Being able to replace working income with income generated from retirement savings is the essential definition of retirement readiness. The percentage of working income that an individual may need in retirement will vary, depending on a number of factors, such as whether or not they will still have a mortgage, the amount of their Social Security benefit, their tax bracket, variable healthcare costs, lifestyle choices and having income from part-time work, among others.
When projecting retirement income needs, a 70%-85% target replacement ratio is commonly cited. Recent research by Vanguard reveals that that goal may be well within reach for many plan participants. The 2022 Vanguard Participant Saving Rate Index suggests that 7 in 10 DC plan participants are currently saving at rates that would enable them to attain a 65% replacement rate in retirement. Furthermore, their data show that just a modest increase in participant elective deferral rates would enable most plan participants to attain a 75% replacement rate.
Vanguard’s researchers analyzed approximately 1.9 million eligible employees and 1.5 million actively contributing participants in approximate 880 plans for which the firm serves as recordkeeper. Research modeling assumes that target saving rates are 9% where income is less than $50,000, 12% where income is between $50,000 and $100,000, and 15% where income is more than $100,000 (saving rates include both the employee elective contributions and any employer contributions). It also assumes a 75% target replacement ratio, 4% real return, 1% real wage growth, 40 years of saving (from age 27 to 67), and a 4% withdrawal rate at retirement.
The Impact of Automatic Features
The researchers note that while some participants may not be saving at or above their target rate, many are close. Auto-enrollment coupled with auto-escalation will be instrumental in helping many of the participants get the rest of the way. Currently, 4 in 10 of the participants in the study are automatically enrolled and will see their saving rates rise by 1 - 3 percentage points over the next few years. At this rate, the study’s modeling shows that 70% of participants would reach a 75% replacement rate in retirement.
Across all eligible participants in plans with automatic enrollment, employees are much more likely to be saving effectively (45% compared with 26% in plans without automatic enrollment). As of year-end 2021, 58% of plans default at a rate of 4% or higher, compared with just 32% ten years ago. An automatic enrollment default of 6% or higher was a strong predictor of participants saving effectively, along with a generous employer match. Plan size did not affect the results of the study.