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Why Are Employer-Sponsored Retirement Plans So Important?

My daughter graduated from college a couple weeks ago, and I couldn’t be more proud. It’s exciting to watch her interview for jobs and contemplate next steps in her future. I’ve done my fatherly duty and helped educate her on the importance of contributing to her future employer’s retirement savings plan as soon as she lands her dream job.

All this talk of my daughter’s retirement planning got me thinking about how critically important a retirement plan is to so many employees – potential and current. Which leads me to ask…what is the real objective of an employer retirement savings plan? Seems like a fairly obvious question, but one that isn’t always asked. For those that actually think about the answer, the answer should likely be to provide a vehicle for employee to accumulate enough savings to be able to maintain a reasonable standard of living in retirement. To achieve that savings level, people may need to save at least 10 percent of their pay plus employer contributions over their entire working careers.* Each individual’s situation is unique, though, so your savings and post-retirement needs may differ.

We’re seeing some results, and they are pretty positive.

According to the 2014 403(b) Plan Survey  sponsored by the Plan Sponsor Council of America (PSCA Survey), plans that have both employer and employee contributions are seeing an average of 10.7% of payroll contributed annually toward retirement savings. This breaks down to a 4.9% employer contribution and an average employee deferral of 5.8%. 

It is even more interesting if we look at different types of employer contributions. 

Employers that provide plan contributions whether or not the employee contributes, add an average of 6.5% employer contribution, and see an average employee deferral of 5.4%. That’s a total of 11.0% annually on average going to retirement savings. 

Interestingly enough, however, some 403(b) plans are structured to provide part of the employer contribution as a match of employee contributions and part as an employer contribution whether or not the employee contributes. In these cases, on average the employer contributes an average of 5.2% of payroll annually, and sees an average employee deferral of 5.9% for a total of 11.1%. In other words, as good to slightly better overall results, better employee engagement in saving for their own retirement, and significantly less expensive from the employer’s perspective. 

Those plans with matching contributions only see a 6.0% average deferral from employees and only an average cost to the employer of 3.9% of annual payroll.  The overall result comes in at a distant third with a total of 9.9% average annual savings rate.

It is clear, though, that plan design plays a huge role in the engagement level of employees and the ability to maximize the percentage of annual income that goes toward retirement savings. Whether it’s a 10.7% overall average, or 11/11.1% total average annual savings rate, these are great indications that we’re seeing plans starting to get up to levels needed for more adequate retirement savings. There is still room for improvement, but it’s a great snapshot.

And, I hope my daughter heeds her father’s smart advice to take advantage of an employer-provided retirement savings plan and save as much as she can as early as she can. Once she lands that dream job, of course.

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In addition to blogging here, I also tweet regularly about topics of interest to Tax Exempt plans. Follow me on Twitter: @1aaronfriedman1.

 * Based on analysis conducted by the Principal Financial Group®, August 2013. The estimate assumes a 40-year span of accumulating savings and the following facts: retirement at age 65; a combined individual and plan sponsor contribution of 12 percent; Social Security providing 40 percent replacement of income; 7 percent annual rate of return; 2.5 percent annual inflation; and 3.5 percent annual wage growth over 40 years in the workforce. This estimate is based on a goal of replacing about 85 percent of salary. The assumed rate of return for the analysis is hypothetical and does not guarantee any future returns nor represent the return of any particular investment. Contributions do not take into account the impact of taxes on pre-tax distributions. Individual results will vary. Participants should regularly review their savings progress and post-retirement needs.    

Affiliation Disclosures

While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that none of the member companies of The Principal are rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

Insurance products and plan administrative services are provided by Principal Life Insurance Company, a member of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.

© 2014 Principal Financial Services, Inc.

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