Employees must be better educated about their retirement needs, as those who do not contribute to their 401(k)s can expect to replace as little as 52% of their annual pre-retirement income when they retire, an amount that is well below the average retiree's income needs. That is according to a recent study by Hewitt Associates of Lincolnshire, Ill., entitled, "Total Retirement Income at Large Companies: The Real Deal."

This is quite troubling, especially since most employees who do not contribute to their 401(k) plan will need to replace as much as 125% of their pre-retirement pay to be able to live comfortably upon retirement. Thus, for these employees, their retirement income might fall short by 73 percentage points. The study also established that nearly a third (30%) of 1.8 million employees at 65 large employers who took the survey do not contribute to their plan.

On the other hand, those who do contribute can look forward to replacing almost all (98%) of their annual pre-retirement income, through a combination of 401(k), pension and Social Security income.

"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," said Lori Lucas, director of Hewitt's participant research.

Retirement plan contributors should increase their contributions because not all 401(k) plans offered by employers have the added support of a pension plan or retiree medical subsidy. Even if they are making steady contributions to their 401(k), if the plan doesn't offer a pension plan or retiree medical subsidy, they would face a retirement income shortfall of nearly 27 percentage points, the study found.

"Pension cost volatility and soaring healthcare costs are putting more companies in a situation where they can only afford to offer 401(k) plans as their retirement vehicle, yet many of their workers are not responding by stepping up their savings in these plans," said Allen Steinberg, a retirement and financial management consultant with Hewitt.

To compensate for this, those employees who contribute to their plans but lack added support of a pension plan or retiree medical subsidy, can avoid a retirement income shortfall by retiring at the age of 67 instead of the age of 65, and contributing 10% per year, instead of the standard 8%, Hewitt said.

The study also found that medical costs are raising income needs, meaning the standard of living in retirement will need sufficient income to be able to fully cover inflation and medical costs upon retirement.

"The typical employee pays 25% of his or her personal healthcare costs, such as premiums, while the typical retiree pays 50% to 100%. For low-wage workers without subsidized retiree medical coverage, medical costs can increase the income required for retirement by a substantial amount," Lucas said. "We think it's critical to raise awareness among employees about the escalating need to save. Companies can help by offering features in their 401(k) plans that encourage employees to save more - for example, offering an option to automatically increase contribution levels over time."

The study found that most employees cannot afford to retire early, unless of course they increased their savings throughout the years or have some sort of additional resources.

Early retirement is out of reach for most people, the study found. Employees who contribute to their 401(k) but who want to retire before the age of 65 may have a shortfall in needed income of 33 percentage points, and for those who don't contribute, the shortfall shoots up to 88 percentage points.

When early retirement is considered, even those who have raised their contributions by two percentage points, will not have sufficient retirement income, and this applies to a significant number of employees, Hewitt added. And when a retiree's medical costs are factored in, early retirement is something impossible for many plan participants regardless of increased savings.

However, a two-year delay in retirement can raise retirement income levels by about 14 percentage points. In addition, the study found that improving investment diversification, avoiding high fees, preserving 401(k) savings in job transitions and saving early and often can also be of great help when saving for retirement.

"The best way for employees to insure themselves against lower-than-anticipated returns is to remain in their plans, increase their contributions and take steps to avoid investment mistakes," according to the report.

Because disappointing investment returns can really devastate one's retirement income, Hewitt recommends investors assume a 7% annual return, rather than the 10% annual return that so many investment firms and retirement calculators go by.

The study concluded that despite the highly publicized troubles at Enron and WorldCom, many employees continue to invest in company stock. The average 25-year-old has approximately 43% invested in company stock, while the average 40-year-old has 40% invested and the average 55-year-old 39% invested.

Hewitt stresses that portfolio diversification is critical for assuming more appropriate risk levels.

Employees with only defined contribution plans have a much smaller estimated retirement income than those who have or who are also augmented by a defined benefit plan, and since more and more employers are switching to DC plans, it is becoming crucial for workers to improve both savings and investing habits.

(c) 2005 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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