Can I retire on time and with enough money to live with dignity? This is top of mind to any retirement plan participant who contributes to their employer’s retirement. Employers are equally interested in this answer as well.
In response, many record-keeper providers have developed retirement readiness scores or projections for future account balances that employees can views on their participant website. These tools vary from provider to provider in what they deliver and how they formulate their results, but one element that they often share is an attractive simplicity. Participant input is generally minimal, or the result is automatically generated based on account details.
Either way, the simplicity of a raw score or number is attractive to plan participants increasing usage, but it begs the question: how realistic are these projections?
As advisers, it is important to have a thorough understanding of these scores and projections in order to relay their relative strengths and weaknesses to our plan sponsor clients. Most importantly, as each provider has their own methodology, it is crucial to understand the inputs and the outputs to a retirement score or projection.
If the score provider gives a plan participant a projection, such as a dollar value expected account balance at retirement, employees need to understand how they get to that figure. Many providers simply take an employee’s projected contribution rate, current salary, inflation rate, and grow that figure at a stable rate over his or her working career. This straight line future value calculation is highly dependent on the variables that are entered, and some require participants to enter the variables. If a participant’s return expectation is too high, it will give them an overly optimistic view of their potential retirement balance. If the market experiences a reasonable selloff that affects the beginning balance, for example, it could also greatly affect the ending projection.
For the providers that give a retirement readiness score, what constitutes the scores? Does it include assets outside of the plan? What are the projection methodologies? Does it account for aspirational goals, such as travel, or just an income replacement?
These scores can fluctuate depending on market results, which can be disconcerting for a participant to see their score drop at the same time as their account. While a concise and simple retirement score can be appealing to participants, advisers have to be able to relay what success under the score actually means to a participant’s retirement.
While these services are far from perfect, they are a useful conversation piece to have with participants. It is wise to remember that the best use of these tools is to encourage participants to save more. Of all the potential inputs into a financial plan, the one that can have the greatest effect, and is most under a participant’s control is the savings rate.
It is also important to remember that market results have a strong impact on the outlook for these scores and projections, so participants need to be prepared to have their retirement outlook correlate with market results, which could set them up for a bumpy ride.
