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Products September 12, 2011
Russell Introduces “Rule-of-Thumb” For An Appropriate Savings Rate
September 12, 2011 (PLANSPONSOR.com) – In its latest research, “What’s the right savings rate?,” Russell Investment proposes a new framework to help defined contribution (DC) plan sponsors better answer the question, “Are my participants saving enough?” and in turn to take measured steps through plan design in an effort to improve participant behavior.
Reported by Tara Cantore
“Savings matter because it is the lever over which participants have the most control. Participants who save adequately relative to their retirement spending expectations will greatly diminish their reliance on risk factors outside of their control,” said Josh Cohen, Defined Contribution Practice Leader. “Describing one’s retirement savings rate in terms of target replacement income (TRI) can greatly simplify the retirement savings puzzle.”
The framework is built on exploring the answers to two distinct but related questions:
How much should participants save for a high chance of achieving a given TRI – the percentage of one’s final, pre-retirement salary that will be required to meet spending needs in retirement?
What TRI is sufficient to fund retirement?
The first question, “How much should participants save?” is addressed by the TRI 30 rule-of-thumb. Participants can determine their appropriate individual savings rates by multiplying their TRI rate by 30%. According to Russell’s research, saving 30% of the TRI rate each year, including any employer contribution, leads to about a 90% probability of meeting the income goal at retirement.
The second question, “What TRI is sufficient to fund retirement?” is answered in part by an often cited study by AON Consulting and Georgia State University, which provides analysis on how to determine the correct TRI. Russell also outlines additional considerations for determining an individual’s TRI in the paper, including the volatility of health care expenses and the challenges faced by lower-income participants.
“We’ve designed this framework to help plan sponsors determine what the right savings rate is for their average participant,” said Cohen. “There will never be a single answer for everyone, but what we hope is that this approach can spark a smart conversation focused on setting reasonable savings goals.
“Once a plan sponsor has decided on a reasonable TRI for their participants, the next step is to imbed that knowledge into the plan’s design through the company match and auto-features,” he added. “Well thought out plan construction can have an impact on participant behavior and encourage saving at a higher rate. This can provide a cost-effective way for plan sponsors to increase the chance of better retirement outcomes for participants.”