Participant-directed retirement plans put onus on the employee to make important decisions regarding their financial future. The obvious (and most important step) an employee can take when it comes to his or her retirement plan is to participate in the plan. But what is the next important step?
Choose from the multiple choice below:
A. Asset Allocation and Diversification. While this is a critical determiner in the return a participant will earn, it is not the most important step he or she can take.
B. Pick the fund(s) with the best returns from last year. This is probably the least recommended way to choose an investment, although it is commonly employed by many participants.
C. Setting an appropriate deferral savings rate. Yes!!! Correct Answer. Reality is, if the participant’s deferral rate isn’t set at the appropriate level, the investment selection (e.g., asset allocation and diversification) plays a minimal role in reaching retirement readiness.
Until recently, the service provider community had yet to uncover a simple way of helping participants determine how much they should be saving to reach a sufficient post-retirement income. Nowadays you may have already heard about an approach called “Gap Analysis.” This technique uses a participant’s current deferral rate, account balance and salary, together with estimated Social Security payments and sponsor matching contributions, to determine whether the participant’s income at retirement will be sufficient to meet a user specified replacement percentage (typically 80%-90%; source: ebri.org). If a gap exists, the Gap Analysis proposes a deferral percentage that will close or eliminate the gap. It also demonstrates the impact of working longer and making do with a lower replacement income assumption.
We all know that we can be saving a bit more for a worthy cause: our future financial security. Gap Analysis provides a bias for action among participants to help themselves become financially secure at retirement. To learn more about Gap Analysis, check with your consultant at First Western Trust.