Consulting/Outsourcing Retirement Retirement Readiness: Bridging the Gap Across s.. December 2010
Retirement Readiness: Bridging the Gap Across s Over the past decade, the rise in defined contribution plans as the primary employer-sponsored retirement vehicles has placed more risk and responsibility on individuals for achieving retirement security. While Baby and employees from earlier generations may have once been able to rely more heavily on Social Security, pension plans and retiree medical benefits, younger employees are more likely to find themselves relying primarily on their own savings. This report examines participant behavior in defined contribution plans and retirement readiness across three generations Y, X and younger Baby. It shows how each generation faces their own set of challenges in preparing for retirement and offers solutions employers can utilize to help their diverse employee base achieve their retirement goals. This report includes in-depth analyses and data from two recent Aon Hewitt reports, 2010 Universe Benchmarks: How Well Are Employees Saving and Investing in 401(k) Plans and Retirement Income Adequacy at Large Companies: The Real Deal 2010. The majority of participant behavior data was captured through 2009, unless otherwise noted. In total, data from more than 2.9 million eligible employees was analyzed. Summary of Findings Y Y, also known as the Millennial, includes workers ranging from 18 to 30 years of age. The group is known for being technologically savvy. They are characterized as realistic, confident and open to changes, with an affinity for opinionated dialogue and free spending. It is also a relatively large generation, with significantly more individuals than X. Y is the least likely demographic to have access to a pension benefit, thus pushing risk and personal responsibility to the individual. At the same time, retirement needs are expected to continue to rise for this generation due to increasing life expectancy and growing retiree medical costs. Y Overview Significant issues with current saving behaviors: Only 50% of eligible employees participate. The average savings rate is relatively low at 5.3% of pay. More than 40% of savers don t contribute enough to obtain the company match. Six in ten terminated participants cashout their savings rather than roll over monies. Automation can play a key role in getting Y employees on the right path. Employers should be careful to use defaults that will lead to optimal behavior. Further, for Y workers, communication needs to be quick and easy to understand, and require minimal effort on the part of the employee. Technology including the use of smart phones and other devices can also play a key role. While defined contribution plans are critical to Y employees, only half of the employees in this generation who are eligible to participate in their employer-sponsored defined contribution plans do so. On average, Y participants contribute only 5.3% of pay, and 41% don t save enough to receive the full company match. 1
These low savers, coupled with nonsavers, mean that 70% of Y employees leave free employer money on the table. In addition, cashout behavior among participants in this generation is significant. Sixty percent will cashout their retirement savings when changing jobs. This is an important finding given Y is also the most mobile of the three generations. As a result of the low participation and savings rates of the group, the typical Y worker is projected to have a shortfall of more than six times final pay upon retirement at age 65. For those without a pension plan, the average shortfall increases to nearly eight times pay. Another factor contributing to this large discrepancy between retirement income and retirement needs is increasing health care costs at retirement. To meet all of their financial needs in retirement, it is expected that many Y participants may need to work up to or past age 67. It should come as no surprise that savings plan automation has the greatest impact on the saving behaviors of Y participants. In 2009, nearly 60% of new Y enrollees were defaulted through automatic enrollment when it was available rather than selecting their own savings rate based on their needs. Participation levels were significantly higher when automatic enrollment was offered. Because of default behavior and inertia, automatically enrolled participants are also more likely to invest in a premixed portfolio (including target-date and target-risk funds) and put all assets in one premixed portfolio than the two older generations. Therefore, their retirement investments tend to be better diversified than those of their predecessors. Their portfolios are also more likely to be consistently rebalanced, which is critical given recent market volatility. Additionally, they have the highest usage of automatic contribution escalation, whereby their savings rates will be automatically boosted each year. While Y employees are often not on the right path, the good news is that this group has more time to recover and is responding well to automation. Automatic enrollment is clearly having a big impact. When coupled with automatic contribution escalation and rebalancing, Y savers can achieve, and sometimes even exceed, their projected retirement savings needs. X X workers are in their early 30s to mid 40s. They are typically results-driven, adaptable and flexible, sometimes skeptical, and strongly focused on achieving a work-life balance. Like Y workers, X individuals are less likely to be covered by a pension plan than and are increasingly reliant on defined contribution plans for their retirement future. Among eligible employees, one-third of X workers are not contributing to their defined contribution plan. When they do save, their rate of contribution is higher than that of Y, at 6.8% of pay, on average. Additionally, 30% of participants are saving less than the company match threshold, thereby X Overview Concerns around saving behaviors: One-third of eligible employees don t participate. The average savings rate is 6.8% of pay; however, 30% contribute less than match threshold. Many aren t diversified, and 19% of participants do not allocate any monies to stock funds. Nearly 30% have loans outstanding, and 46% of terminated employees cashout their savings. Automation can also play a key role; however, more backsweeping needs to be done to also solicit existing nonparticipants. An array of investment advisory services is needed to reach the diverse needs of this demographic. This includes managed accounts, online advice and target-date portfolios. missing out on additional contributions from their employers. Low savers, coupled with nonsavers, mean that half of X employees leave free employer money on the table. 2
Investment behavior among X participants is often suboptimal. Nineteen percent of these participants hold less than half of their assets in equities, despite having more than 20 years until typical retirement age. In addition, 29% of these workers have an outstanding loan, and cashout behavior is quite high. Nearly half (46%) of participants withdraw their assets in cash when they terminate employment. Similar to Y, the retirement needs of X workers continue to mount with increasing longevity, a higher retirement age for collecting unreduced Social Security benefits, decreased coverage by pension plans and less (or no subsidy for) retiree medical benefits. Based on current savings patterns, the typical X employee is expected to have a shortfall of 4.2 times pay at retirement. This shortfall increases to 6.4 times pay for those not covered by a pension plan. X employees have 20 to 30 years until they reach age 65 retirement, so taking significant action in the near term can help improve the outcomes. Investment advisory services and tools, such as target-date portfolios and managed accounts, can help employees in this generation manage more complex financial situations. Automation can also play a strong role, and tools like automatic escalation and rebalancing can assist employees in accumulating sufficient retirement assets. Younger Baby Younger Baby are those in their late 40s through mid-50s. This research focuses on this subgroup rather than all Baby due to their anticipated longer investment time horizon. Because of this time horizon, a change in behavior can still influence their retirement preparedness. Younger comprise about a quarter of the working population. They are generally known to be work-centric, independent, competitive and loyal to their employers. These employees are more likely to have access to a pension benefit, although defined contribution plans are also a key component of their total retirement package. This group is more likely to save for retirement than the other generations and is more likely to save at a higher level. Among younger Baby Younger Baby Overview Significant issues with current saving behaviors: Three-quarters (76%) of eligible employees participate. The average savings rate is 8% of pay, although 24% of savers miss out on employer matching dollars. Only 12% of those eligible take advantage of the catch-up contribution feature. Diversification and rebalancing remains suboptimal for many participants. Personalized support is required for younger, including financial planning assistance and access to an array of investment advisory tools. Additionally, reminders and personalized messaging regarding the ability to defer more, and on the use of catch-up contributions, should be provided., three-quarters (76%) of eligible participants actively save in their defined contribution plans, deferring, on average, 8% of pay. Still, there is room for improvement: About one-quarter of participants do not participate, and about a quarter (24%) of savers do not save enough to take full advantage of employer matching contributions. Additionally, some younger Baby those aged 50 and older qualify for catch-up contributions. However, among those who are eligible, only 12% take advantage of the catch-up feature. By the end of 2009, the average 401(k) plan balance among by full-career younger Baby Boomer participants was $161,440. Due to the economic and financial climate, many participants in this generation still have significantly lower balances than they did in 2007. Surprisingly, company stock remains over allocated among some younger Baby, with 14% investing more than half of their 3
401(k) balance in employer stock. Most participants in this generation do not rebalance, with only 18% of participants making any sort of investment transaction during a year. Loan activity remains significant with nearly one-third of participants having a loan outstanding (29.5% at year-end 2009). The average younger Baby Boomer is projected to have the smallest savings shortfall among the generations in this study, at 2.8 times pay. This is mainly due to legacy defined benefit plans and lower retiree medical costs. Although the study predicts a retirement income shortfall at age 65, workers in this generation who have a defined benefit plan can reduce or eliminate the shortfall by delaying retirement just two years to age 67. Unfortunately, the news is not as positive among employees who do not have access to a defined benefit plan. These younger Baby are expected to have a shortfall of 5.3 times pay at retirement quite distant from a financially secure retirement. To assist younger Baby and help bridge that gap, more personalized support is needed, including financial planning assistance and access to an array of investment advisory tools. According to recent Aon Hewitt/Financial Engine research, older workers and those closer to retirement more often prefer managed accounts as the tool to help with their retirement savings. Additionally, reminders and personalized messaging regarding the ability to defer more, and on the use of catch-up contributions, should be provided. Detailed Findings Demographics The table below describes the generations included in this analysis (salary numbers are rounded). Age Ranges (average) Average Salary Average Tenure Perception / Attitude Towards Retirement Readiness Y 18 to 30 (25) $30,000 3 Lack of urgency and other priorities, such as credit card payments and student loans, supersede saving for retirement. X 31 to 45 (38) $60,000 7 Distracted by current spending (e.g. mortgage, monthly bills, child care, and saving for children's college). Younger Baby 46 to 54 (49) $66,000 13 More concerned about retirement readiness than other generations and still have more than a decade or more to earn, save and invest for their future. 4
Participation and Savings Rates Older employees tend to participate more and save more in their retirement savings plans. Younger Baby are most likely to save and at relatively higher levels, followed by X and Y workers. In recent years, participation rates have risen across all generations, especially among s Y and X. In 2009, half of Y workers participated in a 401(k) plan, up nearly 20 percentage points from 2005. Seventy-one percent of X employees participated, up 8 percentage points. In contrast, contribution rates in 2009 were marginally lower than they were four years ago. These patterns have likely been heavily influenced by automation driving participation rates up, and savings rates down (as passive participation becomes more common). Another strong influence may be the volatile economic environment, resulting in decreased savings for some employees. Participation Rates Average Contribution Rates Y 31% 50% 2005 Y 5.6% 5.3% X 63% 71% 2009 X 7.2% 6.8% Younger Baby 72% 76% Younger Baby 8.3% 8.0% 0% 20% 40% 60% 80% 100% 0% 2% 4% 6% 8% 10% Effect of Automation on Participation and Contribution Rates More employers implementing the automatic enrollment feature in their defined contribution plans has significantly aided retirement saving across all demographics. This is especially true among younger generations, where nearly 60% of Y enrollees were defaulted under automatic enrollment in 2009. Younger Baby, however, are more likely to proactively enroll (only 45% are defaulted). In addition, nearly a quarter of Y workers elect or are defaulted to automatic contribution escalation when available, compared to only 10% of young Baby. Y also has the highest use of Roth contributions, which might help them accumulate more in after-tax savings. Enrollment Paths by of Those Subject to Auto Enrollment % of Participants 100% 80% 60% 40% 20% 0% 41% 59% 51% 55% 49% 45% Y X Younger Baby Defaulted through AE Proactively Enrolled 5
Active Participants Saving Below Match Threshold 24% 30% The majority of 401(k) employers provide matching contributions, adding to employees savings rates. However, a significant number of employees across all generations do not contribute enough to receive the full contributions from their employer Either they either save nothing or they save below the threshold of the matching contribution. Y participants are often not saving enough to receive these employer contributions, with 41% of active participants saving below the match threshold. Even those closer to retirement struggle, with one in four younger Baby Boomer active participants missing out on free money to help fund their coming retirement. 41% Y. X Younger Baby 0% 10% 20% 30% 40% 50% Plan Balances and Participant Returns The median full-career younger Baby Boomer participant has accumulated $108,060, versus the average balance of $161,400. By comparison, Y savers have a median balance of $4,800, and an average of $10,100. Total and Median Plan Balance for Full-Career Participants Average Total Plan Balance Median Plan Balance Y $10,100 $4,800 X $52,900 $25,700 Younger Baby $161,400 $108,000 6
Although many participants balances remain below 2007 levels, 2009 returns were largely positive. Interestingly, Y participants experienced slightly smaller losses in 2008 but benefited from larger gains in 2009. This is likely because participants in this generation typically have more diversified/efficient portfolios than other generations due to a larger allocation in premixed portfolios. Median Rate of Return 2008 2009-28% Y 29% -30% X 27% -28% Younger Baby 23% -40% -30% -20% -10% 0% 0% 10% 20% 30% 40% Investment Behavior and Diversification Y participants hold the highest amount of equities, averaging 75% in stocks. This is a dramatic change from 2005, when, on average, Y participants investment in equities was only 63%. The averages among X and younger were both up slightly, at 72% and 65%, respectively. Total allocation to equities was calculated based upon direct investment into diversified equities and company stock, as well as indirect investment in stocks through balanced and target-date portfolios. The dramatic change in Y investment behavior is primarily due to premixed portfolio exposure. The average equity exposure among participants using premixed portfolios is higher than other generations. Y workers not using premixed funds were far more conservative and had equity allocation levels similar to younger Baby. 7
Average Equity Allocation Overall and by Participant Usage in Premixed Portfolios % of Assets in Equities 90% 85% 80% 75% 70% 65% 60% 55% 50% 75% 72% 65% Y X Younger Baby Fully in Premixed Some in Premixed No Premixed All Premixed portfolios are very prevalent Premixed Portfolio Usage among Y investors, and they are 80% used significantly more than among other 70% generations. Sixty-nine percent of 69% Y participants use a premixed 60% 54% portfolio, with more than 40% of assets held in premixed portfolios on average. Further, 50% 40% 45% Y participants are more likely to 30% use these diversified investments 20% appropriately with nearly 60% of those holding a premixed portfolio investing 10% exclusively in it. 0% Y X Younger Baby Meanwhile, despite their closer proximity to retirement, younger Baby tend to hold a higher allocation in company stock than other generations. Company stock % Using Premixed % Using Exclusively makes up 14% of younger total balances or just under one-quarter (22%) of the total equity balances. Additionally, when the distribution of employer stock holdings is evaluated, 14% of younger hold more than half of their assets in company stock. This is down significantly from previous years (23% in 2005), but excess allocation to company stock remains a diversification challenge. Outside of premixed portfolios, very few employees rebalance their portfolios. In 2009, only 11% of participants elected autorebalancing when available. While older participants are more likely to perform an investment transfer than participants in other generations, the percentage of these workers doing so is very small. Just 18% of younger Baby made an investment transfer in 2009. Amid the substantial market volatility, the lack of a rebalancing strategy has significantly impaired results for many individuals and further explains the performance differential seen among users and nonusers of premixed portfolio strategies. 8
Plan Leakage Loans, Hardship and Cashouts Asset leakage out of defined contribution plans prior to retirement remains a significant issue and can significantly impair employees ability to meet their future retirement goals. While Y participants are less likely to take a withdrawal (either an in-service or hardship withdrawal), they are far more likely to cashout their defined contribution balance when terminating their employment. This trend is typically linked to the size of the accumulated balance the smaller the balance, the more likely a participant is to cashout. This can be a risky move, particularly for younger workers, who would then miss out on the value of compounding Plan Leakage Percent of Participants over the course of their career. Further, because younger 3% Y employees are more mobile, Withdrawal 7% repeated cashout behavior can X 7% make it extremely difficult for Younger Baby Y employees to meet all their financial needs in 15% retirement. Loan Outstanding 29% 30% Loan usage is significant among X and Younger Baby, with nearly one-third having a loan outstanding at year-end 2009 (29% and 30%, respectively). Cashout behavior is also significant. Cashout Post Termination 37% 46% 59% 0% 10% 20% 30% 40% 50% 60% 70% 9
Retirement Income Adequacy The discussion around suboptimal saving and investing behavior leads to the question: Are the various generations of savers on track to meet their future retirement needs? This analysis leverages Hewitt s recent study that projects retirement income sources (defined contribution, defined benefit and Social Security), as well as future expected needs. These findings are expressed as multiples of pay at retirement. Full-career contributors (those hired at age 35 or younger, with the potential for a full career at one employer) are evaluated because this avoids potential skewing of results due to lack of information about employees prior employer benefits. Full-career employees who are contributing to their defined contribution plan are projected to have retirement resources that fall 2.4 times pay short of their retirement income needs. Employees without access to a defined benefit plan are projected to be significantly less prepared than those with pension benefits. 8 Projected Retirement Income Gap (Multiples of Pay) 7 6 5 4 3 2 1 0 2.2 6.3 2.7 Y X Younger Baby 4.2 2.1 2.8 Full-Career Contributors Full-Career All Y full-career employees, including participants and nonparticipants, are expected to have a shortfall of 6.3 times pay on average a third of their total needs. Among active savers, the gap is significantly smaller at 2.2 times pay on average. Levers to cover a shortfall mainly include working longer and saving more. Unfortunately, even if Y employees work until age 67, a shortfall remains (4.0 times pay among all full-career employees). Therefore, it is imperative that Y employees begin participating at a young age and contribute at a more robust level. Contribution escalation is a compelling tool that appeals to younger savers. If escalation is used to elevate savings levels beyond 10% of pay, it is likely that this gap can be bridged. Meanwhile, a full-career X employee is projected to have a shortfall of 4.2 times pay, with the gap reduced to 2.7 times pay among active savers. Working until age 67 reduces the gap to 2.7 times pay. Of course, saving more also helps. 10
Younger Baby (full career) are expected to have a shortfall of 2.8 times pay. Those who are actively saving for retirement are projected to have a shortfall of 2.1 times pay at retirement. However, the average Younger Baby Boomer who does not contribute to the defined contribution plan may expect a shortfall of 7.4 times pay at retirement. Access to a defined benefit plan significantly influences projected outcomes employees without a pension benefit are projected to have a shortfall of 5.3 times pay. Extending retirement age by two years, to age 67, allows Younger to bridge the projected gap. Saving more for retirement can also improve results, but the impact is less dramatic because younger Baby may only have a few years before retiring. These findings should be considered optimistic, because they do not include a real and prevalent savings killer: leakage. Specifically, cashouts are the most pervasive and detrimental form of asset leakage, and this trend makes the future reality quite grim. For example, a Y contributor is expected to fall short by 2.2 times pay at retirement. The gap more than doubles if that person cashes out their balance at age 35 (the gap grows to 5.7 times pay). Cashouts at younger ages generally involve smaller amounts; however, the impact grows quite significantly over time because of the loss in future investment earning. Comparably, cashouts would be relatively larger among older workers, and these employees have fewer years to rebound and recontribute to their defined contribution plan when switching jobs. In short, all employees are adversely impacted by leakage. Projected Surplus / Shortfall at Retirement if Cashout at Termination Cashout All DC Savings Y X Younger Baby Baseline All -2.2-2.7-2.1 Cashout at Age 30-4.4-3.2-3.0 Cashout at Age 35-5.7-4.5-3.9 Cashout at Age 40-6.9-5.6-4.7 Note: Baseline includes all full-career contributors 11
Closing the Gap So what does all this mean for employees and plan sponsors? The availability of pension plans and employer-subsidized retiree medical benefits has been steadily declining particularly for those generations furthest from retirement. To maintain their preretirement standard of living, many workers may find that they need to significantly increase their saving levels, work in retirement and/or even delay retirement. Plan sponsors can do their part by effectively urging employees to participate and save more toward retirement. Many solutions effectively bridge all generations, with the understanding that an array of services and tools are required to reach an increasingly diverse employee base. Adding automatic tools and being more assertive with defaults. More than one-half of employers offer automatic enrollment in their defined contribution plans, and more are adopting this feature each year. Automatic enrollment, coupled with automatic contribution escalation and solid defaults, can have a dramatically positive impact on retirement income adequacy, especially among Y employees. Acknowledging differences in learning styles and needs across generations. For Y employees, communications need to be quick and easy to understand, and require minimal effort on the part of the employee. Asking younger employees to check the box will be much more effective than asking them to read a 30-page brochure on their investment options. Technology including the use of smart phones and other devices plays a key role when communicating with this generation. Further, providing personalized, targeted communication will resonate across generations. Designing innovative employer matching contributions. Aon Hewitt s research continues to show that employee savings rates tend to focus on the company match threshold. Therefore, employers should consider redesigning their employer matches to encourage higher savings rates among employees. For example, consider offering a 50% match on 8% of pay instead of a 100% match on 4% of pay. (Note that ADP/ACP safe harbor plan designs may emphasize lower match thresholds at or below 6% of pay.). Offering an array of investment advisory services and support. Investment behavior continues to be suboptimal, with nondiversified portfolios, lack of rebalancing and skewed risk taking. Aon Hewitt research shows younger workers tend to prefer target-date portfolios, while older workers and those closer to retirement tend to prefer managed accounts. This is intuitive, as younger workers financial situations are generally less complex. Younger Baby who are nearing retirement tend to have more complex financial situations with may require more individualized support. Clearly there is no single answer to meet all participant needs. An array of investment advisory services may be needed to meet the diverse needs of Y, X and younger Baby. Adopt a Roth. Saving through a Roth feature can provide significant tax diversification benefits to both younger and older generations. According to Aon Hewitt research, one-third of defined contribution plans currently allow Roth savings, and this number continues to grow. Further, younger employees are more likely to access Roth when available, with 16.6% of 20- to 29-year-olds using Roth, versus only 4.2% of 50- to 59-year-olds. Contact Information 12
Pamela Hess, CFA Director of Retirement Research Aon Hewitt +1.847.295.5000 pam.hess@aonhewitt.com Rob Reiskytl Practice Leader of Retirement Strategy and Design Aon Hewitt +1.612.339.7501 rob.reiskytl@aonhewitt.com About Aon Hewitt Aon Hewitt is the global leader in human capital consulting and outsourcing solutions. The company partners with organizations to solve their most complex benefits, talent and related financial challenges, and improve business performance. Aon Hewitt designs, implements, communicates and administers a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies. With more than 29,000 professionals in 90 countries, Aon Hewitt makes the world a better place to work for clients and their employees. For more information on Aon Hewitt, please visit www.aonhewitt.com. 2010 Hewitt Associates LLC www.aonhewitt.com 2