The Right Amount to Save for Retirement
We all know we should be saving more for retirement. But it's difficult to figure out how much to save. With conflicting priorities -- like your kid's college education and next year's vacation -- it's tough to save enough for every financial goal. Is there a magic percentage of our salary we can set aside knowing with a reasonable level of confidence that we'll be able to retire when and how we want? One recent study attempted to find out.
The Employee Benefit Research Institute (EBRI) took a look at retirement savings "success" in 401(k) plans. For the study, "success" is defined as "a 401(k) accumulation large enough that, when combined with projected Social Security benefits, will provide 80% of pre-retirement income." Financial planners agree that you'll need at least this percentage of your current annual income, assuming you're not planning to downgrade your lifestyle in retirement.
Since many workers in the past never signed up for their 401(k) plans, most employers now automatically enroll new employees. But they also set your contribution rate, typically 3% of your salary. Yet most people can't retire comfortably at this rate. The EBRI study looked at the impact of plans with higher default deferral rates and "automatic escalation," which increases employee contribution rates by a predetermined amount, typically 1% per year until reaching a certain ceiling.
The study uncovered substantial increases in "success" rates for employees in such plans, regardless of income level. The EBRI analysis found that when actual plan-specific default contribution rates were used, only 62% of employees in the lowest-income quartile would be projected to have a "successful" retirement. But if plans were assumed to adopt a 6% default rate, the "successful" percentage increased to 72%. Higher wage earners would also benefit, but not as much. The "success" rate increased from 41% to 52% for the highest-income quartile.
While those increases in "success" rates are noteworthy, that still leaves a lot of employees falling short of amassing enough money to retire.
Will the real 401(k) beneficiaries please stand up?
Retirement plan administrators, including Aon Hewitt (NYS: AON) , Fidelity, and Vanguard, report average 401(k) contribution rates have decreased since the 2006 introduction of auto-enrollment. For Aon Hewitt-administered plans, the average contribution rate decreased to 7.3% in 2010, from 7.9% in 2006. Meanwhile, average contribution rates for Fidelity's plans fell to 8.2% in 2010 from 8.9% in 2006, and Vanguard's plans fell to 6.8% from 7.3%.
But if auto-enrollment default percentages increase, coupled with widespread adoption of automatic escalation, plan administrators could see business surge. In addition to Aon, Fidelity, and Vanguard, plan administrator Paychex (NAS: PAYX) would certainly welcome the increased business. It struggled during the recent recession, as its revenue growth from payroll processing has slowed during the past several years.
And traditional plan administrators aren't the only players to potentially benefit. Not surprisingly, too-big-to-fail banks are salivating over the too-big-to-pass-up 401(k) market. Bank of America (NYS: BAC) , JPMorgan Chase (NYS: JPM) , and Wells Fargo (NYS: WFC) are all ramping up staff, developing technology, and competing on fees to vie for a slice of the burgeoning 401(k) business.
Foolish bottom line
The benefits of auto-enrollment and auto-escalation are many, including the sad reality that many individuals would have far less money saved if they had to proactively opt in and ratchet up contributions. However, there are drawbacks to auto-enrollment. If employers select percentages that are too low, savers may not make up the difference. On the other hand, if they're too high, more would-be savers might opt out altogether.
Additionally, auto-enrollment does not mean autopilot. There's a risk that some savers become complacent by thinking their retirement planning is "taken care of." It's certainly not the same as having a comprehensive retirement plan. All things considered, your 401(k) provides you with the best chance of retiring on your terms. Just don't assume it's doing your retirement planning for you.
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The article The Right Amount to Save for Retirement originally appeared on Fool.com.Fool contributor Nicole Seghetti owns shares of JPMorgan Chase & Co., Paychex, Wells Fargo & Company, and Bank of America. The Motley Fool owns shares of Aon, Bank of America, JPMorgan Chase & Co., and Wells Fargo & Company. Motley Fool newsletter services recommend Aon, Paychex, and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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