401(k) Eligibility Key Driver in Retirement Readiness

Eligibility for participation in a workplace 401(k) savings plan is one of the single-most important factors in closing the retirement savings gap for Generation X, according to a new report by EBRI.

But for Gen Xers trying to calculate how much they will need in retirement, EBRI also finds that taking potential nursing home and home health care expenses into account is crucial to a realistic estimate of retirement savings needs.

EBRI, which has extensively measured retirement readiness levels using its Retirement Security Projection ModelTM (RSPM) since its launch in 2003, recently focused on Gen Xers (those born between 1965–1974).

Earlier EBRI research has found that, overall, about 44 percent of both Baby Boomer and Gen Xer households are likely to be at risk of running short of funds during retirement, assuming they retired at age 65 and retained any net housing equity in retirement until other financial resources were depleted.

However, EBRI’s modeling reveals great variability in that overall percentage, with a key factor being how long a Gen X worker will be eligible to participate in a defined contribution retirement plan such as a 401(k):

  • For those with no future years of eligibility, the average retirement savings shortfall is projected to be approximately $78,000 per individual.
  • Those Gen Xers with at least 20 years of future eligibility are projected to have an average financial shortfall at retirement of approximately $23,000.

The inclusion of nursing home and home health care costs is a crucial factor in calculating realistic retirement expenses because, while those events will not be experienced by all households, or experienced to the same extent, they can have catastrophic financial consequences for a household’s retirement income adequacy. Unlike many other models, that impact is already incorporated in the RSPM results.

For example, with nursing home and home health care expenses modeled, 68 percent of single male Gen Xers are projected to have no financial shortfall in retirement. On the other hand, if these expenses are ignored, more than 90 percent of this group would appear to have no projected shortfall.

“Ignoring the impact of nursing home and home health care costs in retirement significantly overstates the likelihood of retirement income adequacy,” said Jack VanDerhei, EBRI research director and author of the report. “Any realistic calculation of retirement needs has to include those expenses.”

The full report is online here.

“Opportunity” Costs

By Nevin Adams, EBRI

Adams

When I was 16, my family moved from a small town in Southern Illinois to the suburbs of Chicago. It was a move that was to change my life in ways I could not have even imagined at the time. Had that move not occurred, I’d likely have wound up at a different university, might well have chosen a different major, and almost certainly would never have stumbled across the college internship doing pension accountings that has, many years later, brought me here today.

As you might expect, those possibilities were not obvious to me at the time of that move. But looking back, the reality is that that move greatly expanded the life choices—and thus, the opportunities—available to me at a particularly critical point in my life.

At EBRI’s Research Committee meeting this past week, Research Director Jack VanDerhei shared the updated findings of the EBRI Retirement Readiness Rating (RRR), TM which will be published later this month. The Retirement Readiness RatingsTM measure the percentage of simulated life paths in retirement that are at risk of inadequate retirement income. Simply stated, a household’s simulated lifepath in retirement is considered to be at‐risk in the baseline version of the model if its aggregate resources in retirement are not sufficient to cover their aggregate minimum retirement expenditures.(1) Previous research by EBRI has demonstrated that one of the most important factors contributing to retirement income adequacy for the Baby Boomers and Gen Xers is eligibility to participate in employment-based retirement plans.

In fact, the updated version or the RRR shows that the number of future years workers are eligible for participation in a defined contribution plan makes a tremendous difference in their at-risk ratings. For example, according to the simulation results, Gen Xers with no future years of eligibility would run short of money in retirement more than half (60.7 percent) of the time—a circumstance that would effect fewer than 1 in 5 of those in that demographic with 20 or more years of future eligibility.

And, bear in mind, that’s the kind of difference in outcome that results from mere ELIGIBILITY, thanks to their likely participation when a program is available, boosted by design enhancements like automatic enrollment and contribution acceleration.

My kids have the chance to learn from my past—to ask about the availability of a workplace retirement savings plan during their job interviews—and to take early advantage of that opportunity.

After all, it’s hard to take advantage of an opportunity you don’t have.

Notes

(1) In EBRI’s RRR,TM aggregate minimum retirement expenditures are defined as a combination of deterministic expenses from the Consumer Expenditure Survey (as a function of income and age) and some health insurance and out‐of‐pocket health‐related expenses, plus stochastic expenses from nursing home and home health care expenses (at least until the point such expenses are picked up by Medicaid). The resources in retirement will consist of Social Security (status quo benefits for the baseline version of the simulation), account balances from defined contribution plans, IRAs and/or cash balance plans, annuities or lump-sum distributions from defined benefit plans (unless the lump‐sum distribution scenario is chosen), and (in some cases) net housing equity (in the form of a lump‐sum distribution at the point that other financial resources are exhausted). This version of the model is constructed to simulate “basic” retirement income adequacy; however, alternative versions of the model allow similar analysis for replacement rates, standard‐of‐living, and other thresholds. More information on the RRR is available in the July 2010 EBRI Issue Brief online here.

“After” Math

By Nevin Adams, EBRI

Adams

Last week, EBRI Research Director Jack VanDerhei(1) testified before the House Ways & Means Committee on the subject of “Tax Reform and Tax-Favored Retirement Accounts”, a hearing described as considering “…the current menu of options for retirement savings—both with respect to employer-based defined contribution plans and with respect to IRAs.” According to Committee Chairman David Camp (R-MI), the hearing was to “…explore whether, as part of comprehensive tax reform, various reform options could achieve the three goals of simplification, efficiency, and increasing retirement and financial security for American families.”

That hearing preceded by just a day Senate Budget Committee Chairman Kent Conrad’s (D-ND) unveiling of his Fiscal Commission Budget Plan (see link here).  That plan(2) referenced the original Bowles-Simpson Fiscal Commission’s “Illustrative” Tax Reform option under which the exclusion for employment-based health insurance would be eliminated, capping its value for five years and then phasing it out over 20 years, while retirement savings accounts would be consolidated, with a cap on tax-preferred contributions.(3)

While the prospects for actual legislation ahead of the November election seem unlikely, it is clear that concerns about the nation’s budget deficit will keep tax reform—and the tax status of workplace benefit programs—front-and-center in the weeks and months to come.

Appropriately enough, next month EBRI will host its 70th policy forum, titled “’After’ Math: The Impact and Influence of Incentives on Benefit Policy.” At this semi-annual policy forum, panels of experts will deal with a variety of pertinent and timely issues, including the potential impact of changes to current tax incentives for employee benefits, and the “true cost” of tax deferrals.

We’ll also talk about what 401(k)/defined contribution plans are delivering, and what individuals actually do after retirement with respect to their retirement savings, as well as optimal approaches on retirement income designs for defined contribution plans. We’ll even look around the globe for some potential lessons to be drawn from international comparisons.

It’s a day of information, interaction, and networking that you won’t want to miss.

However, seats are limited—reserve your place today. You can’t afford not to.

A copy of the full policy forum agenda, and registration information is online here.

Endnotes

1) A copy of Jack VanDerhei’s written testimony for the House Ways & Means Committee is available online here.

Video of the testimony is available in two sections, online here.

Additional information regarding the Ways & Means hearing is available online here.

2) See page 11, online here.

3) Last year an EBRI Notes article (July 2011, online  here)  analyzed the potential impact of those kind of changes on retirement savings.

“Generation” Gaps

By Nevin Adams, EBRI

Adams

If you think it’s complicated trying to determine an individual’s retirement funding needs, imagine trying to do so for all American workers. That was the topic of a Senate Banking subcommittee hearing last week titled “Retirement (In)security: Examining the Retirement Savings Deficit,” at which EBRI Research Director Jack VanDerhei was asked to testify.(1)

When EBRI modeled the retirement savings gap of Baby Boomers and Gen Xers earlier this year, we found that between 43 and 44 percent of the households were projected to be at risk of not having adequate retirement income for BASIC retirement expenses plus uninsured health care costs—though that was 5–8 percentage points LOWER than what we found in 2003. That’s right: In terms of that retirement savings gap, American households are better off today than they were nine years ago—even after the financial and real estate market crises in 2008 and 2009.

Measuring retirement income adequacy is an extremely important and complex topic, and one that EBRI started to provide back as far as the late 1990s. Our recent projections indicate that the average individual deficit number (for those with a deficit) ranges from approximately:

• $70,000 for families, to

• $95,000 for single males, to

• $105,000 for single females.

Stated in aggregate terms, that would be $4.3 trillion for all Baby Boomers and Gen Xers in 2012. That’s a large number, to be sure, but still considerably smaller than some of the projections that have been put forth.

Here are four things that are sometimes overlooked that help explain the “gaps” in retirement projection gaps:

Some won’t have a retirement

The reality is that some people won’t make it to retirement. On an individual level, we may not know who they are, but in the aggregate we can project the impact with some precision.

You can’t ignore the impact of uniquely post-retirement expenditures.

Health care costs—and post-retirement health care costs particularly—remain a potential source of underplanning, both for retirement and retirement projections. The reality is that we spend differently in retirement than we do before retirement. Moreover, the costs of care, and particularly care such as nursing home and/or long-term care, loom large. And many won’t think or insure for that risk until it’s too late.

Tomorrow’s retirement will be funded differently.

Looking back, even only a few years, assuming that the income sources of current retirees will be available to future retirees glosses over the reality that a major shift in emphasis in retirement plan design has taken place. In the future, the proportion of retirees receiving traditional pension income will almost certainly decline, and the percentage relying on defined contribution savings (primarily 401(k)-type plans) as a primary source of post-retirement income is certain to increase. Projecting future retirement income flows based on the experience of today’s retirees is certain to miss the mark.

We’re already saving “better.”

Thanks to the growing popularity of automatic plan design trends—automatic deferrals, contribution acceleration, qualified default investment alternatives—many of today’s retirement plan participants are already saving earlier and investing more age-appropriately than ever before. There’s no reason to assume these trends won’t continue to extend and expand going forward. Projections based on pre-Pension Protection Act defined contribution trends are relying on yesterday’s news.

Endnote

(1) Video of the hearing is available online here.

Dr. VanDerhei’s testimony is available online here.

New from EBRI: Tax Reform Proposal Could Clip 401(k) Balances

A recent proposal to change the tax preferences for employment-based 401(k) retirement plans could result in an average reduction in 401(k) account balances of between 6‒22 percent at Social Security normal retirement age for workers currently ages 26‒35, according to new research by EBRI.

 The response—a combination of plan sponsor reaction and participant response—is strongly tied to plan size, with participants in smaller plans likely to experience deeper average reductions in 401(k) balances, according to EBRI’s baseline analysis. For plans with less than $10 million in assets, participant balances at Social Security normal retirement age for workers currently ages 26‒35 could decline between 23‒40 percent, depending on the size of the plan and income of the participant.

EBRI’s report is the first to analyze the response of both private-sector 401(k) plan sponsors and participants to a proposed scenario where the current tax treatment of employer and worker pre-tax contributions would be modified such that workers would have to pay federal taxes on these amounts currently, rather than on a deferred basis (as under current law), and participants would receive an 18 percent government match on all contributions.

“Some analyses of recent proposals to change the tax preferences for employment-based 401(k) retirement programs have assumed status quo in plan design and contribution flows,” notes Jack VanDerhei, EBRI research director and author of the report. “Surveys of individual participants suggest, however, that some would decrease or even eliminate their contributions in response to these changes. Additionally, surveys of plan sponsors indicate that many would modify their plan design, or even terminate these plans.”

Full results of the study are published in the March EBRI Notes, “Modifying the Federal Tax Treatment of 401(k) Plan Contributions: Projected Impact on Participant Account Balances.”  The press release is online here.

The 2012 RCS:Job Insecurity, Debt Weigh on Retirement Confidence, Savings

Americans’ confidence in their ability to afford a comfortable retirement is stagnant at historically low levels in the face of more immediate financial concerns about job uncertainty and debt, according to the 22nd annual Retirement Confidence Survey (RCS), the longest-running annual survey of its kind in the nation.

Asked to name the most pressing financial issue facing Americans today, both workers and retirees were more likely to identify job uncertainty. “Americans’ retirement confidence has plateaued at the lowest levels we’ve seen in two decades of conducting this survey,” said Jack VanDerhei, EBRI research director and co-author of the report.

Many workers report they have virtually no savings and investments, and workers’ expected age of retirement continues to rise, according to the RCS. However, one area in which Americans are saving for retirement is an employer-sponsored retirement savings plan, such as a 401(k). In fact, 81 percent of eligible workers (38 percent of all workers) say they contribute to such a plan with their current employer, according to the RCS.

These and other findings are contained in the 22nd annual RCS, conducted by the nonpartisan Employee Benefit Research Institute (EBRI) and Mathew Greenwald & Associates, Inc. Full results of the 2012 RCS are published in the March 2012 EBRI Issue Brief, released today and online at www.ebri.org 

The EBRI website also has several RCS-related fact sheets, online here. 

The EBRI press release is online here.

Above “Average”

By Nevin Adams

Nevin Adams, EBRI

Every so often an industry survey will come out with an “average” 401(k) balance.(1) The specific numbers vary, but they are consistently less than even the most optimistic would see as sufficient to provide a financially viable retirement.

Now, in fairness, the validity of an “average,” while mathematically simple, depends heavily on its components. Most are no more than the total of all the balances of those in a 401(k), from those just entering the workforce (and thus, by definition, with negligible balances)—and with decades to go to retirement—to those who are perhaps just days away from that point. Looking at no more than the “average,” you can’t tell how many are in which category. So, while the average can, over time, provide a sense of the direction in which things are moving, it tells you very little about the adequacy of the overall average savings to fund an individual retirement.

One way to help provide a more meaningful measure is to segment those balances by specific age demographics. In fact, the EBRI/ICI 401(k) database has long provided not only an average 401(k) balance, but also totals for different groups. To give you a sense of the difference that can make, at year-end 2010, while the total average 401(k) balance was $60,329, the average 401(k) balance for those in their 60s—at least for those with 20 years of tenure—was $159,654.

In fairness, $159,654 may not look like very much to have saved by someone in their 60s. But even then, there are many things we don’t know about that person’s individual circumstances. We don’t know if they have a defined benefit pension, for one thing, nor do we know if they have savings outside their workplace. Perhaps just as significantly, we don’t know if that average takes into account their accumulated savings in all defined contribution plans, including those savings that might have been left with previous employers or rolled into individual retirement accounts (IRAs) along the way.

In testimony before the Senate Finance Committee last fall,(2) EBRI Research Director Jack VanDerhei noted that “[p]articipation in a retirement plan through current employment at a specific moment in time does not tell the full story of a worker’s preparedness for retirement or the availability of some form of retirement income from an employment-based retirement plan.” He went on to caution:

“Unfortunately, the ‘success’ of these plans is sometimes measured by metrics that are not at all relevant to the potential for defined contribution plans to provide a significant portion of a worker’s pre‐retirement income. For example, some analysts will merely report the average balance in defined contribution plans (most commonly the 401(k) subset of this universe) and attempt to assess the value of these plans by determining the amount of annual income that this lump sum amount could be converted to at retirement age. Of course, this concept does not adjust for the fact that the vast majority of 401(k) participants are years, if not decades, away from retirement age. Moreover, even if one does look at the average balances for workers near retirement age, it is obviously not correct to look only at the 401(k) balance with the employee’s current employer. For example, an employee age 60 may have very recently changed jobs and rolled over a substantial account balance from his previous employer to an IRA.”

Sure enough, as I sit here today, I have three separate 401(k) accounts at three separate employers, a rollover IRA, and a SEP.

Anyone trying to glean a sense of my retirement prospects while looking only at my current 401(k) balance surely wouldn’t feel very optimistic.

But then, they’d only be looking at part of the picture.

Endnotes

(1) Including EBRI, in its annual updates of the EBRI/ICI 401(k) database, in cooperation with the Investment Company Institute—see “401(k) Plan Asset Allocation, Account Balances, and Loan Activity In 2010.”

(2) A copy of the testimony is available online here. See also “Tax Reform Options: Promoting Retirement Security” online here.

The Importance of Defined Benefit Plans for Retirement Income Adequacy

A new EBRI analysis shows that Baby Boomer and Generation X households that have a defined benefit (DB) pension plan accrual at retirement age are overall almost 12 percentage points less likely to be “at risk” of running short of money for basic needs and uninsured health costs in retirement.

The report finds that having a DB pension plan is particularly valuable for those with the lowest income in both age groups, but also has a “strong impact” on reducing at-risk rates for those in the middle class: Among those in the second- and third-income groups combined (covering middle-income workers), the combined relative at-risk reduction is almost 20 percent.

The press release is online here.

The full report is online here.

Target-Date Fund Use in 401(k) Plans

The August 2011 EBRI Issue Brief provides a detailed look at the use of target-date funds (TDFs) by participants in 401(k) plans.

EBRI’s analysis finds that 401(k) participants who invested in target-date funds (TDFs) overwhelmingly tend to stick with these investments over time. Just over 90 percent of 401(k) participants investing in TDFs in 2007 stuck with them through 2009, EBRI found. Using a proxy for the auto-enrollment status of participants, those identified as auto-enrollees were even more likely to have stayed with TDFs, at a rate over 95 percent.

EBRI’s research finds that 401(k) participants who were younger and had lower account balances were more likely to use TDFs and to continue to use them. Those more likely to stop investing in TDFs were older, had longer tenure, or had higher account balances, although these participants overall stayed with TDFs at a high rate.

The press release is online here.

The full report is online here.

What Do You Call a Glass That is 60−85% Full?

By Jack VanDerhei, EBRI

VanDerhei

In the July 7 Wall Street Journal, the headline of an article assessing the Pension Protection Act of 2006 (PPA) provision that encourages automatic enrollment (AE) in 401(k) plans suggests that it is actually reducing savings for some people. What it failed to mention is that it’s increasing savings for many more—especially the lowest-income 401(k) participants.

EBRI has been publishing studies on the likely impact of AE for six years. In a joint 2005 study with ICI,[1] we looked at the potential change in 401(k)/IRA[2] accumulations as a result of changing the traditional voluntary enrollment (VE) 401(k) plans to AE plans. Although we had the advantage of using a database of tens of millions of 401(k) participants going back in some cases to 1996, we were limited in knowing how workers would react to AE provisions, and thus simulated the likely response using the results of academic studies.[3]What we found was that the overall expected improvement in retirement accumulations—especially for the lower-income quartiles—were nothing less than spectacular. 

However, one point that had already been made clear in the academic literature, and was corroborated by our simulation results, was that some workers placed in a 401(k) AE plan (without automatic escalation provisions—more on that later) would continue to contribute at the default contribution rate that the plan sponsor had chosen (typically in the range of 3 percent of compensation). Given that many workers who chose to participate in a VE plan would start contributing at a 6 percent rate (largely in response to the matching contribution incentive provided by the employer), some workers in AE plans were likely contributing at a lower rate than they would have had they been working for a plan sponsor offering a VE 401(k) plan AND had chosen to participate.

This anchoring effect can be seen by looking at the top-income quartile in the 2005 results, where the median replacement rate for the top-income quartile decreased by 4 percentage points for the scenario with a 3 percent contribution rate and default investments in a money market fund (Figure 1 of the July 2005 Issue Brief ). However, from a public policy standpoint, it would appear that this was more than offset by the increase in participation for the lower-income quartiles due to auto-enrollment, resulting in substantial increases in their retirement accumulations (for the same scenario as mentioned above, the third-income quartile’s median replacement rate increased 2 percentage points, the second-income quartile increased 7 percentage points, and the lowest-income quartile increased 14 percentage points).

A year after this study was released, Congress passed the PPA, which eased some of the administrative barriers to providing AE and for the first time setting up safe harbor provisions for automatic escalation. Although it was too soon to know how plan sponsors would react to this new legislation, EBRI published a study in 2007[4] that showed how automatic escalation would make the AE results even more favorable under a number of different scenarios for both plan sponsor and worker behavior.

In 2008, EBRI included all the new PPA provisions in a study[5]that compared potential accumulations under AE and VE for several different age groups. Again, we found certain (high-income) groups that were likely to do better under VE than AE, but overall, the AE results dominated (see Figures 6 and 7 of the June 2008 Issue Brief for details).

By 2009, many of the 401(k) sponsors who previously had VE plans had shifted to AE plans and EBRI was able to track the changes in plan provisions for hundreds of the largest 401(k) plans. This information was used in an April 2010 EBRI Issue Brief to show, once again, the significant impact of moving to AE plans (for those currently ages 25–29, the difference in the median accumulations would be approximately 2.39 times final salary in an AE plan relative to a VE plan).

Later in 2010, EBRI and DCIIA[6] teamed up to do an analysis that focused not on a comparison of VE and AE, but rather how to improve plan design and worker education to optimize the results under AE plans with automatic escalation of contributions. While it is difficult to determine the correct “target” for retirement savings, we tried to demonstrate what, by most financial planning standards, appears to be quite generous: an 80 percent REAL income replacement rate in retirement when 401(k) accumulations are combined with Social Security. We demonstrated that if only the most pessimistic combination of plan design and worker behavioral assumptions were used in the AE plans studied, only 45.7 percent of the lowest-income quartile would obtain this threshold,[7] and given the way in which Social Security benefits are designed, an even lower percentage of the highest-income quartile (27 percent) would reach the 80 percent threshold.

However, the entire point of the analysis was to determine how valuable the proper choice of plan design and worker education can be. The study found that with the all-optimistic assumptions, the percentage of lowest-income quartile workers achieving the 80 percent threshold increased to 79.2 percent, and that of the highest-income quartile workers increased to 64 percent.

The Wall Street Journal article reported only the most pessimistic set of assumptions and did not cite any of the other 15 combinations of assumptions reported in the study. The article reported only results under the threshold of a real replacement rate of 80 percent. Figure 5 of the November 2010 EBRI Issue Brief shows that even decreasing the threshold to a 70 percent real replacement rate would increase the percentage of “successful” retirement events by 19 percentage points for the lowest-income quartile and 12 percentage points for the highest-income quartile.

The other statistic attributed to EBRI dealt with the percentage of AE-eligible workers who would be expected to have larger tenure-specific worker contribution rates had they been VE-eligible instead. The simulation results we provided showed that approximately 60 percent of the AE-eligible workers would immediately be better off in an AE plan than in a VE plan, and that over time (as automatic escalation provisions took effect for some of the workers) that number would increase to 85 percent.

The Wall Street Journal did not report the positive impact of auto-enrollment 401(k) plans on many workers who began to participate due to AE. As with any change, some people will not have the desired results; but if the focus of auto-enrollment is to increase participation among lower-income participants (and, as a result, their retirement financial preparedness), objective analysis suggests auto-enrollment does obtain that goal.

News coverage:

PlanSponsor Perspectives: “Starting Points”

CBS MoneyWatch: “A Hit Job From the Wall Street Journal”

Endnotes


[1] Holden, S., VanDerhei, J., “The Influence of Automatic Enrollment, Catch-Up, and IRA Contributions on 401(k) Accumulations at Retirement” (Employee Benefit Research Institute and Investment Company Institute, 2005).

[2]IRA rollovers that originated from 401(k) plans are included in the projected accumulations.

[3]Choi, James J., David Laibson, Brigitte C. Madrian, and Andrew Metrick, “Saving For Retirement on the Path of Least Resistance,” originally prepared for Tax Policy and the Economy 2001, updated draft: July 19, 2004; and “For Better or For Worse: Default Effects and 401(k) Savings Behavior,” Pension Research Council Working Paper, PRC WP 2002-2 (Philadelphia, PA: Pension Research Council, The Wharton School, University of Pennsylvania, November 9, 2001).

[4]VanDerhei, J.,  The Expected Impact of Automatic Escalation of 401(k) Contributions on Retirement Income,” EBRI Notes no. 9 (Employee Benefit Research Institute, September 2007): 1‒8.

[5] VanDerhei, J., Copeland, C.,  The Impact of PPA on Retirement Income for 401(k) Participants EBRI Issue Brief, no. 318 (Employee Benefit Research Institute, June 2008).

[6]VanDerhei, Jack and Lori Lucas, The Impact of Auto-enrollment and Automatic Contribution Escalation on Retirement Income Adequacy,” EBRI Issue Brief, no. 349 (Employee Benefit Research Institute, November 2010).

[7]Results are limited to employees currently ages 25–29 and assumed to have 31–40 years of eligibility.

See also:

VanDerhei, J. “The Impact of Automatic Enrollment in 401(k) Plans on Future Retirement Accumulations: A Simulation Study Based on Plan Design Modifications of Large Plan Sponsors”. EBRI Issue Brief, no. 341 (Employee Benefit Research Institute, April 2010).