The point of 401(k) savings is to create retirement income. It is governed by the rules of The Employee Retirement Income Security Act. Yet according to most published reports, few Americans are anything but secure.
What is the state of a 401(k) savings plans today
Many have taken steps to become retirement plans, such as automatic enrollment, automatic deferral increases, and investment portfolios designed to ease the chore of investing 401(k) savings. Some of these investing, like age-based investments or risk-based portfolios. Those are some of the criteria for evaluating whether a 401(k) plan is a retirement plan, but they are not enough to convert a 401(k) savings plan into a retirement income plan.
The industry had a good idea for automatic enrollment and auto escalation. That was a bit like sending in the Air Force. Eventually you need to bring the Army to assess what is going on the ground. Note that the skill sets of these two organizations are different. Likely there are varying levels of financial literacy, savings capacity and behaviors among diverse participants.
What’s the difference? Here is my list of retirement income plan characteristics:
Each participant knows how much retirement income they need.
Most experts say that people need an income replacement ratio of 75% to 85% of their final pay. Part of that will be from Social Security—on average, about 40%— and, for most people, the balance will come from their 401(k) plans. (That is because most participants have few, if any, other financial assets.) If you don’t know what you need, how do you know if you are saving enough?
Employees know how much income their 401(k) savings buys
In a retirement plan, participants also know how much retirement income their current 401k savings will “buy” at retirement. (Alternatively, the estimated retirement income could be based on both the current account balance and projected future deferrals.) In a 401(s) savings plan, each participant knows whether he is on course or not and, if not, what changes need to be made. The calculation of the shortfall between current behavior and the needed retirement amount is called “gap analysis” and is available from some providers.
Every employee gets a retirement gap analysis (retirement needs).
When this information is automatically provided to participants, it must be based on assumptions (which should be stated clearly) and on the needs of the average or typical participant. Of course, no participant is truly typical—or even average. That why one-one-advice is promoted. Bring in the army.
Every employee gets one-on-one help. Pensions provide an actuary to calculate savings rates. Why not. Some employee’s may want to live on more or less than the employee’s base replacement rate. Some employees have 401(k) savings from previous employers. They may want to save retire sooner or later than the plan’s assumption. This advice should be delivered by an independent advisor with designations and expertise in planning, such as a CERTFIED FINANCIAL PLANNER ™ professional. Further, this should be a service paid for by the employee through their individual account balance. Selecting low cost investments for the plan can more than offset the cost.
If your plan offers these services, you are sponsoring a 401k savings plan. If not, talk to your providers and advisers about how to convert your savings plan into a 401(k) savings plan. Firms like LPL Financial have services to help participants with the advice portion.
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