Retirement benefit adequacy is the extent to which retirement income is sufficient to replace pre-retirement income over the lifetime of retirees and their dependents. The term “adequacy” is subjective – a 2013 paper by the Society of Actuaries notes that definitions are typically based on income replacement ratios, expected expenses, and societal standards.1 Benefit adequacy factors in all sources of retirement income and savings, which may include payments from employer-sponsored retirement plans (e.g., defined benefit, defined contribution, and hybrid plans), personal savings, and, in many cases, Social Security benefits.2
The factors with the greatest impact on retirement benefit adequacy are volitility in the financial markets and plan design. Fluctuations in the financial markets cause the value of defined contribution holdings and other financial assets to rise and fall, with economic downturns tending to decrease the funded positions of defined benefit pension plans. Defined benefit pension plans often address this situation by changing their plan provisions to control costs and thus make the plan more sustainable. These changes commonly result in a lower level of benefits for new hires and, in some cases, lower benefits to existing employees for future service. Typical defined benefit plan provisions also depend on an employee’s years of service with the sponsoring government, and new employees may therefore have to work longer and save more than existing employees to reach their desired level of retirement savings.
GFOA recommends that government employers and plan administrators educate employees about retirement income and include the following considerations when preparing the education program.
Variability of income. Variables that are likely to affect future retirement income include:
- Specific defined-benefit plan provisions and the impact of years of service on future benefit levels.
- Where to find information about future Social Security benefits (if applicable)3 and the fact that individual pay levels have a direct relationship to those benefits.
- The possibility that the sum of defined benefit retirement income and any other income, including Social Security, may not be adequate. Therefore, employees may need to add a defined contribution component to their overall strategy and/or reconsider the levels or their defined contribution plan contributions as market or plan changes, in addition to potentially pursuing other asset accumulation strategies.
- A strategy for ensuring benefit adequacy throughout the employee’s life, including Social Security age-related factors and IRS-required minimum distributions.
- An understanding of retiree medical benefits (if applicable) and the associated costs of coverage, and the significant impact of these costs on the adequacy of the retirement benefits.
Elements to include. Important points related to financial and retirement planning include:
- An introduction to the importance of saving for retirement in the early years of employment. This can be accomplished through onsite enrollment meetings, employee orientation programs, online financial planning, and other strategies.
- Periodic financial education and retirement planning sessions, conducted throughout the employees’ careers. At a minimum, a plan sponsor should offer pre-retirement planning sessions at least five years before the employee’s projected retirement age.. Employers should work with their retirement systems and human resource officers to develop comprehensive and coordinated strategies for retirement planning services.
- Access to unbiased educational programs and qualified planning services that address the entire benefits package. The investments discussed in these presentations should not be chosen because of any potential financial benefit to the firm presenting the advice.
- Information on other issues employees may face during retirement, including: health care, long-term care insurance, legal issues, wills, and tax issues.
The role of external providers. Elements to consider when procuring financial education and advice from external providers include:
- A selection process that demonstrates due diligence, affords protection against fiduciary liability, and results in quality advice for the employees.
- Information or advice that covers all retirement assets available to the employees (e.g., Social Security, employer-based savings in a defined contribution plan, benefits from an employer-based defined benefit plan, personal savings).
- Information or advice that provides everything employees need to make informed investment decisions related to their retirement assets.
- No transfer of fiduciary responsibility from the investment provider to the employer or retirement system. A contract should clearly state that the vendor bears the risk of fiduciary liability for any recommendations it makes.
- Contractural assurance that the investment advice provider will not provide, sell, or derive income from the sale of any investment products to the participants in the retirement plan.
- Vickie Bajtelsmit, Anna Rappaport, LeAndra Foster, “Measures of Retirement Benefit Adequacy: Which, Why, for Whom, and How Much?” Society of Actuaries, January 2013.
- According to the Social Security Administration, approximately 6.6 million U.S. government employees are covered by state or local government retirement plans in lieu of Social Security.
- Information about individual Social Security benefits is available at www.ssa.gov/myaccount.