A recently published white paper from T. Rowe Price demonstrates that pursuing improved retirement readiness for employees does not have to be costly.
Achieving plan objectives in an environment of constrained budgets, talent competition, and increasingly complex fiduciary requirements can sometimes seem like a difficult balancing act.
However, with the right combination of plan design and automated program features, plan sponsors can improve retirement plan effectiveness within reasonable budget levels.
This paper focuses on three foundational components:
- Employer contributions
Employer contributions: Adjusting the match schedule can significantly affect costs.
- Change the match percentage while leaving the basic structure intact
- Change the structure of the matching formula
- Change the timing of when contributions are made
- Move to a different type of contribution
Vesting: Realignment allows for more effective features.
- Create multiple vesting schedules
- Change the timing of when vesting occurs for new contribution types and/or new hires
- Change the method by which vesting is calculated
Eligibility: Changes can offset improvement costs.
- Change who is eligible for each type of contribution utilized
- Change the timing of eligibility
- Change the nature of eligibility calculations
Two examples of cutting costs while boosting participation rates AND IMPROVING RETIREMENT INCOME REPLACEMENT RATIO
Goal: Add a full range of automatic features while reducing annual cost
- 100% match on the first 4% of deferrals
- 2% nonelective contribution with a last-day rule
- Auto-enroll all who are eligible at 4%
- Auto-increase 1% each year up to 10%
- Annual cost reduced by 7.2%
- Participation rate improves from 58.7% to 97.4%
- Improve average retirement income replacement ratio average while maintaining the average for employees over age 60
Goal: Decrease annual costs by 10% and increase participation rate
- 100% match on the first 3% of deferrals
- 0% matches on deferrals over 3%
- Auto-enroll all who are eligible at 6%
- Auto-increase 1% each year up to 15%
- Annual cost reduced by 10.4%
- Participation rate improves from 85.1% to 99.3%
- Improve average retirement income replacement ratio average while maintaining the average for employees over age 60
Communication is key
As is true for all types of plan changes, an effective and thorough plan for communicating changes to employees is critical to success. Similarly, when periodically reenrolling or resetting participants, a strong opt-out communications program will help ensure that participants aren't surprised by actions taken on their behalf and will create an opportunity to present a strong rationale for why the actions are being taken.
MONTE CARLO DISCLOSURE
RETIREMENT INCOME PROJECTIONS
The future is uncertain; therefore, we predict many futures
To create our projections and model future uncertainty, we use a proprietary Monte Carlo simulation. Monte Carlo simulation is an analytical tool for modeling future uncertainty. In contrast to deterministic tools (e.g., expected value calculations) that model the average case outcome, Monte Carlo simulation generates ranges of outcomes based on our underlying probability model. Thus, outcomes generated via Monte Carlo simulation incorporate future uncertainty, while deterministic methods do not. Although the engine cannot predict future investment performance, by simulating thousands of hypothetical future market scenarios, it can help plan sponsors to more realistically assess whether their employees are likely to achieve their retirement income goals.
The investment results shown in the various Plan Meter charts were developed with Monte Carlo modeling using the following material assumptions, as well as those outlined in the Plan Meter Report Appendix. The underlying long-term expected annual return assumptions for the asset classes indicated in the charts are not historical returns. Rather, these are based on our best estimates for future long-term periods. Our annual return assumptions take into consideration the impact of reinvested dividends and capital gains. We use these expected returns along with assumptions regarding the volatility for each asset class and the intra-asset class correlations to generate a set of simulated, random monthly returns for each asset class over the specified period of time.
These monthly returns are then used to generate 1,000 simulated market scenarios. These scenarios represent a spectrum of possible performance for the asset classes being modeled. The success rates are calculated based on these scenarios. We take taxes and required minimum distributions (RMDs) into consideration, as described in the Appendix, but we assume no early withdrawal penalties. Investment expenses in the form of an expense ratio are subtracted from the expected annual return of each asset class. These expenses are intended to represent the average expenses for a typical actively managed, no-load fund within the peer group for each asset class modeled. The analysis does include all of a participant's assets in the defined contribution plan(s), but categorizes them simply as individual stocks, diversified stock funds, bonds, and short-term investments. Other asset classes not considered or modeled may have characteristics similar or superior to those being analyzed.
The replacement income (in current dollars) is the percentage of the employee's current annual salary withdrawn in the first year of retirement; in each subsequent year, the amounts withdrawn are adjusted to reflect a particular annual rate of inflation. The underlying long-term expected annual return assumptions (gross of fees) used in each of the Monte Carlo simulations are 10% for large-cap individual stocks; 11% for mid-/small-cap individual stocks; 10% for stock funds; 6.5% for intermediate-term, investment-grade bonds; and 4.75% for money market/stable value investments. The following expense ratios are then applied to arrive at net-of-fee expected returns: 0% for individual stocks; 1.211% for stock funds; 0.726% for intermediate-term, investment-grade bonds; and 0.648% for money market/stable value investments. The simulation success rate of each employee's retirement planning strategy is identified for a sponsor's plans in the Rules and Assumptions section of the Plan Meter Report. Simulation success is defined as having at least one dollar remaining in the portfolio at the end of retirement. (The retirement period in the simulations is assumed to end at age 95.) The simulation success rate of a particular retirement strategy is determined by counting the number of simulation scenarios that result in at least one dollar remaining and dividing this figure by the total number of simulation scenarios of that strategy used.
Limitations of the model
Material limitations of the investment model include: Extreme market movements may occur more frequently than represented in our model. Some asset classes have relatively limited histories. While future results for all asset classes in the model may materially differ from those assumed in our calculations, the future results for asset classes with limited histories may diverge to a greater extent than the future results of asset classes with longer track records.
Market crises can cause asset classes to perform similarly over time, reducing the accuracy of the projected portfolio volatility and returns. The model is based on the long-term behavior of the asset classes and, therefore, is less reliable for short-term periods.
The model assumes that there is no correlation between asset class returns from month to month. This means that the model does not reflect the average periods of bull and bear markets, which can be longer than those modeled.
Inflation is assumed to be constant; variations in inflation levels are not reflected in our calculations. These results are not predictions, but they should be viewed as reasonable estimates.
This paper has been prepared by T. Rowe Price Retirement Plan Services, Inc., for informational purposes only. T. Rowe Price Retirement Plan Services, Inc., its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this paper, including any attachments, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this paper.
What do people really think about retirement?
A new study by T. Rowe Price Retirement Plan Services, Inc., is revealing some surprising insights.
Faces of Retirement provides a refreshing, unedited glimpse into the lives of 88 Americans—those in retirement as well as those transitioning to retirement. Their candid stories—captured during a series of in-depth interviews—offer valuable insight into the thoughts and experiences of real retirees and preretirees. This context is critical for providers, sponsors, and advisors: It shapes current thinking and provides a basis for thoughtful solutions and meaningful conversations.
Here's a summary of some key points regarding the Faces of Retirement study.
Faces of Retirement is a comprehensive study with a specialized focus:
- Collect information through the eyes of, and in the language of, people within seven years (on either side) of retirement
- Speak with people who represent the nation's diversity
- Uncover underlying reasons for attitudes, perceptions, and behaviors of those approaching—and living in—retirement
Respondents—44 preretirees and 44 retirees—were surveyed and interviewed at length in July 2012. Through the study, T. Rowe Price summarized the conversations into top key findings.
The study gives an inside look at the hopes, concerns, and lessons learned in planning for and living in retirement. A continuing trend, according to Naomi Proshan, manager of the Research Data and Analytics group for Retirement Plan Services, is the notion that Americans are, for the most part, feeling more positive about retirement.
"Retirement may not be as daunting, particularly for recent retirees. It's no surprise those with a 'plan' were feeling much more positive about retirement," said Proshan. "Overall, we were pleased that nearly all the survey respondents were so forthcoming and at ease sharing their experiences."
Faces of Retirement is more than a one-time study. T. Rowe Price intends to track the same respondents through ongoing journaling, interviews, and online surveys.
This phase is distinct among industry research and provides a deeper understanding of the experiences people face early into retirement. T. Rowe Price is currently testing other ways to bring the stories to life.
Retirement is a topic that touches almost every aspect of the financial services and retirement plan industry. With the latest research, you can gain clarity on the issues and mindsets of today's preretirees and retirees—and define how you can best meet their needs.
- To the advisor: provides valuable information to boost your knowledge and expertise to DC clients and prospects; helps you position products and frame the conversation about retirement income.
- To the plan sponsor: helps you provide the support that workers need to feel more comfortable and confident during the transition to retirement; points to plan enhancements and designs that will have the most impact for your organization.
The Faces of Retirement video series highlights the real-life stories of preretirees and retirees who participated in the year-long study. With a very personal mix of emotion and straight talk, they share their hopes, successes, and mistakes—and offer practical advice to underscore the importance of early planning. These videos help bring the most inspiring stories to life and align with current theories that personal stories can be a powerful way to shape participant behavior.
reap rewards later