In 2015, tell your clients — particularly those in their 30s — to aim for 15% contributions of their salary into their 401(k) plans.
With pensions drying up and employers cutting health care plans for retirees, workers are taking a greater share of responsibility for their retirement income security and the 401(k) will shoulder most of the retirees' costs going forward.
How much to save in that 401(k), however, is in flux. Historically, employers with automatic enrollment features would slot their workers into the plan at a default contribution rate of 3 % of salary or less.
Additional plan design features followed, including auto escalation, which boosts employee contributions by a set percentage each year, and match formula adjustments, which can encourage workers to contribute more of their own money in order to qualify for a match from the employer up to a certain percent.
Nowadays, a 3% deferral rate won't cut it, not even if an employee gets a 100% match, bringing him up to a 6% total savings rate. Recent research is now showing that the ideal contribution rate is closer to 15%.
THE MAGIC NUMBER
Wade D. Pfau, professor of retirement income at The American College, points to a contribution rate of 15% for a 35-year-old worker who hopes to retire at 65 as the benchmark for his upcoming Retirement Wealth Accumulation Index, a feature he will host on his new site RetirementResearcher.com in the coming weeks. Fans of Mr. Pfau's work will recall a 2011 paper he had authored, in which he highlights the safe savings rate of 16.62% in order to weather the worst market tumult in retirement.
Check out his current site here.
In Mr. Pfau's benchmark, the hypothetical worker will also invest in a portfolio of large cap stocks and 10-year U.S. Treasuries, with asset allocations that are based on the averages in Morningstar Inc.'s 2014 Target-Date Series Research Paper. At age 35, 89% of the 401(k) balance will be allocated toward large cap stocks, with the amount shifting to 50% equities by age 65.
Fifteen percent isn't a cure-all.
“The 15% is calibrated to a 35-year-old,” said Mr. Pfau. “If you're 40 years from retirement, 8% to 10% [contributions] is fine, but if you're already 45, 50 years old and you haven't saved much, 15% isn't going to get you a very good lifestyle at retirement.”
Retirement plan service providers support the 15% deferral rate. T. Rowe Price's FuturePath retirement savings calculator uses a package of guidelines to help users determine how much they ought to be saving.
“If we know nothing about a person and they haven't used our site or calculator before, we give them one number: 15%, and that's including the employer match,” said Stuart Ritter, vice president of T. Rowe Price Investment Services.
FINDING EXTRA DOLLARS
But there is a conflict. Advisers note that even though 15% would go a long way toward safeguarding retirement income for clients, it's quite a stretch for them to find the extra dollars.
“There's a big gap between 5% and 15%,” said Mac Gardner, branch director of executive planning at the Noble Group, an independent firm with Raymond James Financial Services Inc. “The standard is to put away what you need for the match, but at 15%, unless you have a substantial cash flow that you do nothing with, that's tough to swallow for a lot of people.”
With planning clients, the three words “'I max out [my 401(k) contributions],' is music to my ears," said Mr. Gardner.
In the trenches, advisers working with 401(k) plans are helping clients get close to that 15% through a combination of auto-enrollment and auto-escalation, as well as the use of contribution matches and profit-sharing programs.
Employers struggle with the additional cost of diligent matching. “Ultimately, the employer has to be comfortable with it, that if there's a match, they'll take on additional costs,” said Jeffrey H. Snyder, vice president, senior consultant at Cammack Retirement Group. So experts suggest that employers consider tweaking matching formulas to encourage greater employee contributions.
“You can change the match in such a way that it doesn't cost more money but encourages higher deferrals,” said Meghan Murphy, director of thought leadership at Fidelity. Instead of matching 100% at a 3% salary contribution, go for 50% at 6% salary contribution.
In practice, Mr. Snyder's clients might have employees contributing at 6%, enabling them for a matching contribution at 3%, plus another discretionary 3% via profit-sharing. That will get them to 12%, which isn't 15% but it's close.
Alexander G. Assaley III, adviser of corporate retirement plans at AFS Financial Group, points to auto re-enrollment efforts at 6% deferrals as a huge success in getting workers to save more money. That program can be paired up with an auto-increase of 1% each year, bringing employees up to 12% contributions gradually.
Those additional contributions can't be made in a vacuum, however. Mr. Assaley noted that those higher salary deferrals go hand-in-hand with budgeting at the employee level. His firm rolled out a beta version of such a program last year and will kick off an interactive client-wide budgeting challenge in the first quarter.
“Retirement readiness is the big trend that started in 2009, and now it's grown up,” Mr. Assaley said. “The next one you'll hear about is budgeting and financial wellness for employees.”