Retirement Income Replacement Ratios

[JButtrick]

When doing plan design, attention may be given to the ratio of retirement benefit to pre retirement income. I believe that historically a good target was considered to be between 60% and 75% of pre-retirement income.

A question has come up as to whether in these days of 401(k) plans, those percentages are typically discussed with respect to employer funded benefits only OR taking into account all known sources of retirement income.

For example if an employer has a 401(k) profit sharing plan, do people typically talk about:

1) Only the benefit provided by the profit sharing balance

OR

2) The benefit provided by the profit sharing balance and 1/2 of the Social Security benefit, because the employee is funding the 401(k) and the half of the SS tax.

OR

3) Profit sharing and 100% of Social Security.

OR

4) Profit sharing and 100% of Social Security and 401(k).

I would assume that in (1) the target ratio would be lower than in (4). I can imagine a more complex communicnation where we might say:

Target Income - 75%, provided by:

- Profit Sharing - 25%

- Employer Funded Social Security - 12.5

- Employee Funded Social Security - 12.5%

- Your own Savings - 25%

How is the rest of the benefits world taking about this issue with employers?

[Effen]

There is lots of good stuff written about replacement ratios if you do a few internet searches. I believe the SOA has a few studies available on their web site and you might want to check the web sites of some of the big boys (Buck, Wyatt, Towers, etc.) There are also lots or articles written in the financial trades.

There was a session at last year's EA meeting that might be helpful if you can get the handouts or tape of the session. It wasn't the best, but it might help you in your thinking.

Basically, the necessary replacement ratio changes based on the person’s income. Lower paid employees will require a higher replacement ratio than higher paid. Also, you need to consider the impact of inflation over time. A 100% replacement at 65 might only be worth 70% at 80.

[tuni88]

Aon Consulting provided us with a really great piece on replacement ratios.