T. Rowe Price, the mutual fund giant, recently completed a study which showed that participants should average 15% in contributions into their 401(k) plan accounts each year to achieve retirement readiness. Approximately three years ago, Alliance Bernstein conducted a similar study which came to basically the same conclusion.
The 15% contribution rate includes employer contributions and should be maintained for the length of a participants 40 year career. Since many employers provide matching contributions (typically at a 3% rate) a 12% participant contribution rate may seem pretty reasonable.
Unfortunately most of us don't contribute -- at all -- at the beginning of our careers. Student loan debt, the need to save to buy a car or home, etc. cause many younger workers to forgo 401(k) contributions early in their careers. It is often not until our 30's that we begin to think about funding our retirements.
At that point, most of us contribute the minimum required to receive the maximum employer match. Since most employers match 50% of the first 6% of employee contributions, total contributions are around 9% annually. Applying some basic math to the average participants situation yields the following contribution short-fall:
Early career contributions (first 10 years): 0%
Mid career contributions (second 10 years): 9%
Mid career contributions (third 10 years): 15%
Late career contributions (final 10 years): 15%
Average contribution rate over 40 years: 9.75%
Required average contribution rate: 15%
Most participants are aware of this situation and feel they can fix it by contributing much more during their latter years to make up the difference. Continuing the example above, the contribution rate they would need to average during the final 10 years of their careers (to average 15% for 40 years) is 36%! Contributing at this level still leaves participants far short of the account balance they would have had if 15% contributions had been made during the first 10 years (due to the power of compounding).
Are there any solutions? Look for some answers in the Retirement Readiness: Re-setting Expectations post found here next week.
Contributing Editor Robert C. Lawton is President of Lawton Retirement Plan Consultants, LLC a Registered Investment Advisory firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. Mr. Lawton has over 25 years of experience working with corporations on their retirement plans and is a Chartered Retirement Plan Specialist (CRPS) and Accredited Investment Fiduciary (AIF). He may be contacted at email@example.com or 414.828.4015.
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