Lifetime retirement income is the key ingredient for an
effective 401(k) plan
The definition of “success” is constantly changing. Plan
sponsors who want to offer successful 401(k) plans need to participate in that
evolution … rather than being anchored to historical measurements.
In the 1990s, 401(k) plans were largely measured by features
and funds, the success of the plans often determined by whether they offered
brand-name mutual funds and “extras” such as a website, investment education or
advice, and/or brokerage accounts.
Beginning in the early 2000s, and continuing to date,
success has been based on current results. By “current,” I refer to
measurements of where a plan stands today. Perhaps the most commonly accepted
current yardstick is level of participation. If a plan has high participation,
it’s a successful plan. Similar thinking applied to deferral rates and
participants investing in portfolios of balanced funds, target-date funds,
asset allocation models or managed accounts.
We are now evolving into the next generation of success
standards. The new measurement will be based on back-end results. Rather than:
“What is the plan doing?” the question will be: “What is the plan
producing—will it yield adequate benefits for participants to live on in
retirement?” Success will be measured not by account balances but retirement
income. After all, the need for benefits in retirement is month-to-month and
How will plan sponsors know if they are evolving to this new
standard? The first test will be whether the plan offers gap analysis to its
participants. Simply stated, gap analysis tells participants whether they are
on course to having adequate retirement income and, if not, what they need to
do. To calculate benefit adequacy, a participant would need to perform relatively
complicated actuarial calculations. And a participant would need to have
information about income replacement ratios, Social Security benefits, life
expectancy and probabilities of exceeding life expectancy, and so on. For
example, does the typical participant know that one member of a 65-year-old
couple has a 25% chance of living at least 30 more years? Probably not.
Participants also need information about sustainable
withdrawal rates in retirement. For instance, based on authoritative research,
many experts believe that participants should withdraw no more than 4% a year
(inflation adjusted) if they want their retirement savings to have at least a
90% probability of lasting for 30 years.