Explaining retirement income adequacy

Along with these initiatives, providers and plan sponsors have continued with efforts to build knowledge and encourage interest—along with action—among members. During the careful reviews conducted as pension reform options were being considered, three mantras were frequently repeated: increasing access to group retirement programs; ensuring retirement income adequacy; and improving financial literacy. As simple as these ideas may sound, the concepts are far more involved. Getting to a point where plan sponsors can help members ensure their retirement income adequacy or improve their financial literacy requires sponsors to help members get a clearer sense of what the terms mean, then help them navigate more effectively toward those targets.

Ultimately, members do have to be accountable for achieving these ends, but legislators and the industry have a role to play. While research and surveys show that education isn’t a magic bullet, it is an important piece. The substantial efforts the industry has already made have taught it much about what might work, what won’t work and where it must revisit the assumptions it makes about the needs and knowledge of plan members.

Consider the concept of retirement income adequacy. While it certainly means whether plan members will have sufficient income to fund their expenses throughout retirement, it also reflects members’ ability to understand what they need to do to accumulate enough to serve this purpose. The industry knows members have to start on this path long before they’re actively thinking about retirement. Getting into a group program and starting to save while they still have an opportunity to take action and improve their outcomes is one of the key concepts that the industry and plan sponsors need to reinforce.

To create a clearer picture of outcome—in terms of income rather than savings—providers have introduced resources that show members a reasonable estimate of the income their savings will create. Putting outcome into this context helps members relate better, since the idea of annual income can be more clearly applied than a savings balance. Show is the operative word here. Most members won’t complete calculations to get to an estimate—and many find the exercise intimidating.

Number Crunch
Providers have learned over time that generating the estimate and displaying it in context makes a significant difference. So does personalizing the information. General information is easily ignored, but a tool that reflects the member’s individual circumstances provides clarity.

Knowing this, it makes sense to show other key details the same way. Consider, for example, the significant number of members who forfeit the opportunity to make an annual contribution increase or miss out on matching contributions offered by their employers. When the increase or match is explained as a percentage, the magnitude of what the member is forfeiting isn’t immediately evident. In fact, a member may mistakenly believe it’s possible to make up an amount ranging from 1% to 5% later on without too much difficulty.

If we apply what we’ve learned about showing members their estimates, it makes sense to look for ways to illustrate to members what the amount is likely to become over time. This paints a clearer picture. Forfeiting a 1% increase or match on a $40,000 salary over 20 years represents a loss of $8,000 in missed contributions alone. Factor in nominal growth—or, better still, tailor the calculation to use the member’s investor style and include a conservative growth estimate—and the “loss” clearly becomes substantial. The 1% adds up to nearly $12,000 in this simple scenario ($11,911.23, based on a 4% annual rate of return).

Immediately, the member can “see” how small amounts grow over time and then has the context to see what a difference this makes in terms of working to achieve income adequacy. Tailoring information so it’s useful is important in the effort to boost members’ understanding and build members’ knowledge.

Getting Into the Plan
A related issue is helping members focus on the items that should be their leading concerns: joining the plan and making sufficient levels of contributions. More than any other actions members take, enrolling in their group retirement programs and making a reasonable level of contributions have the most dramatic influence over the likelihood of achieving adequate income in retirement.

It may not be lack of understanding that’s preventing individuals from taking action and getting into the game; instead, it’s likely to be competing priorities (which ties back to the notion of financial literacy). In Benefits Canada’s fifth annual CAP Member Survey, more than half of the respondents said managing their general living expenses kept them from saving more (58% of participating members) or saving at all (50% of non-participating members). A significant number of those surveyed noted they were “just getting by,” and some went on to mention debt as a reason they were pressed to find funds to save.

“Just getting by” was a leading reason cited for not saving more or not saving at all among both participants and non-participants ranging in age from 35 to 54. This leaves these individuals in a precarious position, since they’re sacrificing the critical years they need to provide for long-term growth of their savings. Some are already into the period where they should be actively planning, so these competing pressures will leave them unable to make up ground.

Role of the Plan Sponsor
Legislators and providers aren’t the only groups with an interest in boosting understanding and sparking action. Plan sponsors share that concern. Many have been making valiant efforts to engage their members with campaigns that encourage employees to join the plan, choose suitable funds, increase their contributions and claim a match.

Active plan sponsors are most likely to feel the frustration of lacklustre results. When active programs don’t deliver the desired results, those sponsors will fairly ask their providers to help them find a solution that will spur members to take action. But before taking further action, it may be a good idea to go to the source for help in solving the mystery of what’s at issue.

An example of this recently occurred with one of Manulife Financial’s plan sponsors. The sponsor’s pension committee and benefits professionals have long played an active role in plan management and were keen to participate in the development of education materials for their members. They worked diligently to adapt messages for their members’ demographics, which they knew well and considered at every turn. For all their efforts and all the support provided, however, they were disappointed when members weren’t moved to take action.

Before proceeding with another initiative, they decided to survey plan members for additional insights. The members’ answers delivered an epiphany: although the elements of the education program itself were clear and the resources were simple to use, the members felt their investment selections were too complicated, and they weren’t clear on basic concepts such as the differences between a registered pension plan and an RRSP. For example, members didn’t understand why they couldn’t take funds out of the pension plan when they could make a withdrawal from the RRSP. While the members are educated professionals, they felt overwhelmed and frustrated. The complexity they perceived created a barrier to participation. Knowing this, the plan sponsor has changed gears and is undertaking plan design changes, including the introduction of streamlined options that members can manage.

This example reminds plan sponsors why clarity and simplicity are so important. When choices are too complicated, members won’t select, no matter what resources are available to support their decision-making process. Simplifying the choices—to join, to set a contribution level, to pick a fund—works in the members’ best interests. In some cases, refining the nature of the choice (so the member chooses to opt out rather than join, for example) may prove the better approach. Certainly, taking the time to address fundamental concepts continues to be important.

Since putting a member on a path toward retirement income adequacy depends primarily on getting a member into the plan, plan sponsors have to focus on removing barriers that deter members. In terms of where the member will end up, the effects of investment choice, fund performance and even investment fees are dwarfed in comparison with the effects of not joining and not contributing.

And this is the point where the connection between financial literacy and retirement income adequacy comes more sharply into focus—and where we need to consider our strategies. Whether complexity or competing financial priorities are the obstacles keeping members from joining their group retirement programs, introducing strategies that remove barriers—so plan members start from a better position—needs to become a priority.

While Canadian plan sponsors aren’t yet in a position where they can easily offer automatic enrollment or gradually increase members’ contributions, the industry continues to see evidence of the value these options offer. What sponsors can do is provide appropriate default funds—such as target date options—to put these members into suitable selections, and many plan sponsors have already chosen to pursue this. Automatic options always leave the plan member the decision of making changes or opting out, but research and experience suggest most members don’t move out once they’re placed into a program. In some respects, moving toward automatic options capitalizes on typical human behaviour—and also removes the decisions that cause members anxiety.

Sue Reibel is the senior vice-president and general manager of group retirement solutions at Manulife Financial. sue_reibel@manulife.com