Making the most of the 10/30/60 rule
Did you know that 90 cents of every 1 dollar in retirement income may come from investment earnings? Like me, you have probably spoken to dozens of retirement plan participants where this topic has not come up. During enrollment meetings or through managing the wealth of your individual clients, typically the conversation is centered around savings and investments.
However, it is important to help participants increase their understanding about where retirement benefits come from, as they seek to reach their retirement goals. It’s not where you think! If you take a closer look at projections on the accumulation and decumulation phase of participant accounts, you will see cases (as illustrated below) where only 10% of a participant’s retirement income is from savings while 90% is from investment gain. A majority of those returns are generated post retirement. This is known as the 10/30/60 rule1.
Distribution of savings and investment returns
Assumptions used in the baseline retirement savings scenario
- The participant is assumed to join the plan at age 25.
- Contributions in the first year are assumed to equal $1,000, and to rise by 4.75% each subsequent year until retirement.
- Distributions are assumed to begin on retirement at age 65 and to rise by 3% each subsequent year until death at age 902. The level of initial distribution at retirement is set so as to leave the account balance at exactly 0 at the point of death.
- An investment return of 7.8% is assumed earned each year—the full 7.8% is earned on the account balance at the start of the year, while half of that rate (3.9%) is assumed to be earned on contributions and distributions. (This is approximately equivalent to assuming that contributions and distributions are made evenly throughout the year)
This is a hypothetical illustration. Participants’ actual experience could vary greatly from the example.
In order for the 10/30/60 rule to work there is one step that cannot be skipped
Participants have to save and start early to take advantage of compounding investment returns. In fact, for every 1% of savings, a participant might expect a replacement rate of about 5.2% in retirement.
The 10/30/60 rule can provide the foundation for a DC retirement plan and help participants reach their retirement goals. Consider a few enhancements for your client’s plans:
- Plan design changes – automatic enrollment and automatic escalation
- Investment options based on client profiles – do it for me, do it with me, or do it myself
- Investor education – encourage financial literacy and retirement income mindset
Laura Grusczynski is a retirement plan specialist for Russell Investments.
1Ezra, D. Don. ―A Model of Pension Fund Growth.‖ Russell Research Commentary. June 1989.
2The choice of age 90 for the planning horizon—slightly beyond the average life expectancy—reflects the need to build in a margin against the uncertainty introduced by longevity into retirement planning.