Does Half a Percent Really Make a Difference?

By October 4, 2018

By: Tony Black RPA, AIF®

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One half of one percent – it doesn’t seem like a lot, but over time 0.50% can make a significant impact on an employee’s retirement savings. Enough of a difference that retirement plan sponsors should be diligently and thoughtfully managing their plan expenses while offering well-researched investment options.

Many of the decisions an employee makes regarding their retirement plan will determine how successful they will be saving for retirement. The amount they save each year, their willingness to invest at a risk level appropriate for their age and their monitoring of accounts on an ongoing basis are all factors that determine when they will be retirement ready.

On the other hand, there are plan sponsor decisions that employees have no control over that can also impact how much money employees have at retirement. For example:

  • Which retirement plan vendor to hire
  • Which retirement plan advisor to hire
  • Which investments are offered in the plan and how much they cost
  • How the plan expenses are paid (Employee vs. Employer)
  • How investment revenue sharing is used
  • How plan design, such as “auto” features, are being utilized

So how much is a half- percent worth? For younger employees, lower cost and improved investment performance compounds each year and can deliver an incredible amount of additional wealth for their retirement. For employees who are closer to retirement, every penny becomes more precious.

Let’s look at how these plan sponsor decisions can potentially impact the financial future of an employee. Chart 1 is an example of a 25-year-old employee that makes $40,000, whose salary increases by 3% each year, and saves 6% of their pay per paycheck. The chart below shows the results of an average annual return of 7%, 7.5% and 8%, and the difference that makes on this employees’ balance at age 65.

 

Chart 1
Balance at age 65 assuming $40,000 starting salary, 3% inflation, 6% savings rate all years.
Return assumptions are Net after plan and investment expenses.

Age Begin Saving for Retirement 7% Return 7.5% Return 8% Return
Age 25, 6% Savings Rate $702,745 $788,384 $886,199
Difference from 7% Return N/A $85,639 $183,454

Source:  http://www.calcxml.com/calculators/are-my-current-retirement-savings-sufficient?skn=73

 

A 0.50% annual improvement in net investment performance would deliver over $85,000 more in retirement savings for this 25-year-old.  If net performance could be improved by 1% annualized, this employee would have more than $183,000 in additional savings for retirement.

Plan design and employee education also have a significant impact on the amount employees have accumulated at retirement age.  With sound plan design strategies and ongoing annual education, a plan could potentially increase its employee savings rate by 2% on average. The chart below highlights the effect a 2% increase in savings rate may have on this employee’s balance at age 65.

 

Chart 2

Balance at age 65 assuming $40,000 starting salary, 3% inflation, 8% savings rate all years.
Return assumptions are Net after plan and investment expenses.

Age Begin Saving for Retirement 7% Return 7.5% Return 8% Return
Age 25, 8% Savings Rate $936,994 $1,051,179 $1,181,599
Difference from 7% Return with 6% Savings Rate (Chart 1) $234,249 $348,434 $478,854

Source:  http://www.calcxml.com/calculators/are-my-current-retirement-savings-sufficient?skn=73

 

Taking the same return, while increasing the savings rate from 6% to 8% annually, delivers over $234,000 of additional savings for this employee making a 7% annual return. Additionally, a combination of improved performance net of fees, and an increase in savings rate can have an enormous impact on the retirement balance for a 25-year-old. In this example, improving performance net of fees by 0.50% and increasing deferrals from 6% to 8%, provides almost $350,000 of additional savings at retirement. A 1% improvement in performance with an increased savings rate provides almost $500,000 more at retirement.

TIPS:  So how should a plan sponsor use this to review potential improvements in their retirement plan?

Here are some helpful tips:

  • Evaluate the fees paid to your retirement plan vendors and advisor. You may be able to shave 0.25% – 0.50% off their fees, improving the net performance for your employees.
  • Have a sound investment due diligence process in place to ensure your plan is utilizing a cost-effective and well-performing mix of investments.
  • Use the services of an advisor to have annual group and one on one education meetings to assist employees in making good savings and investment decisions for their future.
  • Implement a financial wellness program for employees to empower them to become comfortable with their current and future financial decisions.

 

Questions? Please reach out to your Pensionmark advisor or (888)201-5488 or info@pensionmark.com.