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Maimizing Income Replacement In Retirement Takes Planning

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Many boomers worry about the adequacy of their retirement income, particularly in light of the concerns heard about climbing medical costs.

Coupled to that concern is that many boomers have witnessed the drastic erosion of traditional pension plans and may have got a relatively late start in putting aside retirement funds in defined-contribution plans such as 401(k)s.

A recent study by Hewitt Associates Inc., Lincolnshire, Ill., gives some context to these concerns. The study, “Total Retirement Income At Large Companies: The Real Deal,” looked at data on employees of 67 large firms and calculated how much of an employee’s final annual income would be replaced when he/she retires.

The study found, reassuringly, that employer-sponsored retirement plans, including 401(k) and pension plans, can, when combined with Social Security payouts, replace most if not all of their working income. But that is more likely to be true of younger employees than for boomers.

Because younger workers have more years to contribute to their plans, they had significantly higher income-replacement ratios. For instance, the average employee aged 35 to 39 would, at a 6% contribution rate with 2% employer match, replace on average about 106% of his/her income upon retirement.

In contrast, among 130,000 workers in the older part of the baby boom generation–55 to 59–the average employee participating in a 401(k) plan could expect to replace just under 80% of final annual income, Hewitt found. For those aged 60 and over, projected retirement income replacement was about 70%.

[Those figures do not include retirement savings that individuals may have left behind when they switched employers.]

The obvious lesson of the study is that boomers need to save more if they are to enjoy a quality of life in retirement close to what they enjoy while working.

Increasing one’s retirement plan contribution by only 2% annually could bring the typical 55- to 59-year-old to within 82% of the desired income level, Hewitt calculated. (For those aged 60+, the difference was insignificant.)

Waiting an extra two years until retirement also had an important impact on income-replacement prospects, the study showed. For those 55 to 59 who plan to retire at age 67, those extra two years would bring their income-replacement total to almost 93% of their final annual working income, while for those in the 60+ group, retirement income could replace better than 80% of their working income.

Hewitt pointed out, however, that employees who anticipate working beyond age 65 may fall short of that goal.

“Illness or disability may make that impossible,” the consulting firm noted. “And even healthy workers may have their plans disrupted by layoffs, particularly if they find it difficult to find comparable-paying new positions.”

Waiting an extra two years until retirement can have an important impact on income-replacement prospects


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