Educating Employees about the Adequacy of Retirement Benefits

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. There is no agreed-upon definition of the term “adequacy” according to the Society of Actuaries. Definitions that are often used are 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 volatility 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.

Variability of income. Variables that are likely to affect future retirement income include:

• Specific defined-benefit or hybrid plan provisions and the impact of years of service on future benefit levels as well as if the plan is mandatory or voluntary.
• 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.
• Continuous financial education and retirement planning sessions conducted throughout the employees’ careers. As an employee approaches retirement eligibility, a plan sponsor, working with human resources and retirement plan, should communicate steps and administrative procedures to transition to retirement.
• 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.
• Information on other offerings that employees can access through existing third-party providers, including an individual retirement account (IRA) or Roth IRA.

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, and personal savings).
• Tool for participants to estimate retirement security, including benefits from mandatory and voluntary plans, employer-sponsored, individual retirement plans, and other financial resources.
• Information or advice that provides everything, as possible, for employees 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.
• Contractual 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.