The Missing Retirement Income Mind-set
By Richard Wolf
After years of political reforms and media warnings, people are now well aware that savings will play a critical role in ensuring comfort in old age, but an alarming number have unrealistic expectations as to the income their savings will provide
In a recent survey conducted by Allianz Global Investors in the United States, only 52% of the 401(k) savers among 1,300 people polled had a realistic idea of the income their retirement savings was likely to generate. “It’s certainly an eye-opener,” says Glenn Dial, head of retirement at Allianz Global Investors. “The message concerning taking retirement preparation into your own hands has definitely sunk in, but people are still unaccustomed to thinking in terms of a retirement income stream.”
In the survey, interviewees were asked about the most important source for retirement income. Some 38% believed employer-sponsored retirement savings plans (defined contribution (DC) plans, such as 401(k)) would be the most important. Including personal savings and investment accounts, 61% of respondents expected that DC retirement plans would be their most important income stream, showing widespread awareness of the new retirement income reality.
Concerns about scheme funding in this environment of low yields and increasing longevity have seen many companies close traditional defined benefit (DB) pension schemes to new hires. Social security is also coming under financial pressure as baby boomers enter retirement. In the future, retirees will rely more on personal accumulated pension pots than on preset pension formulas that pay a regular income stream.
This change in mind-set has been supported by reforms that encourage employees to save far more, far earlier, and that have made the savings process easier. Employer match to individual employee pensions are now close to universal, and more than 60% of new plan entrants are enrolled via automatic enrollment. At the end of 2015, over $1.1 trillion in assets were held in target-date funds – a favorite of younger employees, according to EBRI & ICI.
CONFIDENCE IN RETIREMENT INCOME
But do individuals understand efforts to build stronger, more effective DC plans? In the AllianzGI survey, respondents were asked if they were confident they would have enough money throughout retirement. In the responses, a difference emerged between people covered by a DB pension plan compared with those with only a 401(k) plan. Overall, 87% of DB plan members said they were highly or fairly confident that they would have enough money for retirement, while only 64% of 401(k) members felt the same.
One concern of the survey was whether people understood how DC assets could be turned into a stream of income throughout retirement. In an earlier survey, AllianzGI found that only 50% of Americans aged 45+ had thought about a savings decumulation strategy. Owing to the high level of uncertainty DC savers face regarding old age income security, the more recent survey included a retirement planning exercise.
Interviewees were asked: what were their current 401(k) savings; what proportion of their salary did they contribute; how high was the match of their employer; what was their expected retirement age; what was their aspired level of saving at retirement; and, most notably, the income they wanted to achieve during their retirement period. The median expected final account ranged from $300,000 to $350,000. At the median, respondents estimated their 401(k) pot to yield a future monthly retirement income of $1,500, preferably from the median expected retirement age of 65.
To judge how realistic this is, the benchmark was a “plain vanilla,” gender-specific immediate life annuity from a leading online annuity brokerage firm. As an example, a man aged 65 could receive a 6.5% annuity (best quote). Therefore retirement assets in the range of $300,000 to $350,000 would yield a lifelong retirement monthly income between $1,600 and $1,900. If the retirement saver had aspired to $1,500, then his retirement income expectations were considered realistic.
Only 52% of respondents had realistic expectations regarding their savings. Some 17% would need to hit the upper end of their savings target to achieve their desired income. Another 31% significantly overestimated the income that could be drawn from their potential DC plan savings.
“This is alarming and highlights how complex the task is to convert one’s savings into a lifelong income stream,” says Glenn Dial. “Low-income respondents and families with children especially overestimate their ability to generate expected retirement income from their savings.”
The results reveal that many future 401(k) retirees are at risk of falling short of their desired income and potentially unable to sustain their living standard during retirement. This situation raises the question whether people are currently saving too little for retirement, as they seem to be overestimating the income their aspired savings might “buy.”
“Most recent retirement innovations have related to the accumulation phase,” says Dial. “People today are saving more for longer, but the complexity of the decisions they have to make has also increased.” He suggests as a next step that firms provide plan members with guidance so they can adopt a retirement income mind-set. “The complexity of the retirement decision remains unaddressed and, if it continues, many people will be in for a shock at the point of retirement.”
Source: Project M, January 9, 2017