Part of our State of the Participant 2023 series: insight and tools to help participants on their journey to retirement
What income replacement ratios mean and how they’re calculated
To put it simply, an income replacement ratio is a projection of how much of an employee’s salary can be replaced once retired through retirement savings, pensions, and Social Security. As an individual metric, this may not capture the uniqueness of each participant’s preparedness level, but as an aggregate measure, it may be a useful way to see how an employee population is doing given demographics and plan design.
How is an income replacement ratio calculated?1
John Hancock includes the following factors in our income replacement calculations:
- Participant’s current age
- Retirement age of 67
- Account balance
- Combined employer and employee contributions
- Pension projection, if supplied by the employer
- Social Security projection
Once this calculation is run, an income replacement ratio of at least 70% is considered retirement ready.
Why plan sponsors and their financial professionals should consider keying in on retirement readiness
With a glance, an income replacement ratio can help you assess how much progress individuals, groups, or an entire participant population is making toward generating adequate retirement income. This, in turn, can help show if changes to the plan design or participant experience may be worth pursuing.
- A workforce with replacement ratios below 70% across many ages and incomes may indicate the need for a higher match percentage or the introduction of an auto-increase feature if the plan permits
- Ratios that dip sharply after age 50 could signal the need for enhanced retirement income planning opportunities and more support for participants who might benefit from account consolidation2
- Depending on how the numbers skew, significant differences between lower and higher earners could lead to consideration of a safe harbor design or a supplemental plan for professional and higher-level employees
- Low scores among young participants could be reason to reconsider the way contribution percentages show up in the enrollment process, the default contribution level of a plan with auto-enroll, or if plan communications are underselling the need to save enough
Study reveals declining retirement readiness
To illustrate recent trends in income replacement ratios and retirement readiness, we took two data snapshots of the DC plan participants on our open-architecture recordkeeping system on June 30, 2022, and June 30, 2023.
The retirement readiness figures below represent participants with income replacement ratios of 70% or higher.
Every age group experienced declining retirement readiness
Looking at age groups with this metric, the total percentage of retirement-ready participants slipped several percentage points during the 12 months but remained at more than 50%. Every age group was included in this downward trend, with the biggest movement (nearly 10%) among those under 30.
Percent of retirement-ready participants by age
Since income replacement ratios are driven by account balances and contribution amounts, several factors may contribute to a drop in retirement readiness-percentages. These could include:
- Typical participant behaviors, such as plan loans, hardship and in-service withdrawals, and decreases in contribution amounts.
- A large percentage of new enrollees of various ages, many of whose account balances may not have grown large enough to qualify them for a 70% income replacement ratio.
- Participants exchanging growth investments for more conservative choices. Some may have missed out on at least part of the market recovery that began in the fourth quarter of 2022 and that gained momentum in March 2023.
- A challenging market for bondholders linked to rising interest rates.
While over 60% of those below age 50 are retirement ready based on income replacement ratio, this percentage drops to under 40% at older ages. Some older participants aren’t where they should be with retirement saving, but there are a few factors to keep in mind here.
One of these factors is that an older worker’s current DC plan account may just be part of the total retirement assets he or she has accumulated. Another factor is that decades of future contributions and investment returns are assumed in calculating the retirement readiness of younger workers. Those in mid and late career just don’t have as much time available for their savings to grow.
Pacesetter segments: age groups with the highest percentage of participants with income replacement ratios of 90% or higher
Lagging segments: age groups with the highest percentage of participants with income replacement ratios below 60%
Through a different lens, some retirement readiness increased
Unlike with the age groups, when we look at retirement readiness by income range, we observe slight growth in some segments. Participants whose retirement readiness actually improved during the past year include those earning under $25,000, $25,000–$49,999, $75,000–$99,999, and $250,000 or more.
Percentage of retirement-ready participants by income (%)
Just as with the oldest participants, those earning more than $200,000 face unique obstacles in achieving retirement readiness based primarily on their current DC plan savings. The most notable of these obstacles: the limits the IRS places on pretax and Roth account contributions.
Pacesetter segments: Income groups with the highest percentage of participants with income replacement ratios of 90% or higher
Lagging segments: Income groups with the highest percentage of participants with income replacement ratios below 60%
Using income replacement ratios to help shape better outcomes
In our opinion, combining insightful plan data, strategic design, and effective communication/education can help keep your participants on track toward their retirement goals. Consider these resources to help make a difference.
Tools for measurement
- Create and analyze snapshots of income replacement ratios and retirement readiness based on age, income, or other relevant plan groupings at desired intervals
- Outline detail on what’s causing shortfalls—whether it’s account balances, contributions, leakage, investment strategy, or an aspect of plan design
Tools for improvement
- Establish target plan readiness scores and assess regularly to see if communication and marketing efforts are moving the needle
- Implement automatic contribution increases as either a standard or a voluntary opt-in feature
- Raise your default contribution rate—and consider auto sweeps to increase contributions among current participants
- Consider increasing the 3% default contribution rate if adding auto-enrollment to your plan for the first time
- Provide guidance on deferral rates as part of the enrollment process
- Adjust your employer match and discretionary contribution formulas and practices with improved retirement readiness in mind
- Expand communication and education to include information on measuring and improving retirement readiness
- Make it easy for employees to consolidate assets from old retirement accounts2
Add income replacement ratios to your retirement readiness toolbox
To make your retirement program as useful and valuable as possible, you need to optimize its ability to help employees achieve comfortable retirements. And you can likely do this by maintaining a clear picture of where participants stand—and where they’re headed.
Income replacement ratios and other types of indicative and prescriptive data may form the foundation of a successful DC plan. Together, plan sponsors, consultants, financial professionals, and providers can set up reliable systems for making this intelligence available and putting it to work promptly. So, take advantage of it.
Because with better data, better outcomes are possible—for your participants and your plan.
1 Retirement readiness pension projections are based on defined contribution, defined benefit , and employee stock option plans in our John Hancock open-architecture plans. 2 As other options are available, such as leaving it in an old plan, rolling over to an IRA, or cashing out, participants are encouraged to review all of their options to determine if combining their retirement accounts is suitable for them.
All data is from our open-architecture platform. 2022 data reflects John Hancock Retirement Plan Services LLC’s 1,756 plans, 1,440,374 participants, and $95,176,036,431 in assets under management and administration (AUMA) as of June 30, 2022. 2023 data reflects John Hancock Retirement Plan Services LLC’s 1,966 plans, 1,511,835,participants, and $100,319,359,778.24 in AUMA as of June 30, 2023.
The projected balances at reirement age and iincome replacement ratios wihin the dashboard are hypotheticaland for illustrative purposes only. Result ar not guaranteed and do not represent tye current or future performance ofan specific account or investment. Due to market fluctuations and other factors, it is possible that investment objectives may not be met. Investing involves risks, and past performance does not guarantee future results..
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.
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