Stronger market returns and continued retirement savings behaviors by employees over the past few years have helped U.S. workers make progress in closing the gap between the amount of money they need to meet their financial needs in retirement and what they are on track to accumulate, according to two new reports from Aon Hewitt.
When factoring in inflation and postretirement medical costs, Aon Hewitt projects employees will need 11 times their final pay in retirement resources, such as company-provided plans and personal savings, to meet their needs in retirement beyond Social Security.
Aon's The Real Deal: 2012 Retirement Income Adequacy at Large Companies examined the projected retirement levels of more than 2.2 million employees at 78 large companies and found that, on average, full-career contributing employees are on track to accumulate 8.8 times their final pay, leaving a shortfall of 2.2 times pay. This is a slight improvement over 2010 when the shortfall was 2.4 times pay. Employees who rely solely on a defined contribution (DC) plan to fund their retirement are making similar progress, reducing their shortfall from 4.3 times pay in 2010 to 3.8 times pay.
According to Aon Hewitt, two main factors contributed to closing the gap: continued savings by employees and strong return on assets. Aon's 2012 Universe Benchmarks report, which analyzes the saving and investing habits of more than 3.6 million U.S. employees, shows 76% participated in a DC plan during 2011. While flat recently, this rate remains at a record high. Participation among younger workers increased by two percentage points since 2009 to 54% of eligible workers. In addition, the median annualized participant rate of return from 2009 through 2011 was a substantial 12%.
However, there is still room for improvement. The average before-tax contribution rate remains nearly unchanged, at 7.2% of pay. As a result, less than 30% of full-career employees are currently "on track" to achieve adequate retirement income. Passive employee behavior also is at an all-time high, with just 15% of participants initiating a trade in 2011, down from 20% in 2008 and prior years.
Among factors influencing retirement income adequacy, Aon found that employee savings rates have the largest impact. For example, if not covered by a pension plan, an employee who begins saving at age 25 and targets 11 times pay at retirement needs a combined employer and employee contribution rate of 12% to 18% of pay each year (15% on average) to build up adequate retirement income by age 65. This combined contribution rate increases if the employee does not start saving until later in life.
Aon's analysis shows the number of full-career contributors who can retire with sufficient retirement assets increases from 29% to 46% if they increase retirement contributions by as little as 1% each year for five years. For an employee making $40,000 a year, this 1% increase in contribution rates roughly equates to giving up purchasing one cup of coffee a day for a year.
Aon's research also shows that automation tools can have a dramatic impact on saving and investing behaviors. The participation rate among those subject to automatic enrollment is 83%: 18 percentage points higher than those employees who are not defaulted. The research shows employers that offer automatic enrollment have 15% more employees on track to meet their needs in retirement than employers that do not offer automatic enrollment. Similarly, 53% of employees who are enrolled in automatic contribution escalation programs are expected to meet their financial needs in retirement, compared to just 26% of those who are not.
While automation has played a strong role in helping employees' saving behaviors, Aon says it can also be potentially detrimental if it is not leveraged effectively. Employees who are automatically enrolled in their DC plan have an average savings rate of 6.7%, which is a full percentage point below those not subject to automatic enrollment. Additionally, these workers are much more likely to miss out on employer matching contributions. Thirty-nine percent of automatic enrollees save below the match threshold versus just 25% of other savers.