projected account balance will be sufficient and are often too optimistic in their estimates as a result. Many may assume that a seemingly substantial projected account balance will be sufficient and are often too optimistic in their estimates as a result.

5 Income-oriented statements The opportunity to educate Mercer believes that retirement income projection statements present a teaching opportunity for plan sponsors to help their participants understand the issues that come with turning a pot of money into a paycheck through retirement. Moving participants away from a focus on a single lump sum to realistic retirement income estimates will help participants to develop a more realistic understanding of their retirement readiness. Properly designed income statements provide an opportunity to educate participants on the variability of potential outcomes. An employer eager to educate participants on the income-generating qualities of annuities versus traditional methods, such as a managed account drawdown, could provide two projections of retirement income to capture the relative merits of each approach. In addition to providing a basis for comparison to the one revenue source American workers are keenly aware of namely, their current take-home pay there are other advantages. From quarter to quarter, estimates of retirement income amounts are likely to appear less volatile than the account-balance figures themselves. This can reinforce a long-term perspective by reducing the desire to make investment and contribution changes following short periods of poor performance. From quarter to quarter, estimates of retirement income amounts are likely to appear less volatile than the accountbalance figures themselves.

6 Can modifying statement content really make a difference? Research conducted by Stanford University economist Gopi Shah Goda and co-authors has attempted to answer this question by studying the impact of providing lifetime income projections on the savings behavior of 17,000 employees at the University of Minnesota 1. The study found that providing statements of retirement income modestly increased the aggregate savings amount. However, savings improvement varied significantly depending on personal characteristics and motivations. The increase in savings was the greatest for employees who were already motivated to save and could manage their financial affairs. Presumably, this group appreciated lifetime income projection information. Those who had difficulty paying bills, a strong preference for living for today, and a tendency to procrastinate were not influenced much by the retirement income statements. Although sophisticated retirement income statements can have a positive impact, they must be considered in conjunction with other financial education and savings efforts. Unsurprisingly, retirement income statements in isolation do not constitute a silver bullet solution, but we believe they can be an effective tool in an employer s retirement strategy. Although sophisticated retirement income statements can have a positive impact, they must be considered in conjunction with other financial education and savings efforts. 1 Goda GS, Manchester CF, Sojourner A. Do Income Projections Affect Retirement Saving? Center for Retirement Research, Boston College (April 2013), available at

7 Understanding the challenges To be used effectively, employers must be aware of the challenges this expanded communication can create and prepare accordingly. Participants often do not understand that their retirement income is significantly impacted by their age at retirement and the method they choose to generate retirement income. Furthermore, as it is not a near-term issue, participants do not always appreciate the impact of inflation on their future spending power. Focusing on the impact of the method chosen, a Stanford Center on Longevity and Society of Actuaries report 2 showed that a couple, both 65 years of age, with retirement savings of $100,000 could generate an annual retirement income ranging from $3,500 to $5,490 (over 50% more), depending on the retirement income vehicle chosen. Just as participants may ultimately experience variability because of their selections, it is important that employers do not create confusion because of variation among the available modeling tools they provide. Many employers are facilitating access to third-party financial education and investment advice providers. Ensuring consistency among the messaging and the tools provided should be a primary focus. COUPLE BOTH AGED 65 Annual With retirement savings of $100,000 Retirement Income can vary from $3,500 TO $5,490 depending on the Retirement Income Vehicle Chosen. That s more than 50% 2 Stanford Center on Longevity and Society of Actuaries. The Next Evolution in Defined Contribution Retirement Plan Design (September 2013), available at

8 Making it happen Fortunately, plan sponsors can shape the communications their participants receive. However, there are some technical issues that plan sponsors should consider. As evidenced by the responses to the US Department of Labor s (DOL) recently proposed regulations, opinions vary about how retirement income calculations should be performed. Ideally, if a plan sponsor offers a retirement income option in the plan, then using the same basis would allow consistency on the statement. Otherwise, Mercer advocates presenting a range of outcomes based on independently developed best estimates of expected returns and their variability. We also believe that it is relatively straightforward to customize and modify projections to reflect both the current investment selections at the member level and its likely evolution. Though organizations may be constrained in making format changes to income statements, even simple layout adjustments can make a difference. For example, increasing the prominence of retirement income on a statement can have the effect of increasing its importance to a member. Whatever adjustment is made, given the findings from the Minnesota study it is important to make it easy for employees to react to the information shared. Ensuring that participants receive and review statements is the key to the success of the overall effort. The current focus on reducing cost by distributing s with embedded links rather than sending hard-copy statements may not be effective in encouraging a detailed review of income statement content among some participant populations. Employers should evaluate not only the statement content but also the delivery method. Whatever adjustment is made, given the findings from the Minnesota study it is important to make it easy for employees to react to the information shared.

9 In conclusion Contact: For many sponsoring employers, an opportunity does exist to take a significant step toward improving participant retirement outcomes through the simple step of redesigning the income statements they receive. However, it is important to recognize that a statement is but one element of a broader communications campaign needed to drive change. Amy Reynolds amy.reynolds@mercer.com For more articles in the Mercer and Stanford Center on Longevity series, visit MAKING ACCOUNTABILITY WORK

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