10 excellent reasons to offer stress testing for retirement plans

Stress testing can be a powerful tool for financial professionals to personalize their approach to retirement plan service. But retirement plan professionals are far from alone in benefiting from stress testing.

Plan participants can get a clearer understanding of their retirement readiness. And plan sponsors can know they’re demonstrating concern for their employees’ financial wellbeing and doing their utmost to promote plan participation.

Performing a stress test can help illustrate concretely how a plan may (or may not) withstand events and scenarios that can affect investment outcomes.

The most popular techniques for financial stress testing use data analysis or computer simulations of an individual’s investment portfolio. Financial professionals can access specialized stress testing software or program spreadsheets that apply various formulas, functions and macros to achieve similar results.

Stress testing is just one tool financial professionals can use to help sponsors and participants focus attention on investments—and potentially help improve outcomes for the plan as a whole. Let’s take a closer look.

Stress testing’s value to plan sponsors, financial professionals and plan participants

Good or bad, retirement planning isn’t a set-it-and-forget-it activity. On one hand, as market variables change so can investment outcomes. On the other hand, as life circumstances change so can retirement income needs. And if a plan sponsor’s purpose for offering a retirement plan benefit is to improve employees’ retirement readiness, occasional stress testing can help meet that goal.

Consider the many variables that can impact investment outcomes: deferral rates, risk aversion, time horizon, diversification, tax liabilities, fees, age and health at retirement, withdrawal rates, economic conditions… the list goes on. Professionals understand that each investor brings a unique set of variables to the table. Stress testing offers a view into individual participants’ lives, wants and needs.

Sitting down face-to-face to stress test and review results can help participants understand their own personal variables and adjust their plans to align it with their goals. Participants stand to learn a great deal about:

• Income estimates based on different retirement ages and other scenario options
• Plan sensitivity to a single variable, such as a lower rate of return or a higher withdrawal rate
• Compounding of different outcomes, like experiencing a recession early in retirement and an unexpected one-time expense
• What-if considerations they might not think about on their own
• Investment options that align with their goals and personal values

Need more good reasons to consider stress testing? Think about these 10:

1. Promote and increase plan participation among eligible employees

Improving retirement readiness among employees can have cascading benefits to the business in the long run by alleviating the stress associated with financial insecurity and worry. Plus, stress testing creates an opportunity to educate participants on the impact of plan loans and hardship withdrawals.

2. Demonstrate concern and support for participants’ retirement security

Stress testing retirement plans is a way employers can demonstrate care toward their employees that extends beyond their service to the organization. Demonstrated concern for employees can have positive effects on morale, retention and performance.

3. Measure and quantify the probability of their plan’s success or failure

A numerical score can help some individuals better conceptualize their investment risk and realize that even the most conservative approaches include some level of risk. Stress testing software can compute a percentage likelihood of plan success, which can help investors see the potential benefits of diversification or other plan adjustments.

4. Assess whether saving and investing strategies are appropriate

A retirement plan takes into account more than just the investor’s desired outcome; it helps balance today’s needs with tomorrow’s plans. Stress testing opens the door to a conversation about maximizing tax deferrals, reviewing allocations, and planning for what may lie ahead, between today and retirement.

5. Investigate potential impacts of different scenarios on retirement income

Sometimes events happen with little forewarning—like a global pandemic or supply chain meltdown. Market conditions, inflation, interest rates and even geopolitical events can bring surprises, and not always good ones.

When participants can see for themselves how hard a portfolio can be hit by early-retirement recession, or how significantly inflation can reduce purchasing power, they may become motivated to engage more actively in planning for uncertainty.

6. Determine participants’ optimal asset allocation and diversification 

By playing out scenarios and poking at a retirement plan with potential investing and event sequences, a plan participant can see how various options may perform. That can help them get a more comprehensive awareness of their options so they feel more confident about the choices they make.

7. Explore alternative investments and create contingency plans 

Unforeseen events such as an unexpected illness, job loss, death of a spouse or partner, or disability can be made more tangible. Walking through “what-if” scenarios creates opportunities to learn more about plan participants' individual needs and life circumstances, and about the people and things in life that matter most to them.

8. Communicate plan strengths and weaknesses with transparency

Stress testing can reveal returns that fall short of projections, or a participant account that’s growing out of balance. Financial professionals can potentially also help participants understand account fees and other costs. 

A clear understanding of plan strengths and weaknesses can inform investment choices outside the employer-provided plan. Do participants know where they can go to purchase financial products or establish an individual investment account?

9. Educate participants about individual risks 

As healthcare and technologies improve, longevity risk may actually grow, but do participants know how to plan to live to 100 instead of 80? After all, rising healthcare costs or the need to hire a professional caregiver can complicate the math. 

A face-to-face stress testing conversation can help increase participants’ awareness of how today’s choices can affect retirement expenses. It could even inspire plan participants to make investments in their physical, mental and emotional health that could pay big returns in retirement enjoyment.

10. Deepen client relationships 

By setting aside time to focus on individual participants, financial professionals stand to gain when those investors need individualized help. Over the long term, those client relationships could become a valuable source of referrals.

Collaborate to help participants

Plan sponsors and advisors have a fiduciary responsibility to monitor the plan, its investment options and employee participation. But it’s important for participants to remember that successful retirement planning and investment can involve consistent, regular adjustments to changing internal and external factors.

It’s also important to remember that stress testing is not a one-time event. Retirement planning is an ongoing process. With the right tools and resources, financial professionals can offer a personalized service approach and help align plans with sponsors’ overall goals while improving participants’ engagement in their own retirement planning.

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