Highly compensated employees often face retirement without sufficient income to maintain their pre-retirement lifestyle. Qualified plan contribution and benefit caps, coupled with current limits on Social Security benefits, mean that a highly compensated employee usually cannot reach the necessary retirement income targets with qualified plans alone. In fact, the higher the individual’s compensation level, the more severe the retirement income gap can be.
Income Needed For Retirement
A big question facing pre-retirees is how much income will be needed in retirement to preserve their family’s pre-retirement standard of living and allow for their desired retirement lifestyle.
When a person retires, spending patterns often change. Some of these changes occur gradually as people age. For example:
? Health care expenditures tend to increase at all income levels.
? Educational expenditures tend to decrease at all income levels.
? Household utilities tend to decrease at lower income levels and increase at higher income levels.
? Household operating costs tend to increase at all income levels.
? Mortgage, rent and repair expenditures tend to decrease at all income levels.
? Entertainment and leisure expenditures tend to increase at lower income levels and decrease at higher income levels.
Expenditures directly related to employment can change abruptly upon retirement. For example:
? Food expenditures tend to decrease upon retirement for lower income levels and increase for higher income levels.
? Apparel expenditures tend to decrease upon retirement at all income levels.
Income Replacement Ratios
An income replacement ratio is the percentage of pre-retirement income an individual needs in retirement to maintain a desired standard of living. By using these ratios as a benchmark, plan sponsors can measure the sufficiency of their own programs when combined with Social Security benefits and personal savings.
A comprehensive retirement income replacement ratio study should include the projected effects of:
? Federal, state and local tax rates.
? Various levels of taxation on Social Security benefits.
? Offsets in Social Security benefits by post-retirement earned income.
? Factors that cause changes in spending patterns post retirement.
The 2008 Georgia State University-Aon study2 suggests the following replacement ratios:
Qualified Plan Limitations