According to MetLife’s 14th Annual U.S. Employee Benefit Trends Study, 54% of Gen X employees, 57% of younger baby boomers and 51% of older boomers are extremely concerned about outliving their retirement savings. As employees continue to rely on company-sponsored plans, like a 401(k) or 403(b), they will need guidance to help ensure that they are financially secure in retirement.
Instituting a plan, however, is only the first step in helping to secure your workforce’s financial independence in retirement. For many employees, the concepts of investing and saving for retirement are difficult to understand. In order to make the most of the plan expense and the employee’s benefit, it’s important to fill the information gap by having regularly scheduled information or advisement sessions with eligible employees.
When I advise employees preparing for retirement, I often find some common misconceptions regardless of seniority, compensation or tenure. Here are the most commongaps I’ve found and the best ways to address them.
The maximum contribution
Many of the employees I speak to are confused about maximum contributions to retirement accounts. They often believe that they’re contributing the maximum, when in reality they’re simply contributing at the level that their employer matches or the maximum their budget allows. I also find that employees think that the limit is the same as it was in the tax year in which they began contributing, not realizing that the annual maximum increases for inflation. It’s just not something they think about regularly, so it gets neglected over time.
Employers would do well to clearly communicate what “maximum” means for employees participating in their plans and notify them of any changes when they happen. For employees, it’s important to take the time to review contributions to the plan every year and make sure they understand the rules surrounding them.
Another common pitfall for employees is failing to reallocate their retirement holdings. I’ve found that many people assume that changes to the actual investments within their portfolio can only be made during open enrollment. Similarly, many employees establish their asset allocation when they enroll in a retirement plan, but don’t go back to adjust it in future years.
Employees can and should occasionally reallocate their portfolios. Slight changes that adjust for fundamental shifts in market conditions can make a big difference down the road. Moreover, it’s important that the allocation reflect the employee’s current risk tolerance, which will likely change as they progress through their career toward retirement.
The power of compounding
Every dollar counts, but the dollars you invest early in your life count more. The power of compounding is remarkable. Encouraging young employees to enroll early and contribute as much as they can will position them to get ahead of the game when it matters most.
That being said, it is never too late to begin contributing or to increase contributions. Older employees may feel they’ve missed the boat or that it’s too late to make any significant difference. They should be reminded that it is never too late. Just five years of contributions at $18,000 per year (the pre-50-year-old calendar year maximum for 2015) will accrue to over $127,000, assuming a 5% rate of return.
An easy way for employees to increase contributions without feeling it in their take-home pay is to increase 1-2% annually at the time of their regular wage increase. Some plans allow employees to set automatic increases so that they don’t have to remember to do this each year. Following this method, employees can quickly reach the maximum contribution level without having to adjust their standard of living.
Employees with a retirement plan such as a 401(k) or 403(b) commonly believe that their spouse or children will automatically receive the proceeds of their plan if they should pass away. If no beneficiary is named, however, then the plan’s proceeds are considered a probate asset, which means they have to go through the courts (if there is no will) and the laws of intestate govern who gets the money.
Employees should always make sure that they take the time to appropriately designate their beneficiaries in their plans, and update them if any changes within their families occur.
Defined benefit plans
Pension plans are quickly becoming a thing of the past, but employees who are fortunate to still have an employer-sponsored DB pension plan need to understand their distribution options. I find that employees are typically unaware that there are alternative ways to provide for a spouse other than taking a reduced or spousal pension option. In many instances, this means a permanent reduction of 18-25% compared to what the individual pension would be. It is also important to teach employees that pension benefits can only be spouse-to -spouse once they start. There are no benefits left to children.
Although the term is commonplace in the HR world, I’ve met with many individuals who are confused about the term “vesting” and think that being vested means being ready to retire. They’ll tell me things like, “I’m vested in 10 years” or “I’m vested at age 55,” not realizing that vesting simply means that they are entitled to something, not necessarily that they can live on that amount.
Also see: “Equity incentive programs need closer look.”
Employees should be encouraged to look at their monthly income needs along with their projected benefits to determine if they can and should retire. For those of us in the industry, it’s easy to forget how a simple concept such as a vesting schedule can be misunderstood by employees. The responsibility lies with the administrator to make sure that participants in the plan fully understand its inner workings. This means regular education to make sure that the mechanics of the plan aren’t misconstrued over time.
Even though Social Security falls outside of the scope of a company’s retirement plan, it is an important part of your workforce’s complete retirement picture and therefore warrants attention. After all, you’re contributing 6.2% of employee salaries to this benefit, so you might as well make sure they’re getting the most out of the expense.
I’ve come across quite a few clients that plan to begin collecting Social Security as soon as they are eligible. Certainly, if someone needs this money to live, they should collect it. However, I find that more often people are collecting because they believe that they should take advantage of the benefit now in case they die young.
The numbers tell a different story. According to data compiled by the Social Security Administration:
- A man reaching age 65 today can expect to live, on average, until age 84.3.
- A woman turning age 65 today can expect to live, on average, until age 86.6.
- For a married couple who reaches the age of 65, there is a 50% chance of one spouse living past 90 and a 20% chance of one spouse living beyond 95.
Why is this important? By delaying your Social Security, you get an average of 8% per year in additional benefits from age 62 to 70. Furthermore, upon the death of a spouse, the lower Social Security benefit will expire and the higher one will remain. It therefore makes sense to grow at least one benefit to be as large as possible. Finally, if a recipient meets certain income thresholds, benefits could be reduced if taken prior to full retirement age.
Employees need to educate themselves on the role that Social Security can and will play in their retirement, based on when they collect their benefits. Employers can help by making sure this topic is included in their education efforts.
Too often, employees are overwhelmed or unaware of the many considerations and strategies that go into maximizing retirement benefits. Simply put, the process requires a high level of communication and education to ensure that all employees are positioning themselves for financial independence down the road. It’s up to company’s human resources departments to fill the knowledge gap, whether it’s with in-house training or by relying on a financial professional that can help employees clarify their retirement vision, determine their retirement needs and create a plan for success. At the same time, employees must participate in the process and take advantage of all the resources at their disposal.
Claudia Ferreira, CFP, ChFC, LUTCF, is a financial professional for the MetLife Premier Client Group, which designs and provides wealth management, retirement planning, estate planning and small business planning solutions tailored to their needs. She is located in East Hills, New York. MetLife does not provide tax or legal advice. Please consult your tax adviser or attorney for such guidance.
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