Skip to main content
MENU
Subscribe
  • Sign Up Free
  • LOGIN
  • Subscribe
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Face to Face
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2023 Defined Contribution East
    • 2023 ESG Investing
Breadcrumb
  1. Home
  2. ASSET OWNERS
June 11, 2012 01:00 AM

Income replacement math doesn't add up, report says

Robert Steyer
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    Calculating expected income replacement rates can be an imprecise and misleading way for defined contribution plan executives to assess participants' retirement readiness, according to new research from the Ibbotson Associates unit of Morningstar Inc.

    That's because there are so many variables and economic assumptions used in calculating how much of a participant's final-year compensation will be replaced per year during retirement.

    “Plan sponsors are increasingly requesting — and making decisions based on — replacement rate studies where each provider conducts an analysis of its own product” to forecast the best replacement rate, said David Blanchett, a research consultant at Ibbotson in Chicago and the author of a report on the research. Because different providers use so many different assumptions, plan officials can be presented with wildly varying recommendations, he added.

    “It is virtually impossible to compare the results of various studies and form any type of reasonable conclusion,” Mr. Blanchett said in an interview. “Each provider uses a different methodology.”

    Instead, Ibbotson recommends hiring a single consultant to create a “controlled experiment to meaningfully compare replacement ratios,” said Mr. Blanchett. But he thinks an even better choice would be for sponsors to hire a consultant to analyze the different methodologies of the providers to see which approach best matches the needs and demographics of the sponsor's workforce.

    “Replacement rate estimates can vary materially based on different assumptions and provide varying levels of insight,” according to his report, “Inaccurate Precision: The Danger of Replacement Rate Calculations.” “Plan fiduciaries should never compare replacement ratios calculated by different vendors.”

    To illustrate how minor changes in assumptions can have a big impact on replacement rate calculations, Mr. Blanchett created a replacement rate calculator using 10 factors ranging from specific assumptions — such as a participant's retirement age, outside assets, change in savings rate, and asset allocation — to broader ones, such as market forecasts and inflation.

    Then, he varied these assumptions for 20 sample plans to determine their impact on replacement rates. The range of median replacement rates among the 20 plans was between 48% to 107%, based on the different assumptions, the report said. The replacement rates ranged from 67% to 261% for individuals based on the different assumptions, the report said.

    Mr. Blanchett's report said several factors typically will have a greater impact on results than others. They are a higher percentage of younger workers, participants with higher levels of pay, workers with higher savings rates and workers with lower plan balances.

    Although sponsors approach replacement-rate strategies with good intentions for retirement readiness, “these studies are fundamentally flawed,” Mr. Blanchett said in the interview. “Plan sponsors need to better understand the methodology.”

    Jack VanDerhei, research director for the Employee Benefit Research Institute, Washington, said in an interview that the Ibbotson research is “something different than anyone has done.”

    Mr. VanDerhei, who reviewed the Ibbotson Associates' research at the request of Pensions & Investments, said the Ibbotson report achieved its goal of illustrating the “dramatic” variability of factors in trying to figure a replacement rate. However, Mr. he also noted the analysis didn't include factors such as health care expenses or long-term care costs.

    Like Ibbotson Associates' questioning the adequacy of sponsors calculating replacement rates, EBRI has questioned the adequacy of participants relying on replacement rates, Mr. VanDerhei said.

    Replacement rate calculations are “overly simplistic and potentially inaccurate,” according to a 2006 EBRI report. These calculations often rely on replacing pre-retirement cash flow after adjusting for taxes, savings, age and/or work-related expenses, but they ignore investment risk, longevity risk and/or the risk of “potentially catastrophic health care costs,” the report said.

    “Replacement rates can give you an answer,” Mr. VanDerhei said in the interview. “Whether it's the right answer — or not — is debatable.”

    Related Articles
    More employers skeptical about workers' retirement preparedness
    Non-profits put investible assets under microscope
    A crisis of confidence on retirement
    Mercer: Decline in working-age population to affect pension funds
    Recommended for You
    FTX_Screen_i.jpg
    FTX bankruptcy ensnares Kraft, Och and other family offices
    ONLINE_180419851_AR_0_SWJHUISTXOVN.jpg
    Northern Trust plan universe returns -4.2% in Q3
    Research for Institutional Money Management
    Sponsored Content: Research for Institutional Money Management

    Reader Poll

    January 25, 2023
    SEE MORE POLLS >
    Sponsored
    White Papers
    The Future of Infrastructure: Building a Better Tomorrow
    Fulcrum Issues: Equity Returns and Inflation — Choose Your Own Adventure
    What Matters Most in Considering a Private Debt Strategy
    Why pursue direct lending in the core middle market?
    Research for Institutional Money Management
    Are Factors a Thing of the Past?
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    December 12, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2023. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Face to Face
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2023 Defined Contribution East
      • 2023 ESG Investing