Add value & improve retirement security by helping participants stress test financial plans

In a recent study, nearly two thirds of U.S. adults agreed that their financial planning could use some improvement, yet only a little over a third reported working with a financial professional.¹ Getting employees on board and contributing to a retirement plan is already an important step toward improving their future financial security, but sponsors and financial professionals can do more to help participants better understand and anticipate their income needs in retirement.

How can plan participants know whether they’re contributing the right amount to their long-term retirement investments? Are they on track for a reliable income after they stop working? Could they be shortchanging their short-term liquidity needs by contributing more than they need to a 401(k) only to set themselves up to need a hardship withdrawal — and then face the ripple effects it could cause on their finances over time?

Recent market volatility and fast-rising inflation only underscore the need for all plan participants to prepare well for uncertainty. Leading participants through a stress test of their retirement plan can help them make adjustments — and move more confidently toward their retirement horizons.

Together, sponsors and financial professionals are in a unique position to offer stress testing as a planning tool for participants that adds value to retirement plan offerings.

Stress testing offers a learning opportunity

Not everyone gives the same amount of thought to the transition from earning and saving to spending in retirement, or to the fluctuations in markets, interest rates, inflation and asset values that can impact income streams. On the other side of the equation, a stress test can remind plan participants of the ways their expenses can be affected by inflation, health concerns, timing of retirement, individual longevity and even changes to tax laws.

In fact, some employees set their contribution level just once — when they first enroll — and never revisit or think twice about what they could do differently.

Stress testing participants’ retirement plans enables financial professionals to have individual conversations with participants and project at least a couple of likely income scenarios at their current rate of contribution and retirement horizon. This can give participants a solid basis for their confidence in their own retirement readiness.

Most plan participants don’t have access to the same simulation software that financial professionals do. This creates an opportunity for them to demonstrate how various adjustments participants may choose to make today can have a big impact between now and retirement, whether that’s reconsidering allocations, contributing more, or pushing retirement out an extra year.

Key considerations for stress-testing participants’ retirement accounts

A stress test starts with establishing a baseline while relying on a set of assumptions: contribution rate, anticipated rates of return, retirement date, withdrawal rates, expenses and longevity. As financial professionals know, while they may all be underlying assumptions of a plan, none of these factors is a certainty.

The stress test applies deviations from the plan’s performance and expense assumptions and pushes the plan toward extremes to identify potential weaknesses. Essentially, it performs hypothetical experiments to see what it takes to “break” the plan, including risks like:

• Underperforming investments
• Potential asset bubbles
• Unanticipated, big-ticket, one-time expenses
• Higher than anticipated living expenses
• Loss of home value
• The need to retire early
• Sequence of returns risk
• High inflation
• Longevity risk

Stress testing can open doors to in-depth conversations

It’s one thing to run Monte Carlo simulations and give participants a percentage of likelihood that they’ll be able to meet their expectations. But financial professionals can use the stress test occasion as an opportunity to really dig in and talk to participants about their expectations—and to help them better understand their cash flow needs in retirement, and the adjustment they can make now to retire with greater confidence and security. 

For example, rather than simply push for larger employee contributions, a financial professional might recommend that a participant start diverting some cash into an emergency fund to reduce the likelihood of needing to pull funds in the form of a hardship withdrawal. 

If a participant’s investments don’t reflect the level of risk they’re actually comfortable with, some guidance on rebalancing may not only set them at ease, but could actually improve their likelihood of success. Yet another participant may benefit from an action as simple as increasing pre-tax contributions as a way to encourage them to reduce spending today for a more comfortable retirement.

Sponsors and financial professionals should work together to create opportunities to educate participants. While newsletters, online content, webinars and group meetings are all important, one-on-one meetings to stress test retirement plans can not only educate participants on their needs in retirement; they can also highlight the value of working with a financial professional and the empowerment it can bring to their retirement planning.

SOURCE
Northwestern Mutual, Planning & Progress Study 2022, 2022.

CMRS-4950292.1-0922-1024