What is the Ideal Deferral Rate a 401k Fiduciary Should Ask Employees to Work Towards?
(Part three of a four part series.)
If they’re going to be arbitrary, (and they don’t necessarily have to be – that’s the point of using FiduciaryNews.com’s Retirement Readiness Calculator, but more on that at a later date), is there any arbitrary deferral rate number out there that’s better than the rest? The short answer is “yes,” but with qualifications.
Offering a broad range, Gregory S. Ostrowski, Managing Partner of Scarborough Capital Management in Annapolis, Maryland says, “In order to maintain a similar lifestyle from working life to retirement life, 15-20% retirement savings is statistically what they will need to save during their working career.”
There is a “textbook” answer, and it’s based on a number of fairly common assumptions. Jonathan Leidy, Principal at Portico Wealth Advisors in Larkspur, California explains this when he says, “The generally accepted replacement ratio in retirement is 80% [of your salary]. If one assumes a 20% savings rate and both a constant salary and rate of return, e.g. 5%, an annual draw equal to an 80% replacement ratio should last about 35 years, which is at the longer end of most people’s expected retirement window.”
Jennifer Guillot, Marketing Director for Horizon Wealth Management in Baton Rouge, Louisiana believes setting as a goal a 20% deferral rate “is a good idea because it slowly, over time, creates a great habit of not spending all of what you earn.” She says, “It helps create a balance between enjoying the here and now and yet saving for the future. You can’t forsake your future income need (a time when you may not want to or be able to earn income) merely to live it up in the here and now. Likewise, you can’t forsake enjoying the here and now to save for a future income that you may never live to need. It’s a delicate balance…You never know when the last grain of sand is falling through your hourglass, yet you must prepare as though you’ll live a normal lifespan.” She likens this to the fable of the ant and the grasshopper: “Prepare for the days of necessity. While you can still earn income, save little by little for the point in time when you’ll no longer want to (or have the capacity to) earn income yet still have the need to pay bills to live your lifestyle.”
Clearly, it’s highly unlikely any employee will survive the sticker shock of going from saving nothing to saving 20% of their salary. Still, there are practical strategies to build up to this goal over time. Darryl J. Poisson, founder and president of DJP Wealth Management in Tampa, Florida says, “Participants that slowly increase deferrals over time (often on an annual basis) tend to create positive reinforcing habits. Psychologically, the impact of small, yet increasing, deferrals feels negligible. In addition, the participant benefits from positive reinforcement and a more rapidly self-funding retirement.”
Sean Ciemiewicz, Principal of Retirement Benefits Group in San Diego, California offers a well-defined process toward building up one’s deferral rate. His firm doesn’t pick an arbitrary target but determines the exact deferral rate needed by each investor. He says his firm “recommends deferral rates of anywhere between 12% to 15%, if the employee is able.” He finds “this allows employees to have a balanced life with regards to the amount of pay they are able to take home while still saving for a comfortable retirement.” In order to reach 12% and hopefully 15%, Ciemiewicz recommends “investors slowly increase their contributions overtime. I tell employees all the time, every three to six months, increase your contribution by 1%. If they follow through there will be very little impact on their take home pay and they’ll be able to adjust to the difference quite quickly. Furthermore, they’ll often reach 15% within a year. People are hesitant to immediately start at 15%, but once you walk them through how to simply increase their contributions over time, it becomes a lot less burdensome.”
As we can see from the above, trying to target a 20% deferral rate may be harder than meets the eye. Kevin Hall, President of BenePAY Florida, located in Clearwater, Florida, alludes to this when he says, “A deferral of 20% for later would be great if all could afford to have that amount deducted and still pay the mortgage today.”
“I’d love to see a 20% deferral rate, but in many cases it’s not possible,” says Sean Moore, Vice President of Alter Retirement Planning in Boca Raton, Florida. “Younger employees many be paying off student loans or be struggling to make ends meet and saving 20% might stretch the budget too thin. For established employees, 20% may not be allowed due to the maximum contribution limits (Anyone over $87,500 (or $115k if over 50 years old) will not be able to defer a full 20% due to the $17,500 (or $23,000 with catch-up) limits.”
Although its ultimately up to the plan participant to choose their own deferral rate, the plan sponsor is not left without any cards up his sleeves. Plan designs and policies can be constructed in such a way as to encourage participants to save more. What are some of these ways? They are revealed in the final installment of this series, “10 Incredibly Easy Things a 401k Fiduciary Can Do to Increase Deferral Rates.”
Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada. His forthcoming book Hey! What’s My Number features his usual whimsical dialogue in a face-to-face talk with a plan participant mixed with the combined wisdom of the financial professionals he’s interviewed over the years. Be sure to subscribe to FiduciaryNews.com so you can be to the first to hear when this book is available to the public.