401(k)s Are More Important Than Ever

Employees who contribute to their 401(k) plan and who are willing to make small improvements to their saving and investing habits can increase their future income potential, according to a study by Hewitt Associates. When factoring in inflation and increases in medical costs, Hewitt predicts that employees will need to replace, on average, 126% of their final pay at retirement. That is significantly more than the traditional targets of 70% to 90% pay replacement.The Hewitt’s study examined the projected retirement levels of nearly 2 million employees at 72 large U.S. companies using actual employee balances and behaviors. Only 19% will be able to meet 100% of their estimated needs in retirement. On average, employees are projected to replace just 85% of their income in retirement, compared to the 126% they need. In other words, assuming inflation of 3% and a retirement age of 65, an average 40 year old with 10 years of service and earning $83,000 at retirement in today’s dollars would have saved enough to provide just $70,500 per year in retirement in today’s dollars -- a $34,000 annual shortfall. In fact, 67% of employees are expected to have less than 80% of their projected needs at retirement.The scenario is even more serious for employees who do not contribute to their 401(k) plans. Employees who contribute an average of 8% of pay to their 401(k) plan can replace 96% of their preretirement income at age 65, providing about 80% of what is needed to provide the same standard of living during retirement. That number drops to just 54% for employees who do not contribute, which equates to less than 40% of projected needs. Even employees who have a pension plan can expect to replace just 62% of their income at retirement if they do not contribute to their 401(k) plan, compared to 106% for those who do contribute. Recent Hewitt research shows that 26% of employees do not participate in their 401(k) plan, and of those that do, 61% contribute less than 7% a year. Hewitt’s study found that employer-subsidized retiree medical coverage has a dramatic affect on an employee’s ability to achieve adequate retirement savings. The good news is that people can take small actions in several areas and make a big difference. Gradual increases in savings rates, smarter investing, lower fees and delaying retirement can have a significant affect and enable most people to achieve a much more comfortable standard of living once they retire.

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