Having many working years ahead of them might not be enough of a safety net, when rising health care costs, increased life expectancy, and the steady decline in pension plan and retirement medical benefits are factored in, says Aon Hewitt. Improving their saving and investing behaviors could help Gen Y workers meet their financial needs in retirement, the analysis found.
After factoring in inflation and post-retirement medical costs, Aon Hewitt projects Gen Y workers will need to save 18.7 times their final pay in retirement resources—including Social Security, employer-provided defined benefit and defined contribution plans and employee savings—to maintain their current standard of living in retirement (this assumes retiring at age 65; more will be needed to retire earlier). However, according to a press release, Aon Hewitt’s research shows that employees of this generation who work a full career are on track to accumulate just 12.4 times their final pay, leaving a shortfall of 6.3 times pay—a third of their total needs. The situation is even bleaker for workers without a pension plan, who have a shortfall of eight times.
Aon Hewitt’s analysis assumes no future leakage from withdrawals or cashouts, and that Social Security benefits are not reduced, rendering these scenarios optimistic at best, the announcement said.
The analysis shows that only half of Gen Y workers who are eligible to participate in a defined contribution plan are currently doing so. Among those who save, the average before-tax contribution rate is only 5.3% of pay, with 41% of workers not saving enough to receive the entire employer-provided match.Even if workers begin saving early, Aon Hewitt’s research shows that most cash out their savings well before retirement. Nearly 60% of Gen Y workers cash out their retirement savings when changing jobs, which means they are missing out on the opportunity for decades-worth of tax-deferred growth on their investments.
“Automatically” Getting Them There
According to Aon Hewitt's analysis, automation in defined contribution plans is playing a strong role in helping employees save across all demographics, but especially with younger generations. The participation rate of Generation Y workers who were automatically enrolled was 85% in 2009 compared to just 42% under traditional enrollment.
Gen Y workers are also more likely to use contribution escalation features. For example, nearly a quarter of this demographic elected or were defaulted into contribution escalation when available in their employer's defined contribution plan, compared to just 10% of younger Baby Boomers.
In addition, Aon Hewitt's data shows that Gen Y participants use simplified investment solutions more often and are more likely to use them correctly - primarily because of the growing popularity of premixed portfolios as the default investment under automatic enrollment. More than two-thirds (69%) of Gen Y investors used a premixed portfolio (mainly target-date funds) in 2009, compared to 54% for Gen X investors and 45% of Younger Boomers. Further, nearly 60% of Gen Y workers holding a premixed portfolio used it as a turnkey solution—meaning they invested 100% of their assets in the fund—compared to 40% of Gen X workers.
According to Aon Hewitt's analysis, while Gen Y workers saw losses in their defined contribution plans similar to other generations during the 2008 market crash, their portfolios rebounded well when the markets recovered given better diversification and the embedded rebalancing. Gen Y workers experienced a -28% median rate of return in 2008 and a 29% median rate of return in 2009, compared to -28% and 23%, respectively, for Younger Boomers.
Following its analysis, Aon Hewitt suggests steps employers can take to help employees of all generations address retirement readiness risk, including:
- Adopting and/or enhancing automated tools and defaults;
- Acknowledging differences in learning styles and needs across generations;
- Designing innovative employer matching contributions (see Employer Match Still Powerful Deferral Incentive);
- Offering more robust investment help and advice; and
- Adopting a Roth.