Bill Would Require Lifetime Income Statements Be Provided

Social Security mails benefit projection statements annually detailing the projected monthly benefit participants can expect to receive at retirement. Now, U.S. Senators Jeff Bingaman (D-NM), Johnny Isakson (R-GA), and Herb Kohl (D-WI) want 401k plans to also provide lifetime income reports. According to an announcement on Senator Bingaman's website:

The Senators' Lifetime Income Disclosure Act (S. 2832) would require 401(k) plan sponsors to inform participating workers of the projected monthly income they could expect at retirement based on their current account balance. The measure is patterned on the Social Security Administration's annual statements, which are mailed annually to working Americans to inform them of estimated monthly benefits based on their current earnings. Congress mandated annual Social Security statements in 1989, and they have proven to be very useful to workers in preparing for retirement.

By providing similar information for 401(k) plans, the Lifetime Income Disclosure Act would give American workers a more complete snapshot of their projected income in retirement.

Specifically, under the Act, defined contribution plans subject to ERISA – including 401(k) plans – would be required annually to inform participants of how the account balance would translate into guaranteed monthly payments – a "retirement paycheck for life" – based on age at retirement and other factors.

To ensure there is no material burden or potential liability on employers who voluntarily sponsor 401 (k) plans, the legislation directs the Department of Labor issue tables that employers may use in calculating an annuity equivalent, as well as a model disclosure. Employers and service providers using the model disclosure and following the prescribed assumptions and DOL rules would be insulated from liability.

As far as Congressional bills go, the Lifetime Income Disclosure Act is relatively simple and straightforward - only six wide-margin, double-spaced pages in length. The heart of the bill is comprised of three sections setting forth the type of lifetime income disclosures to be made:

1. DISCLOSURE — A lifetime income disclosure shall set forth the annuity equivalent of the total benefits accrued with respect to the participant or beneficiary.



2. ANNUITY EQUIVALENT OF THE TOTAL BENEFITS ACCRUED — For purposes of this subparagraph, the ‘annuity equivalent of the total benefits accrued’ means the amount of monthly payments the participant or beneficiary would receive at the plan’s normal retirement age if the total accrued benefits of such participant or beneficiary were used on the date of the lifetime income disclosure to purchase the life annuities described in subclause (III), with payments under such annuities commencing at the plan’s normal retirement age.
3. LIFE ANNUITIES.—The life annuities described in this subclause are a qualified joint and survivor annuity (as defined in section 205(d)), based on assumptions specified in rules prescribed by the Secretary, including the assumption that the participant or beneficiary has a spouse of equal age, and a single life annuity. Such annuities may have a term certain or other features to the extent permitted under rules prescribed by the Secretary.

Details concerning the assumptions to be used and implementation rules are left for the Labor Department to determine.

With the transition from defined benefit pensions to 401k's, Americans have been forced to assume greater responsibility for their own retirement funding. Too many are ill-prepared for the task. If the defined contribution retirement model is to succeed, it is critical that workers be better educated on retirement issues and provided good information on which they can base their savings decisions. Senate Bill 2832 appears to provide a low-cost, common-sense way to greatly improve 401k planning.

IRS Announces 2010 Contribution Limits

The IRS has issued the cost-of-living adjustments for 2010 that affect employee benefit plans. Most 2010 limits applicable to 401k and other plans will remain at their 2009 levels.

There are several "limits" that apply to 401k plans under the Internal Revenue Code (IRC). The limits are found in various sections of the IRC. 401k plans must comply with the various IRC limits to maintain tax-qualified status. The Internal Revenue Service (IRS) annually increases 401k plan limits to reflect changes in the Consumer Price Index (CPI). Often, adjustments are made only if the change in the limit attributable to the CPI exceeds a certain threshold (e.g., $1,000 or $5,000).

The table below shows the primary 401k plan limits in effect for 2010 and 2009. Brief descriptions of the various limits are also provided.

Maximum Deferral and Threshold Limits for 2009 and 2010
Limit	2010	2009
Elective Deferral Maximum for 401(k) Plans and 403(b) Plans - IRC § 402(g)(1)	$16,500	$16,500
Elective Deferral Maximum for 457 Plans - IRC § 457(e)(15) - (below note a)	16,500	16,500
Catch-Up Limit (Age 50 and Older) for 401(k), 403(b), and 457 Plans - IRC § 414(v)(2)(B)(i)	5,500	5,500
Maximum Contribution to a Qualified Defined Contribution Plan - IRC § 415(c)(1)(A) - (below note c)	49,000	49,000
Maximum Compensation Limit - IRC § 401(a)(17) - (below note d)	245,000	245,000
Highly Compensated Employee Salary Threshhold - IRC 414(q)(1)(B)	110,000	110,000
IRA Contribution Limit	5,000	5,000
IRA Catch-Up Limit (Age 50 and Older) - IRC § 219(b)(5)(B)(ii)	1,000	1,000
Social Security Maximum Taxable Earnings – OASDI	106,800	106,800

note a - Elective deferrals are voluntary agreements in which employees elect to forego current income in return for the employer’s contributions to retirement or other benefit plans. Elective deferrals are available for a variety of tax-qualified retirement plans, including 401(k) plans.

note b - 401k plan participants who are or will be age 50 or older by the end of the plan year may voluntarily make additional “catch-up” contributions to the plan, above the maximum elective deferral limits. The maximum catch-up contribution is the lesser of (1) a specific dollar amount (the “catch-up dollar limit”) or (2) the participant’s compensation for the year reduced by any other elective deferrals made during the year.

note c - IRS limits the maximum "annual additions" that can be made to a member’s defined contribution plan account to the lesser of $49,000 in 2010, or 100% of annual compensation. In this context, annual additions include employer and employee contributions, as well as forfeitures.

note d - IRS limits the amount of compensation that can be taken into account by the plan, for the purpose of determining benefits and contributions, to $245,000 in 2010. For private sector plans, even if a plan member earns more than this amount, only $245,000 may be used in 2010 to calculate employee contributions to, or benefits provided by, the qualified plan.

401k Planning: To Retirement or Through Retirement?

A question garnering lots of attention these days in defined contribution (DC) retirement circles is: should 401k planning and investment strategies focus on getting participants to retirement or through retirement? Mostly, this question is asked in relation to the appropriate risk exposures assumed by "target date funds" (TDF's). These are the default investment option for many 401ks - i.e. where the money goes if no other investment choices are made.

But the to or through consideration also provides a helpful framework for understanding how individuals view 401k's and how they view 401k planning in general. Everyone has their own thoughts of what retirement should be so there are no right or wrong answers. Reflecting on the to retirement or through retirement question is a useful exercise that can help you clarify these thoughts. Below are some things to consider:

Issue	My 401k Planning Focus is on Getting To Retirement	My 401k Planning Focus is on Getting Through Retirement
Retirement Goal	Focus is on living well during early retirement years, perhaps using big share of 401k savings to indulge in a major purchase such as a new motorhome.	Focus is on not outliving savings and, perhaps, guaranteeing a lifetime retirement income stream.
401k Plan Participation	Most 401k participants quit employer-sponsored 401k's when they retire and rollover assets to an IRA.	Benefits of being a "participant for life" in your employer's 401k after retirement may include lower management/investment costs and better investment choices.
Sales Pitch	401k rollovers are a major source of revenue for mutual funds and investment advisors. There is considerable sales pressure to get participants to rollover their accounts.	Plan sponsors are recognizing the value of keeping participants after they retire - more assets can equate to lower fees and management costs. Also, sponsors are providing low-risk annuity products that guarantee lifetime income.
Investment Risk Posture	Low (or no) exposure to equities as retirement age nears. Example glidepath: 40% cash; 60% US Treasury inflation protected securities (TIPS). Goal is to preserve capital even through a market melt-down like that experienced in 2008.	Maintain equity exposure throughout retirement, recognizing that equities historically produce highest return over long-term. Example glidepath: 65% equities at age 65; 35% at 80; 20% at 90.

Factors That Impact Optimal Retirement Replacement Ratios

A new study from the Michigan Retirement Research Center (MRRC) sheds more light on the topic of retirement replacement ratios - i.e., the percentage of pre-retirement income that needs to be targeted to maintain living standards in retirement. This is key component of effective retirement budget planning.

Typical advice suggests that replacement rates should be 70 to 85 percent of pre-retirement income. Target replacement rates are thought to be less than 100 percent for three main reasons. First, upon retirement, households typically face lower taxes than they face during their working years, if for no other reason than Social Security is more lightly taxed than wages and salaries. Second, households typically save less in retirement than they do during their working years, so saving is a smaller claim on available income. Third, work-related expenses generally fall in retirement.

Interestingly, the MRRC study finds that 75% is the median optimal replacement rate for married couples - seemingly confirming the standard rules of thumb often used in retrement budget planning. However, the study cautions that, as is often the case, the median misrepresents the wide variation in optimal replacement ratios for households in differing situations. For instance:

1. Replacement rates for a married couple need to be higher than for an otherwise identical single person, both because of couples’ greater expected medical expenses in retirement and because of longer expected longevity for at least one partner. While the study found the median optimal rate for married couples to be 75%, the median optimal rate for singles was 55%.
2. Replacement rates of low-income individuals and families would need to be higher than replacement rates for high-income individuals and families, because the reduction (relative to their levels during the working year) in saving and taxes in retirement would be smaller for low income individuals and families.
3. High-income households need lower replacement rates than low-income households, because of their substantial reduction in average effective tax rates. Of course, the opposite point applies going forward: if one expects future taxes to rise, optimal target replacement rates for highincome households should reflect those expectations.
4. Other things being equal, a household with lots of children will have a smaller replacement rate than a household with no children, because the couple with kids, once retired, will face far lower child-rearing costs than they did while working.



5. Other factors (including medical costs, educational attainment, and taxes) affect optimal retirment replacement rates.

The study concludes that no single target replacement rate is appropriate for all households and that financial planning tools (like online calculators) relying on simplified, rule-of-thumb replacecement ratios need to be used with caution. This research includes findings that will be incorporated into the next generation of 401k planning and online tools.

Still, there is something to be said for retaining the understandable and teachable concept of a 75% retirement replacement ratio. The number of people who do even basic retirement planning (such as using an online retirement calculator)is far too small. Overcomplicating the retirement planning discussion runs the risk of keeping even more people away from serious planning efforts.

Thoughts on 401k Plans vs Traditional Pensions

The recent 60 Minutes report on 401k plans (The 401k Fallout) has rekindled the debate over defined benefit vs defined contribution plan design and stirred a lot negative commentary on the adequacy of the 401k as the principal retirement funding vehicle for Americans. The broad market declines of 2008-09 left bare the shortcomings of a retirement system that solely depends on the decisions of amateur individual workers/investors. This article at the Huffington Post is representative of the negative commentary asking:

"Why didn't we just keep company pensions, which worked fine for most people for years?"

Supporters of traditional pensions (defined benefit or "DB" pensions) rightfully point to the fact that traditional pensions are more efficient to manage than individual 401k accounts (defined contribution or "DC") plans. Investment management costs in a DB plan are lower, for example, since assets are pooled. Moreover, active professional management of DB assets is likely to result in higher investment returns over time than can be achieved with 401k worker-directed investments.

Still, despite the efficiency advantage, there are good reasons why traditional pensions have been so widely abandoned:

• Portability - DB pensions "worked fine" particularly for the company man of the 1960's - when the norm was to stay with an employer for a whole career. DB plans don't work so well for today's workforce where workers frequently change employers and even careers. Unless you get vested (minimum 5 years service typically required), quitting a job at a DB employer can mean leaving with nothing to show in your retirement account. 401k's and other DC plans are portable, meaning you can carry accumulated retirement account balances from one employer to the next.
• Contribution Requirements- The funding gap in DB plans is filled by contributions from the employer. That is, each year an actuary assesses DB plan assets vs liabilities and computes an employer contribution amount that must be paid into the plan. When investments perform well, it is possible that the employer will have little or no contribution requirement - a fact that DB supporters point to as an advantage. Unfortunately, actuarially determined employer contributions tend to peak at the worst possible time - i.e. when investments aren't performing, economic conditions are poor and the company can least afford the higher payments. Matching employer contributions to DC plans, on the other hand, typically are a much more stable throughout the economic cycle.
• Sustainability - DB plans are lifetime promises: work long enough to qualify, and the plan sponsor guarantees you a monthly annuity payment for the rest of your life. But like most long-term promises, the DB promise proved harder to keep as time wore on. Longer than projected life expectancies, accumulative costs of incremental benefit improvements, and global competitive pressures spurred companies to rethink the sustainability and risk of funding lifetime pension promises.

   
  "Why didn't we just keep company pensions, which worked fine for most people for years?"

  Well, many organizations did keep them...particularly state and local governments. The same economic tsunami that has wreaked havoc on 401k's has bludgeoned state and local pensions. Many, perhaps most, of these plans will be forced to raise taxes to fund lifetime pension promises made to millions of public employees. By the way, these tax increases will fall mostly upon people whose own retirement accounts have been severely eroded.

• Bloated Benefits - To make matters juicier, in coming months, the taxpaying public will learn just how rich state and local government DB pensions have become. Politics, collective bargaining, and incremental yearly benefit enhancements have combined to create DB pension programs where it is not at all unusual for retirees to get paid more in retirement than when they worked. DB pensions have been dubbed the "gift that keeps on giving" by some because of the seemingly neverending benefit improvements. The administrative efficiencies that DB supporters point to are marginalizeded when retirement ages are negotiated lower, expensive COLA's introduced and "multipliers"¹ enhanced on a regular basis.

   
  "Why didn't we just keep company pensions, which worked fine for most people for years?"

  My guess is that had it been somehow possible to set a fixed DB pension benefit at a uniform and moderate level (say 1% of salary per year of service with retirement at 65), not subject to constant bargaining and "enhancement", DB plans might still prevail. As it is, many organizations saw the financial blackhole that DB plans were becoming and made entirely rational decisions to switch to the DC model.

To second guess the move to 401ks and assert that organizations should have just stuck with traditional pensions seems simplistic. The market downturn has revealed shortcomings in both the DC and DB retirement system models. The "ideal" pension plan policy that emerges from the current crisis hopefully will be a hybrid that includes best features from both DC and DB models.

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This article is an editor's choice in the latest Carnival of Personal Finance at Weakonomics. Check out all of the informative personal finance blog articles at this site.

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Notes:

1. The multiplier in a DB plan is generally a percentage of salary earned for each year of sevice. A 2% multiplier would provide a pension equal to 60% of final salary to a worker who retired with 30 years service. [↩]

Tools for Rating Your 401k

With the retirement hopes of tens of millions of Americans riding on 401k plans, it is noteworthy that very little has been done to allow 401k participants to compare and rate these plans. The prevailing sentiment when it comes to 401k's is: 1) be happy that you even have a 401k (50% of workers don't have any employer-sponsored retirement program) and, 2) 401k plan details and priorities will pretty much be up to the sponsor to decide.

The participants whose retirements are at stake are largely in the dark about how good (or bad) a plan they have or how it compares with plans at other comparable employers. For that matter, employers have no simple way of learning how their 401k stacks up against the competition. Independent and objective comparison of 401k plan facts, to this point, has not been a priority.

A new web service called BrightScope aims to change that. Using a complex methodology¹ that "is 100% quantitative" and "truly independent", the BrightScope service gives a company's 401k a numeric score between 0 and 100 and plots the company's score along a colorful chart that also shows lowest, highest and average ratings of 401k plans in that peer group²

The ratings also give component ratings for six key plan features:

• Total Plan Cost
• Company Generosity
• Investment Menu Quality
• Participation Rate
• Salary Deferrals
• Account Balances

With roughly 800,000 401k plans in existence, BrightScope's stated goal ("to ultimately rate every 401k plan in the country") is truly ambitious. Moreover, with BrightScope being dependent on twelve different government and private data sources that have varying degrees of quality, reliability and timeliness, the accuracy of the ratings is sure to be the subject of much debate.

Still, BrightScope's concept is a good one. We suspect that at some point a BrightScope rating could become something of a "badge of honor" with companies touting their 401k rating just like mutual funds showoff their Mornigstar ratings. This would be a huge step forward in the march toward transparency and informed 401k plan participants.

We hope the venture succeeds and we encourage visitors to check out BrightScope. Here are a few improvements we'd like to see as the service develops:

1. more "drill down" capabilities for users to see underlying details of the rankings
2. industry-specific peer group comparisons (the current peer groups are based mostly on plans size and demographic factors)
3. a top 100 or top 1000 list highlighting the very best 401k plans.
4. less emphasis on the "delay in retirement age" metric - although the calculation is explained in the FAQ notes, this seems to be oversimplified and potentially misleading to casual visitors.

Of course, we also encourage you to to visit the 401k Self-Assessment Tool to better understand and evaluate the quality of your 401k plan.

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This post is part of the latest Carnival of Personal Finance at Wide Open Wallet family finance blog. Be sure to check out the other great entries as well.

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Notes:

1. Here's the official description: The BrightScope RatingTM is a quantitative 401k plan rating developed by BrightScope with the help of leading independent fiduciaries, finance professors and 401k experts. The BrightScope rating algorithm takes in 200+ unique data inputs per plan and calculates a single numerical score for every 401k plan in the country. The algorithm runs thousands of simulations for each plan in order to determine how quickly each 401k plan will get the average 401k participant to retirement. BrightScope believes that this rigorous approach is necessary to ensure that every factor that affects retirement outcomes - company contributions, fees, investment menu quality, vesting schedules etc. - is accurately reflected in a company's rating. The BrightScope Rating is designed to assist industry participants in determining the relative quality of a company's 401k plan when compared to a unique peer group of companies with employees of a similar demographic makeup. We believe that industry adoption of the BrightScope Rating will ultimately lead to more cost-effective plans, increased participation rates, higher employee satisfaction, and better outcomes for employees who depend on their 401k plan for retirement. [↩]
2. Here's the word on peer groups: In order to compare 401k plans, BrightScope constructs a unique peer group for every single plan. BrightScope's peer group algorithm takes into account the number of participants in the plan, the level of assets in the plan, the industry of the plan sponsor and the demographic characteristics of that plan's employees. By controlling for these factors BrightScope makes sure that each is compared to other plans with similar economies for fee comparisons and a similar employee demographic for plan performance comparisons. [↩]

Report on the Status of 401k Plans

The Center for Retirement Research at Boston College recently issued a chilling report tracing the evolution of 401k plans, the substantial progress achieved with changes included in the Pension Protection Act of 2006 and, finally, the devasting impact of the 2008 market collpapse. Conclusion: The time has come to return 401k's to their original place as a supplemental (rather than primary) retirement funding vehicle.

Anyone pondering the status of their 401k in the current market or how we got to this point should consider reading this research brief.

401k's were never intended to serve as workers main retirement income source. Rather they were meant to supplement social security and traditional corporate pensions - a personalized retirement savings program serving as the third leg of a solid three-legged retirement funding stool. As personalized accounts, 401k owners were given nearly total control over key decisions like whether to participate, how much to contribute, where to invest funds, and when and how to cash out.

In the 1980's and 1990's, two unforseen trends emerged. First, more and more corporate pension sponsors came to view the 401k as a convenient way to get out from under the risks and obligations associated with running a traditional pension plan. By 1995, the 401k easily surpassed defined benefit pensions as the principal retirement plan for most workers.

Second, it became apparent that far too many 401k plan participants were not equipped to make prudent decisions about participation, contributions, investments and withdrawals crucial to 401k planning success. Inertia caused workers to make no decision at all resulting in low 401k participation rates and overly conservative investment choices.

The Pension Protection Act of 2006 was enacted in response to the growing importance of 401k's and the mounting evidence that too many workers/participants weren't making good choices. PPA brought about key 401k reforms like encouraging employers to automatically enroll workers in 401k's, automatically increase contributions and provide default investment programs like target date funds to ensure participant investments aligned with long-term retirement goals. It was hoped that the PPA reforms would make 401k's a more effective tool for providing retirement security to workers.

The CRR report finds that by 2007, the PPA reforms were having their intended positive effects:

Historically, poor decisions have led to low 401(k) balances. The 2007 SCF suggests, however, the steps taken to make 401(k)s easier and more automatic have led to somewhat better outcomes.

Unfortunately, the current financial crisis has largely cancelled out the gains from PPA and has called into question the ability of 401k plans to effectively serve as the primary retirement funding vehicle for millions. The CRR report highlights three key areas impacted by the finacial crisis:

401k Balances - Actual vs Simulated (Ideal) - Before Current Crisis

• Decline in 401k Account Balances - The report estimates that the average 401k balance for households nearing retirement (age range 55-64) declined from $78,000 to $56,000 between October 2007 and October 2008. Sadly, since then, things have only gotten worse.
• Elimination or Reduction in Employer Matches. - Numerous employers have cancelled or reduced matching 401k contributions in response to the financial crisis. In most cases, this is seen as a short-term response to economic conditions. If this becomes a long-term trend, fewer workers will choose to participate in 401k's. Workers who do participate without an employer matche will find it exceedingly difficult to achieve a secure retirement.
• Increase in 401k Hardship Withdrawals - As economic conditions have worsened, more participants have sought hardship withdrawals from their 401k to stave off home foreclosure and other pressing financial needs. Withdrawals severely erode 401k savings and workers' future retirement security.

All in all not a healthy picture. The CRR report is avaiable for free (just click the thumbnail image above) and is highly recommended reading for anyone wanting to assess the status of their 401k retirement plan in the current market.

401k Advice and Bad Timing

When it comes to 401k advice, timing may not be everything, but it is certainly important.

A recent report from Greenwich Associates brings to light just how important timing can be. After years of efforts to move workers away from ultra-conservative money market investments and into investment options having a longer-term investment horizon, what happens? Markets fall off the table!

The result is a credibility gap with many rank-and-file participants feeling burned and plan sponsors searching for ways to fix the damage. The Greenwich report likens the situation to a "bad Greek trgedy" and points out that for many plans, implementation of well-intended initiatives like automatic enrollment and target date investments, occurred literally "on the eve of the biggest market collapse in 70 years."

From 2007 to 2008, the share of plan sponsors using money market or stable value funds as their default investment option dropped to just 19% from 35%, while the share of plans using target retirement date funds jumped from 35% to 53%. It is not uncommon for these funds' equity exposures to reach 50% or higher.
Plan sponsors' successes with automatic enrollment and new default investment options place them in an awkward situation at the start of 2009. While everyone invested in financial markets experienced the pain of systemic failure last year, 401(k) participants are feeling particularly hard hit because the money in these plans often represents a large share of their personal holdings and, in some cases, the entirety of their retirement savings. "Furthermore," notes Chris McNickle, "many of these employees began investing not of their own individual initiative, but rather as a matter of corporate policy."

Virtually all 401k participants are feeling the pain of market losses. If you are an investor who moved from "safe" investments to the stocks just in time to see the market fall, you may be feeling even more pain. But regardless of your circumstances, there are plenty of good reasons to "stay the course". Here are a few:

• Remember the match! If you're lucky enough to have a 401k that features an employer matching contribution, bear in mind that even with the market falloff, you are still likely ahead. For example, a dollar-for-dollar match equates to an immediate 100% return on your money. Remembering this can help soften the psychological blow of big investment losses.

Employee Funds	$100
Employer Match	$100
TOTAL	$200
After 30% Loss	$140

• Remember the tax break! Your 401k contributions are made with pre-tax dollars - the same $100 you contribute to a 401k gets you only $85 in additional pay (likely less) if you chose not to participate in the 401k (assuming you're in the 15% tax bracket). Another psychological cushion.
• Focus on "shares" instead of dollars. The money you set aside in your 401k is likely invested in a mutual fund or similar vehicle that prices net asset share values at the end of each business day. It may be some consolation to know that your fixed dollar contribution is buying more shares at today's depressed prices and this will payoff when the market revives and share values are on the rise again.
• Opportunity of a lifetime? The worst thing a 401k investor can do is abandon their stock investments at the market bottom. Yet this is exactly what many frightened investors do. Instead, try to think of the market upheaval as a once in lifetime opportunity to buy in low. Younger 401k investors, especially, need to recognize the opportunity before them.

More on Retirement Replacement Ratios

We wrote a post awhile back saying that, to keep retirement planning simple, you should set as a minimum retirement goal a replacement ratio of 75% of pre-retirement income. When all is said and done, effective 401k planning boils down to figuring out how to attain an acceptable retirement replacement ratio (RRR).

A visitor was kind enough to point us to this excellent 2008 retirement income replacement ratio study done by Aon Consulting. The Aon study goes into far greater detail showing how replacement ratios need to be adjusted for factors such as income levels and family situations. Here's an exhibit from the report showing how they arrived at replacement ratios for a "baseline" couple (ages 65, 62) at various pre-retirement income levels:

Line 10 of the above exhibit shows the overall replacement ratio. Significantly, lower income households will need a substantially higher replacement of pre-retirement income to maintain their standard of living in retirement. As the report explains, there are two primary reasons for this:

First, before they retire, lower paid employees save the least and pay the least in taxes as a percentage of their income. Thus, they spend a higher percentage of their income and need higher Replacement Ratios to maintain that level of expenditures. Second, age- and work-related expenditures do not decrease by as much, as a percentage of income, for the lower paid employees. This also means they need more income after retirement (as a percent of their pre-retirement income) than the higher paid employees.

Line 13 highlights the share of the replacement ratio that needs to from sources other than Social Security. For some this may include defined benefit pension benefits, but for most U.S. workers, this number represents the amount that will need to come from your 401k, IRA, and other retirement savings vehicles.

A second exhibit from the Aon expands on this by showing the lump sum balances that need to be accumulated at retirement to fund a the non-social security portion of the replacement ratio:

Thus, according to Aon, a baseline male with pre-retirement gross income of $80,000 would need a lump sum retirement account balances of $488,000 (6.1 x 80,000) at retirement to fund the non-social security share (38%) of his replacement ratio.

Of course, you can dispute assumptions underlying the Aon study. But, on the whole, it is a very useful and well-done report that could greatly benefit 401k participants who are serious about attaining their retirement goal. The report is free and can be downloaded here.

401k Hidden Fee Inequities

401k plans are coming under increasing scrutiny for a variety of reasons including shortcomings in providing retirement security and excessive administrative fees that take a large bite out of unwary participants' nest eggs.

Another emerging area of concern is the 401k hidden fee inequity that is inherent in the design of 401k plan fee structures.

Most types of 401k plan fees are assessed to plan participants in the form of an "expense ratio". Expense ratios typically are expressed as "basis points" or 1/100's of a percent. A 125 basis point (bp) expense ratio equates to a flat tax of 1.25% on each participant's 401k account balance. A 401k participant with a $100,000 balance pays ten times the fee that a participant with a $10,000 balance pays:

Annual Fee (Basis Points)	$100,000 Account	$10,000 Account
50 bp	$500	$50
100bp	$1,000	$100
125bp	$1,250	$125

But are 401k fees reflective of actual plan administration costs? In other words, are the costs of managing a $100,000 401k portfolio truly ten times the costs of managing a $10,000 plan?

A recent research brief from the Center for Retirement Research points out that constant expense ratio fees, while attractive from the standpoint of being easy to understand, are inherently inequitable:

(T)he familiar constant expense ratio also transfers retirement wealth from accounts with higher balances to those with lower balances. Other things equal, the fees collected from participants tend to be a constant proportion of the balances they hold in the plan. Yet, some of the costs covered by these fees – many administrative and sales costs – are relatively constant for all participants, regardless of the size of their balances. Moreover, participants with twice the balances of others are not likely to entail twice the management cost, although they pay twice the management fee. Thus, a constant expense ratio is a deceptively simple method of pricing, which, by decoupling fees from costs, reduces the return credited to higher balance accounts while boosting that on lower balance accounts. This transfer of wealth tends to be larger within plans with greater ranges of account balances and within plans that achieve greater economies of scale by controlling their costs more effectively.

401k fees and 401k fee inequities significantly impact plan participants' retirement saving success. The author points out that over a 30-year career "paying an annual fee of 50 basis points can reduce the purchasing power of savings at the time of retirement by one-eighth."

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