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Avoiding 401(k) Contributions Is Risky Business

Employees’ retirement income could fall short of their projected needs by as much as 73 percentage points.
Stephen Taub, CFO.com | US
November 29, 2005

Future retiree, beware. If you don't contribute to your 401(k) plan, you probably won't have enough money to maintain your current lifestyle.

That's one of the findings in a new study released by Hewitt Associates. According to the research, employees who do not contribute to their 401(k) plan can expect to replace as little as 52 percent of their annual preretirement income when they retire.

Officials at the global human-resources services firm assert that this finding is particularly troubling given that the majority of employees who don't contribute to their 401(k) plan may need to replace as much as 125 percent of their preretirement pay to meet their income and medical needs when they retire. In other words, employees' retirement income could fall short of their projected needs by as much as 73 percentage points, the study warns.

Shockingly, Hewitt said 30 percent of employees who participated in the study said they do not contribute to their 401(k) plan. This revelation comes at a time when only a minority of companies offer the old-fashioned defined-benefit pension plans — and increasingly, those plans are being terminated by their corporate sponsors. "People's retirement income levels are very quickly eroded if they aren't actively saving for retirement — and that's true even if workers have access to income from pension plans and are covered by rich retiree medical plans," says Lori Lucas, director of Hewitt's participant research.

Hewitt said its study evaluated more than 65 large U.S. employers and 1.8 million employees.

In general, Hewitt principals say that employees who do contribute to their company's 401(k) plan can usually replace nearly all — 98 percent — of their annual preretirement income through a combination of 401(k), pension, and Social Security income. Nevertheless, those contributing employees are never guaranteed financial peace of mind when they retire. To be sure, workers whose company offers a 401(k), but not a pension plan or retiree medical subsidy, could face a retirement income shortfall of nearly 27 percentage points.

There is a way to make up for most of the shortfall, however. According to Hewitt, employees who contribute to their 401(k), but don't have a pension plan or retiree medical subsidy, can reduce their retirement income shortfall to less than 5 percentage points by retiring two years later than the standard age 65 and contributing 2 percent more per year to their 401(k) than the average 8 percent of pay.

On the other hand, employees who currently contribute to their 401(k) plan but choose to retire early can see an income shortfall of as much as 31 percentage points relative to what such employees may need in retirement. For employees who fail to contribute, early retirement can produce a shortfall as high as 88 percentage points.




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