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Employees May Need to Save More than Initially Anticipated

Two recent studies suggest employee savings rates may need to be higher than previously projected to compensate for lower future capital market return expectations.

  • A July report by AQR Capital Management, “How Much Should DC Savers Worry about Expected Returns?,” compared the savings rates needed for a 75% retirement income replacement ratio. AQR found that a rate of 8% was required for portfolios projected to return 5.5% on a real basis (after inflation), while a portfolio with a projected real return of 3.5% would require an estimated savings rate of 15% (nearly double).
  • A second study, conducted by NerdWallet in September, “Millennials May Have to Save 22% of Yearly Income for Retirement if Market Returns Drop,” focused on the Millennial population. NerdWallet examined a 25-year-old individual earning $40,000 and concluded that if the average annual stock return was reduced from 7% to 5%, then their savings rate would need to increase from 13% to 22% in order to reach an 80% income replacement at retirement. The study also reiterated the importance of saving early: under the 5% stock return scenario, if a 25-year-old waited until age 35 to start saving, the required savings rate would jump to 34%.

Rather than focus on these individualized scenarios, however, we suggest plan sponsors take broader-based steps to help improve employee success by targeting higher savings rates in general (thus, counteracting the possible impact of a lower future return environment). Setting initial auto-default rates above the common 3% level, implementing auto-escalation and setting higher caps for auto-escalation are examples of plan design features that can help drive higher participant savings rates, while also getting younger employees on the right track earlier in their careers. Similarly, at the organizational level, plan sponsors could re-examine the composition of their company-match formulas or implement a company-wide re-enrollment to (re)capture employees who are not, or have stopped, contributing to their defined contribution plan.