Reinventing Retirement Income in America

Studies | Retirement

No. 248
Monday, December 31, 2001
by Brooks Hamilton and Scott Burns


Goals for an Effective Retirement System

We have devised what we call the "Triple 90 Yardstick" to assess any 401(k) plan. We have found that if plans meet this yardstick, it is almost certain that even low-wage plan participants will receive an adequate replacement income in retirement. A unique characteristic of this tool is that it does not consider plan provisions or exotic features; it simply looks at employee behavior. Briefly, a plan meets our yardstick measure if:

  • 90 percent of all eligible employees participate in and contribute to the plan.
  • 90 percent of the maximum employer contribution is captured by employees.
  • 90 percent of the plan's assets are invested according to professional asset allocation advice. (For example, if professionals would put 70 percent in equities, the plan would put at least 63 percent - 90 percent of 70 - into equities).

"The ideal plan: 90 percent of employees participate; 90 of the employer's match offer is realized; and 90 percent of investments follow prefessional guidlines."

The second item is generally referred to as the plan's match capture ratio. To illustrate, assume that a company contributes 50 cents for each $1 (up to 6 percent of pay) an employee contributes. If all eligible employees participate and all contribute 6 percent of pay, the plan's match capture ratio is 100 percent. If all employees participate, but each only contributes 2 percent of pay, the match capture ratio is 33 percent. In the latter case, participants forfeit 67 percent of the employer's potential annual matching contribution.

The third item measures how closely the asset allocation of the group as a whole compares to the asset allocation that an investment professional would have made. Investment professionals generally recommend that at least 70 percent of funds be invested in equity investments and no more than 30 percent in fixed-income investments. If employees meet 90 percent of the "professional's target" for equity investments, the third measurement is satisfied.

Applying this yardstick, too many plans don't measure up. This means the retirement income for an employee with average income will be inadequate. If a plan measures up to our Triple 90 Yardstick, the reward is almost always a fourth 90 percent measurement; that is, the replacement-income ratio for the employee with average income (with Social Security considered) will also exceed 90 percent.


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