Key Considerations Impact Retirement Readiness Modeling

The lack of key considerations, such as the effect of future contributions to retirement plans, leads some research to paint an inaccurate picture of Gen X’s retirement readiness.

In the latest edition of its Notes publication, the Employee Benefit Research Institute (EBRI) points out that its own studies since 2010 have consistently found the overall retirement income adequacy prospects for Gen Xers are approximately the same as Early Boomers and Late Boomers (see “What Age Groups Are Most Retirement Ready?”). However, a number of other studies and research groups suggest Gen Xers are set to fare much worse than Boomers in terms of projected retirement income adequacy.

EBRI says there are a number of possible explanations for these very different conclusions. For example, different retirement readiness models account differently for expected retirement benefits from Gen Xers’ participation in a defined benefit (DB) plan. There is also significant disparity around how (or if) the models account for the recent changes enacted within many defined contribution (DC) plans to incorporate automatic enrollment features, as well as automatic escalation of contributions. There are also questions around how the various models project future employee and employer contributions to DC plans.

EBRI explains that, in view of all the complexity and uncertainty associated with estimating future DB pension income streams and the positive impact these can have on retirement income adequacy, the treatment of DB accruals is particularly problematic if the model simply assumes that a survey respondent has an informed estimate of his or her future benefit.

In addition, EBRI contends that accounting for plan design changes within the DC industry over the years—from automatic enrollment and deferral escalation to the increased utilization of target-date funds as QDIAs or participant-directed investments—can make a big difference in modeling projections. Prior EBRI research demonstrated the large positive impact auto-enrollment would likely have on employees eligible to participate in 401(k) plans, especially at the lower-income quartiles, as well as how much larger balances in auto-enrollment 401(k) plans would likely be for eligible employees as a result of automatic deferral escalation.

Finally, EBRI says the projection of future worker and employer contributions to DC plans is particularly important, particularly among younger workers who have longer participation windows, and for whom these contributions constitute a significant percentage of their account growth. EBRI’s Retirement Security Projection Model (RSPM) this year found, when considered as a single group, 57.7% of the simulated life-paths for Gen Xers will not run short of money in retirement (see “Retirement Readiness of Older Employees Is Improving”). However, when future contributions to DC plans are completely ignored in RSPM, the number falls to 48.9%. If the future contributions are reduced by 50%, 54.5% will not run short of money in retirement. And, if future contributions are assumed to be 50% higher than current projected levels, the number who will not run short of money in retirement increases to 60.5%.

“Calculating retirement income adequacy is very complex, and it’s important to use reasonable assumptions and current data if you want credible results,” says Jack VanDerhei, EBRI research director and author of the Notes article.

The article, “Contributory ‘Negligence?’ The Impact of Future Contributions to Defined Contribution Plans on Retirement Income Adequacy for Gen Xers,” is here.