The 10/30/60 Rule:
Where do defined contribution (DC) plan
benefits come from?
It’s not where you think.
The retirement income provided by a 401(k) plan is made up partly of
money that is saved during a participant’s working years (i.e. contributions to the plan) and partly of the increase in those savings
that results from investment growth. Analysis of the accumulation
(and decumulation) of wealth over a typical lifetime shows that
contributions may represent as little as 10¢ of each $1 eventually paid
out. What is more, of the 90¢ represented by investment returns,
roughly two thirds (60¢) is earned after retirement. This surprising
result—that only 10% of retirement income is made up of
contributions, 30% is made up of investment return prior to
retirement and 60% is made up of investment return after
retirement—has been dubbed the 10/30/60 rule.
The magnitude of the role played by investment returns in retirement provision has long been
understood within the defined benefit (DB) system—as long ago as 1989, Don Ezra, Director,
Investment Strategy, Russell Investment Group, modeled DB plan growth and found th at,
“80¢ or more comes from investment returns;; contributions account for the remaining 20¢ of each benefit dollar. 1 ” The same paper found that, “for any one plan member, the largest part of the investment return...accrues during the payout stage.” DB inve stment programs are
accordingly built around the realization that return -generation is a key element in the costeffective provision of pension benefits.
In this paper, we will describe the same exercise in the context of a DC or 401(k) plan. The
dynamics are similar but not identical; instead of a series of cohorts of different ages with new
entrants replenishing the system as older participants retire and eventually die, there is only a
single life to consider in a DC plan. Neither investment risk nor lon gevity risk are pooled in DC as
they are in DB. And, unlike in DC, contributions in DB tend to be back -loaded (there is a
significantly higher cost attached to the accrual of a DB pension at advanced ages than at
younger ages).
The result is that the 80/20 split of DB looks more like 90/10 in DC. The finding that the bulk of
1
Ezra, D. Don. “A Model of Pension Fund Growth.” Russell Research
Commentary . June 1989.
Russell Investments // 10/30/60 Rule
the investment return is earned during the payout stage remains true in a DC world but take s on
added significance because of the absence of inter -generational pooling of investments. Growing
realization of these dynamics is one reason for the greater focus on investment considerations
within DC plan design—it is becoming less common to see investments play second fiddle to
recordkeeping, participant communication or other considerations.
A BASELINE RETIREMENT SAVINGS SCENARIO
A baseline retirement savings scenario is shown in Exhibit 1 below. A number of assumptions must
be made in a projection such as this, and these are listed in the appendix. In a moment, we will
discuss the impact of varying the input assumptions. But first, let us look at how a typical DC
account balance might build up over a working lifetime starting at age 25 and then decline through
a retirement assumed to last until death at age 90.
EXHIBIT 1
Russell Investments // 10/30/60 Rule
Age at
start of
year
Account
balance at
start of year
Savings
added to
account
Distributions
from account
25
0
1,000
0
26
1,039
1,048
0
27
2,208
1,097
28
3,521
1,149
29
4,990
30
31
Investment
rate of return
Investment
return earned
Account
balance at
end of year
7.80%
39
1,039
7.80%
122
2,208
0
7.80%
215
3,521
0
7.80%
319
4,990
1,204
0
7.80%
436
6,630
6,630
1,261
0
7.80%
566
8,457
8,457
1,321
0
7.80%
711
10,489
32
10,489
1,384
0
7.80%
872
12,745
33
12,745
1,450
0
7.80%
1,051
15,245
34
15,245
1,518
0
7.80%
1,248
18,012
35
18,012
1,591
0
7.80%
1,467
21,070
36
21,070
1,666
0
7.80%
1,708
24,444
37
24,444
1,745
0
7.80%
1,975
28,164
38
28,164
1,828
0
7.80%
2,268
32,260
39
32,260
1,915
0
7.80%
2,591
36,766
40
36,766
2,006
0
7.80%
2,946
41,718
41
41,718
2,101
0
7.80%
3,336
47,155
42
47,155
2,201
0
7.80%
3,764
53,120
43
53,120
2,306
0
7.80%
4,233
59,659
44
59,659
2,415
0
7.80%
4,748
66,822
45
66,822
2,530
0
7.80%
5,311
74,662
46
74,662
2,650
0
7.80%
5,927
83,239
47
83,239
2,776
0
7.80%
6,601
92,616
48
92,616
2,908
0
7.80%
7,337
102,861
49
102,861
3,046
0
7.80%
8,142
114,049
50
114,049
3,190
0
7.80%
9,020
126,260
51
126,260
3,342
0
7.80%
9,979
139,580
52
139,580
3,501
0
7.80%
11,024
154,105
53
154,105
3,667
0
7.80%
12,163
169,935
54
169,935
3,841
0
7.80%
13,405
187,181
55
187,181
4,024
0
7.80%
14,757
205,961
56
205,961
4,215
0
7.80%
16,229
226,406
57
226,406
4,415
0
7.80%
17,832
248,652
58
248,652
4,625
0
7.80%
19,575
272,852
59
272,852
4,844
0
7.80%
21,471
299,168
60
299,168
5,074
0
7.80%
23,533
327,776
61
327,776
5,316
0
7.80%
25,774
358,865
62
358,865
5,568
0
7.80%
28,209
392,641
63
392,641
5,832
0
7.80%
30,854
429,327
64
429,327
6,110
0
7.80%
33,726
469,163
65
469,163
0
31,885
7.80%
35,351
472,629
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Age at
start of
year
Account
balance at
start of year
66
472,629
0
32,842
7.80%
35,584
475,372
67
475,372
0
33,827
7.80%
35,760
477,304
68
477,304
0
34,842
7.80%
35,871
478,334
69
478,334
0
35,887
7.80%
35,910
478,357
70
478,357
0
36,964
7.80%
35,870
477,264
71
477,264
0
38,072
7.80%
35,742
474,933
72
474,933
0
39,215
7.80%
35,515
471,234
73
471,234
0
40,391
7.80%
35,181
466,024
74
466,024
0
41,603
7.80%
34,727
459,149
75
459,149
0
42,851
7.80%
34,142
450,440
76
450,440
0
44,136
7.80%
33,413
439,717
77
439,717
0
45,460
7.80%
32,525
426,782
78
426,782
0
46,824
7.80%
31,463
411,420
79
411,420
0
48,229
7.80%
30,210
393,401
80
393,401
0
49,676
7.80%
28,748
372,473
81
372,473
0
51,166
7.80%
27,057
348,364
82
348,364
0
52,701
7.80%
25,117
320,780
83
320,780
0
54,282
7.80%
22,904
289,402
84
289,402
0
55,911
7.80%
20,393
253,884
85
253,884
0
57,588
7.80%
17,557
213,853
86
213,853
0
59,316
7.80%
14,367
168,905
87
168,905
0
61,095
7.80%
10,792
118,602
88
118,602
0
62,928
7.80%
6,797
62,471
89
62,471
0
64,816
7.80%
2,345
0
113,678
1,162,505
Total
Savings
added to
account
Distributions
from account
Investment
rate of return
Investment
return earned
Account
balance at
end of year
Pre-retirement: 355,484
Post- retirement: 693,343
In this baseline scenario, there are total distributions of $1,162,505 – accounted for as follows:
Total
Percent of total distributions
Savings
113,678
9.78%
Pre-retirement investment earnings
355,484
30.58%
Post-retirement investment earnings
693,343
59.64%
Total distributions
1,162,505
100%
This is a hypothetical example meant for illustrative purposes only. It is not meant to represent any actual investment.
This is the basis for the “10/30/60” rule of thumb for the sources of DC retirement income. It also,
incidentally, provides insight into another relationship. If we make the assumption that saving is
constant as a percentage of salary, then for every 1% of salary contributed while working, a
retirement income of 5.2% of final salary is provided by the plan. So if contributions were made at
the rate of 10% of salary throughout a working lifetime under this baseline scenario, for example,
then the plan would provide salary replacement at the rate of 52% on retirement at age 65.
Russell Investments // 10/30/60 Rule
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THE 10/30/60 RULE IS FAIRLY ROBUST UNDER DIFFERENT INPUT ASSUMPTIONS
2
These figures, and
subsequent figures, may
appear not to total 100%
in every case, due to the
effects of rounding. It is
also worth noting that, in
this case, the
distributions from
the plan are significantly
lower than in the base
case—the 5% return
assumption produces
retirement income of only
42% of that produced by
the 7.8% base case
assumption.
Clearly, different assumptions would alter the exact numbers somewhat. The interested reader can
reproduce the baseline scenario in a spreadsheet tool such as Microsoft Excel, and test the impact of
different inputs. As far as the 10/30/60 result is concerned, the impact of certain key changes would
be as follows:
If investment returns are uncompetitive, then the 10/30/60 rule can cease to apply. For
example, replacing the 7.8% return assumption with 5% each year changes the result to
23% / 30% / 46%.2 On the other hand, if only the post-retirement return assumption is
reduced to 5%, the result becomes 13% / 41% / 46%.3
Other changes have far less impact on the result than changing the investment return
assumption. For example, using a start date of 35 (rather than 25) produces a result of
14% / 27% / 60%.
A retirement date of 60 changes the pre- and post-retirement contributions, but does not
significantly increase the amount represented by savings (10% / 25% / 65%).
If death is assumed to occur at age 85 rather than 90, the result becomes 12% / 36% / 52%.
If savings are assumed to escalate at 8% (which may reflect auto-escalation of contributions, or an
increasing rate of saving over a working lifetime) the result becomes 13% / 27% / 60%.
3
The distributions from the
plan in this case are 75% of
those produced by the 7.8%
base case assumption. An
increasingly popular choice
If post-retirement distributions do not increase, then the result becomes 11% / 34% / 55%.
So we can see that the basic 10/30/60 pattern is fairly stable even in the light of changing the input
assumptions from our baseline scenario, with the exception of the pre-retirement investment return
assumption, which is critical.
of investment strategy is a
target date fund, which
gradually adopts a more
cautious strategy as
retirement approaches. This
might be modeled by
assuming a declining
return—e.g. an initial 8.5%
return, that starts to fall by
.08% a year from age 40 to
reach a level of 6.5% by age
65. Using this return
assumption, the 10/30/60
CONCLUSION
It would be wrong to conclude that the 10/30/60 rule means that the contribution level is not
important in a DC plan. Indeed, without contributions, there can be no investment return—an
adequate rate of saving is an indispensable starting point for successful retirement planning.
However, as the DC system continues to grow, and a greater number of Americans become
increasingly dependent on it for financial security in retirement, it is important that plan design is
based on a clear understanding of the economic dynamics that underpin a DC vehicle. In particular,
with roughly 90% of distributions being generated by investment earnings (not by contributions
saved), and the majority of that 90% being earned after retirement, sound investment programs are
critical if DC plans are to be effective in meeting their goals.
result turns into 12/34/54.
Russell Investments // 10/30/60 Rule
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APPENDIX
Assumptions used in the baseline retirement savings scenario:
4
The choice of age 90 for
the planning horizon—
slightly beyond the average
life expectancy—reflects the
•
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 904. 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.)
need to build in a margin
against the uncertainty
introduced by longevity into
retirement planning. Dealing
with longevity risk is in fact
a complex issue, and beyond
the scope of this paper.
The authors wish to thank Don Ezra for his comments and review of this analysis.
Disclosures
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appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon
without obtaining specific legal, tax, and investment advice from a licensed professional.
Copyright © Russell Investments 2011. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in
any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.
Russell Investment Group is a Washington, USA Corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a
subsidiary of The Northwestern Mutual Life Insurance Company.
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Russell Financial Services, Inc. member FINRA, part of Russell Investments.
First use: January 2008. Revised July 2012 RFS 8806
Russell Investments // 10/30/60 Rule
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