Replacement ratio part retirement calculations?

Surveys tell us that the top regrets of retirees are failing to start saving earlier and failing to save a higher percentage of earnings (see a recent survey by ConsumerAffairs, a consumer news and customer review site, at tinyurl.com/yckkfcdt).

There is a way to encourage people to save earlier and save more through 401(k) plans at work, and it's by understanding the “replacement ratio.” A replacement ratio is the percentage of income that someone would need to generate in retirement to maintain a pre-retirement lifestyle. Any number under 100% would mean that savings are insufficient — again, if the goal is to maintain pre-retirement spending levels.

Studies show, however, that retirees do reduce spending. For that reason, the most commonly suggested replacement ratios fall between 70% and 85% of pre-retirement income (U.S. Government Accountability Office — tinyurl.com/yhwnwwut).

It always helps to get some perspective from real-life situations, and Vanguard, an investment management firm, provides some insights. After analyzing 1.5 million actively contributing participants in roughly 880 defined contribution (including 401(k)) plans at Vanguard, this is what they found.

Seven in 10 participants were saving with a 65% replacement ratio (which included both employees' elective contributions and employer contributions).

That means that they were on course to cover 65% of their retirement expenses, assuming they wanted to continue their pre-retirement lifestyles.

If you wanted to downsize, you could. That is, you could plan on reducing your pre-retirement spending by 35% after you retire. But what if you did not want to downsize to a 65% replacement rate?

Vanguard's study (tinyurl.com/475ecv57) showed that with only an increase of 1 to 3 percentage points in the elective deferral rates of the participants, 7 out of 10 participants could reach a higher replacement rate of 75% when they retired.

In fact, that increase could be automated for some plan participants. According to Vanguard, 4 in 10 defined contribution participants were enrolled in automatic annual savings rate escalation, meaning that in the next few years, their saving rate would increase by 1 to 3 percentage points. When factoring in the automatic escalation for the goal of a 75% replacement ratio, an additional 20% of participants would reach their target saving rate.

Overall, Vanguard's research reemphasizes a key point: The more you can save now, the better your retirement future can be. As Vanguard notes in the study, “Saving rates are fundamental to retirement wealth accumulation and are the most important factor to consider when assessing how workers are preparing for retirement.”

To encourage people to think about the future when making savings decisions, let me share a personal commitment I make in my role as financial literacy advocate.

First, some background. I'm writing this column on Sept. 9, National 401(k) day. The purpose of 401(k) Day is to help American workers better understand their retirement plan and retirement readiness.

Second, a few years ago, I created and funded a national competition to encourage 401(k) education on a grassroots, peer-to-peer level. Called the 401(k) Champion® competition, 401(k) participants compete for the title of 401(k) Champion through an essay contest judged by experts in the field.

The purpose of the competition is to identify people who have figured out how to not only maximize their 401(k) benefits for themselves, but also to inspire others to do so as well.

A 2021 401(k) Champion, Robert Brokamp, senior adviser, author and podcaster at The Motley Fool, attested to the award's impact: “I love the spirit of the 401(k) Champion Award. It acknowledges that everyday employees can be motivators and educators, improving retirement security for themselves and their coworkers.”

I invite you to learn more about the competition (go to 401kchampion.com) and to tell everyone you know to compete for the title. The deadline for applying is Oct. 20.

Seasoned Investment Counsel and award-winning columnist and author, Julie Jason, JD, LLM, promotes financial literacy and investor protection. Read her latest book, “The Discerning Investor: Personal Portfolio Management in Retirement for Lawyers (and Their Clients),” published by the American Bar Association. Write to Julie at readers@juliejason.com. While all questions cannot be answered, each email is read and reviewed and can lead to discussion in a future column.