“Out” Takes

By Nevin Adams, EBRI

My first car wasn’t anything special, other than it was my first car. It was an older model Ford, ran reasonably well, with one small problem— it went through oil almost as quickly as it did gasoline. At first I attributed that to being a function of the car’s age, but as the leakage grew, I eventually dealt with it by keeping a couple of quarts of oil in the trunk “just in case.” Eventually, I took the car to a dealership—but by the time they finished estimating the cost of a head gasket repair, let’s just say that, even on my limited budget, I could buy a LOT of oil by the quart, over a long period of time, and still be ahead financially.

“Leakage”—the withdrawal of retirement savings via loan or distribution prior to retirement— is a matter of ongoing discussion among employers, regulators, and policy makers alike. In fact, EBRI Research Director Jack VanDerhei was recently asked to present findings on “The Impact of Leakages on 401(k) Accumulations at Retirement Age” to the ERISA Advisory Council in Washington.[1]

EBRI’s analysis considered the impact on young employees with more than 30 years of 401(k) eligibility by age 65 if cashouts at job turnover, hardship withdrawals (and the accompanying six-month suspension of contributions) and plan loan defaults were substantially reduced or eliminated. The analysis assumed automatic enrollment and (as explicitly noted) no behavioral response on the part of participants or plan sponsors if that access to plan balances was eliminated.

Looked at together, EBRI found that there was a decrease in the probability of reaching an 80 percent real income replacement rate (combining 401(k) accumulations and Social Security benefits) of 8.8 percentage points for the lowest-income quartile and 7.0 percentage points for those in the highest-income quartile. Said another way, 27.3 percent of those in the lowest-income quartile (and 15.2 percent of those in the highest-income quartile) who would have come up short of an 80 percent real replacement rate under current assumptions WOULD reach that level if no leakages are assumed.

The EBRI analysis also looked at the impact of the various types of “leakage” individually. Of loan defaults, hardships, and cashouts at job change, cashouts at job change were found to have a much more serious impact on 401(k) accumulation than either plan loan defaults or hardship withdrawals (even with the impact of a six-month suspension of contributions included). The leakages from cashouts resulted in a decrease in the probability of reaching an 80 percent real replacement rate of 5.9 percentage points for the lowest-income quartile and 4.5 percentage points for those in the highest-income quartile. That effect from cashouts—not loans or hardship withdrawals—turns out to be approximately two-thirds of the leakage impact.

However, and as the testimony makes clear, it’s one thing to quantify the impact of not allowing early access to these funds—and something else altogether to assume that participants and plan sponsors would not respond in any way to those changes, perhaps by reducing contributions,[2] potentially offsetting some or all of the prospective gains from restricting access to those funds.

Because ultimately, whether you’re dealing with an old car or your retirement savings account, what matters isn’t how much “leaks” out—it’s how much you put in, and how much you have to “run” on.

Notes

[1] EBRI’s testimony for the ERISA Advisory Council, U.S. Department of Labor Hearing on Lifetime Participation in plans is available online here.  

[2] An EBRI/ICI analysis published in the October 2001 EBRI Issue Brief found that, “[o]n average, a participant in a plan offering loans appeared to contribute 0.6 percentage point more of his or her salary to the plan than a participant in a plan with no loan provision.” Testimony provided to the ERISA Advisory Council testimony notes that it’s likely that a similar relationship exists with respect to the availability of hardship withdrawals. See “Contribution Behavior of 401(k) Plan Participants,” online here.

Silver Linings

By Nevin Adams, EBRI

We all know people who manage to find the bright side of things, no matter how dire the situation—the folks who can spot a silver lining in every cloud. Then, of course, there are those who have an uncanny ability of discerning the cloud in every silver lining. In my experience, those in the former category know, and acknowledge, their inclination to accentuate the positive.

However, I’ve generally found that those in the latter category don’t view themselves as negative or pessimistic. Rather, they are inclined to see their perspective on the world as “realistic.”

A recent EBRI analysis[1] found that current levels of Social Security benefits, coupled with at least 30 years of 401(k) savings eligibility, could provide most workers—between 83 and 86 percent of them, in fact—with an annual income of at least 60 percent of their preretirement pay on an inflation-adjusted basis. Even at an 80 percent replacement rate, 67 percent of the lowest-income quartile would still meet that threshold. Those projections improve even more when you assume automatic enrollment and an annual contribution acceleration of 1 percent in 401(k) plans.

A more recent analysis[2] using EBRI’s Retirement Security Projection Model^® (RSPM) found that, due to the increase in financial market and housing values during 2013, the probability that Baby Boomers and Generation Xers would NOT run short of money in retirement improved—slightly (between 0.5 and 1.6 percentage points, based on the EBRI Retirement Readiness Ratings (RRRs). For early Boomers (those on the brink of retirement), the analysis found that more than half (56.7 percent) were projected not to run short of the funds they need to cover projected retirement expenses. On the other hand, nearly half are projected to run short (though not “out” of money, since Social Security benefits would continue to be paid).

In 2012, EBRI estimated that the national aggregate retirement income deficit number, taking into account current Social Security retirement benefits and the assumption that net housing equity is utilized “as needed,” was $4.3 trillion for all Baby Boomers and Gen Xers.[3]

Now, certainly compared with some of the figures[4] one hears bandied about these days, those might be considered relatively encouraging numbers. Some might even consider them optimistic, a “silver lining” in a looming retirement “crisis”⁵ cloud.

What the EBRI data show is that, based on current trends and savings patterns, many individuals will fare better financially in retirement than the headlines suggest—and a large number will not. Despite the clarion calls for action, and some shifts in the underlying dynamics, this is not a new issue for America. If a crisis looms, it is surely one of the most widely anticipated, long-standing, and debated issues of the past half-century.

EBRI data and modeling have previously quantified the kinds of plan design and policy changes that can help—and hinder—those results. The true “silver lining” is that there is yet time for many of those currently at risk of running short of funds to remedy that situation[6].

Notes

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[1] See “The Role of Social Security, Defined Benefits, and Private Retirement Accounts in the Face of the Retirement Crisis”.  

[2] See “What Causes EBRI Retirement Readiness Ratings™ to Vary: Results from the 2014 Retirement Security Projection Model.^®”

[3] See “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model.”      

[4] See “Whether Forecasts” online here.

5 For some perspective on the existence of a retirement “crisis,” see Dallas Salisbury’s keynote address at the Pensions&Investments West Coast Defined Contribution Conference online here.  

6 Particularly those who Chooseto$ave®org for your future!  Check out the resources at www.choosetosave.org, including the Ballpark E$timate.    

Safety “Net”

By Nevin Adams, EBRI

Nevin Adams

I’m one of those travelers who absolutely dreads cutting it to the last minute. Not that I haven’t been forced to do so, from time to time, but I’m generally the one chomping at the bit to get to the airport, or to hit the highway an hour before anyone else. In my defense, on more than one occasion that “cushion” has been the difference between catching a flight or not. Planning that only considers a “best” or “normal” scenario too often overlooks the unexpected—and sometimes that margin of error is all you have.

For over a decade EBRI has modeled the nation’s potential retirement savings shortfall, and the EBRI Retirement Readiness Ratings™ provide an assessment of how many Americans are at risk of running short of money for needed expenses in retirement. In contemplating expenses, that model considers the regular expenses of living in retirement, as well as uninsured medical expenses, and the potential costs of nursing home care.

However, we have also documented and quantified the role of Social Security, defined benefit and private retirement accounts on retirement income adequacy for Baby Boomers and Gen Xers with an eye toward replacing their preretirement wages and income. While this more traditional focus on income replacement may misstate an individual’s actual post-retirement financial situation, many financial planners work with this goal as a starting point, and it can provide valuable insights particularly when—as is the case with EBRI’s projections—it is able to leverage actual 401(k) data from the unique EBRI/ICI 401(k) database, the largest such repository in the world.

Indeed, based on a recent EBRI analysis, between 83 and 86 percent of workers with more than 30 years of eligibility in a voluntary enrollment 401(k) plan are simulated to have sufficient 401(k) accumulations that, combined with current levels of Social Security retirement benefits, will be able to replace at least 60 percent of their age-64 wages and salary on an inflation-adjusted basis. When the threshold for a financially successful retirement is increased to 70 percent replacement of age-64 income, 73–76 percent of these workers will still meet that threshold, relying only on 401(k) and Social Security combined. At an 80 percent replacement rate, 67 percent of the lowest-income quartile will still meet the threshold; however the percentage of those in the highest-income quartile deemed to be “successful” relying on just these two retirement components slips to 59 percent, reflecting the progressive nature of Social Security.

As positive a result as that seems for many, when the same analysis is conducted for automatic enrollment 401(k) plans (with an annual 1 percent automatic escalation provision and empirically derived opt-outs), the probability of success increases substantially: 88–94 percent at a 60 percent threshold; 81–90 percent at a 70 percent replacement threshold; and 73–85 percent at an 80 percent threshold.

That’s not quite the doomsday crisis scenario portrayed by many of the headlines in vogue today, though EBRI’s projections still show that a large number of Americans—even among those eligible for a 401(k) plan for 30 years—won’t be able to replace that pre-65 salary even at the various levels modeled, based on current savings patterns.

It does, however, illustrate the impact that changes in those current savings behaviors can have—and it underscores the significant role of Social Security as a vital safety net for the nation’s retirement security.

Note

“The Role of Social Security, Defined Benefits, and Private Retirement Accounts in the Face of the Retirement Crisis” is available online here.

“Lead” Times

By Nevin Adams, EBRI

There’s an old saying that you can “lead a horse to water, but you can’t make him drink.” It’s a sentiment expressed by many a benefits manager who has devoted significant time and effort to plan design, only to find the adoption rate by individual workers to be “disappointing.” And yet, in the retirement savings context, there’s ample evidence that individuals who have access to a savings plan at work do, in large part, take advantage of that opportunity.

Consider that average participation rates in excess of 70 percent are commonly reported in industry surveys, and that’s for plans that don’t take advantage of automatic enrollment. Moreover, previous EBRI research has pointed out that merely having access to a defined contribution plan at work can have a significant positive impact on one’s retirement readiness rating, simply because it greatly enhances the likelihood that those individuals WILL participate (1).

Those who say that you can only “lead a horse to water” might well expect that a horse will drink when it’s thirsty, or when it needs water—but equine experts will tell you that many horses refuse to drink when they need to most, especially in times of competition, illness, travelling or stress. So, while you may not be able to make them drink, it’s generally important for their health and well-being to find ways to encourage them to do so—adding a little salt in their diet, for instance, or putting an apple in their water bucket.

Similarly, all workers don’t have access to retirement plans at work, and those who do don’t always take full advantage of it—with some saving below the employer match levels of their plan, many older workers failing to take advantage of catch-up contributions, and a number of automatically enrolled workers leaving those relatively low initial default contribution rates in place.

There are, however, steps employers can take to help: Prior EBRI research has documented the profound influence of plan design variables, as well as employee behavior in auto-enrollment 401(k) plans (2). Not only the impact that automatic enrollment can have on retirement readiness, but what setting that initial default rate at 6 percent, rather than the “traditional” 3 percent (now codified in the Pension Protection Act of 2006) could mean in terms of improving retirement readiness “success.(3)”

For example, using actual plan-specific default contribution rates, and assuming an automatic annual deferral escalation of 1 percent of compensation; that employees opted out of auto-escalation at the self-reported rates from the 2007 Retirement Confidence Survey; and that they “started over” at the plan’s default rate when they changed jobs and began participation in a new plan; along with the assumption that the plan imposed a 15 percent cap on employee contributions, the EBRI analysis found that more than a quarter (25.6 percent) of those in the lowest-income quartile who had previously NOT been successful (under the actual default contribution rates) would then be successful (4) as a result of the change in deferral percentage.

As benefit plan professionals know, and as EBRI research has quantified, plan design can be effective at doing more than just leading workers to the opportunity to save for retirement—it can help them make decisions that improve their chances of success.

Notes

[1] See “’Retirement Income Adequacy for Today’s Workers: How Certain, How Much Will It Cost, and How Does Eligibility for Participation in a Defined Contribution Plan Help?” online here.  

[2] See “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,” online here.  

[3] See “Increasing Default Deferral Rates in Automatic Enrollment 401(k) Plans: The Impact on Retirement Savings Success in Plans With Automatic Escalation,” online here.  

[4] In this case, success equals a real replacement rate of 80 percent or more when combined with Social Security.

“Upside” Potential

By Nevin Adams, EBRI

Adams

I once spent a very uncomfortable period of time stuck in one of those carnival rides that, for brief periods of time, spins riders in a circle as the cab you are in also twirls. As uncomfortable as the ride was, the “stuck” part came while my cab was high in the air—and turned upside down. In no time at all, it was obvious that this extended “upside down” state wasn’t contemplated by those who designed the seating compartment (nor, apparently, had they considered that my compartment “mate” would find it exciting to rock our stuck cab during our brief “internment”).

One of the comments you hear from time to time is that the tax incentives for 401(k)s are “upside down,” that they go primarily to those at higher income levels, those who perhaps don’t need the encouragement to save. And from a pure financial economics perspective, those who pay taxes at higher rates might reasonably be seen as receiving a greater benefit from the deferral of those taxes.

Indeed, if those “upside-down incentives” were the only forces at work, one might reasonably expect to find that the higher the individual’s salary, the higher the overall account balance would be, as a multiple of salary. However, drawing on the actual administrative data from the massive EBRI/ICI 401(k) database, and specifically focusing on workers in their 60s (broken down by tenure and salary), those ratios hold relatively steady. In fact, those ratios are relatively flat for salaries between $30,000 and $100,000, before dropping substantially for those with salaries in excess of $100,000.

In other words, while higher-income individuals have higher account balances, those balances are in rough proportion to their incomes—and not “upside down.”

(click to enlarge)

As those who work with these programs know, what keeps these potential disparities in check is the series of limits and nondiscrimination test requirements: the boundaries established by Internal Revenue Code Secs. 402(g) and 415(c), combined with ADP and ACP nondiscrimination tests. Those plan constraints were, of course, specifically designed (and refined) over time to do just that—to maintain a certain parity between highly compensated and non-highly compensated workers in the benefits available from these programs. The data suggest they are having exactly that impact.

And that’s why focusing only on the incentives—and not also on the limits—can leave you “stuck” with only part of the answer.

“Better” Business?

By Nevin Adams, EBRI

Adams

It has become something of a truism in our industry that defined benefit plans are “better” than defined contribution plans. We’re told that returns are higher(1) and fees lower in the former, that employees are better served by having the investment decisions made by professionals, and that many individuals don’t save enough on their own to provide the level of retirement income that they could expect from a defined benefit pension plan. Even the recent (arguably positive) changes in defined contribution design—automatic enrollment, qualified default investment alternatives, and the expanding availability of retirement income options(2)—are often said to represent the “DB-ification” of DC plans.

However, a recent analysis by EBRI reveals that DB is not always “better,” at least not defined as providing financial resources in retirement. In fact, if historical rates of return are assumed, as well as annuity purchase prices reflecting average bond rates over the last 27 years, the median comparisons show a strong outcome advantage for voluntary-enrollment (VE) 401(k) plans over both stylized, final-average DB plan and cash balance plan designs.(3)

Admittedly, those findings are based on a number of assumptions, not the least of which include the specific benefit formulae of the DB plans, and the performance of the markets. Indeed, the analysis in the June EBRI Issue Brief takes pains not only to outline and explain those assumptions,(4) but, using EBRI’s unique Retirement Security Projection Model® (RSPM) to produce a wide range of simulations, provides a direct comparison of the likely benefits in a number of possible scenarios, some of which produce different comparative outcomes. While the results do reflect the projected cumulative effects of job changes and things like loans, as well as the real-life 401(k) plan design parameters in several hundred different plans, they do not yet incorporate the potentially positive impact that automatic enrollment might have, particularly for lower-income individuals.

Significantly, the EBRI report does take into account another real-world factor that is frequently overlooked in the DB-to-DC comparisons: the actual job tenure experience of those in the private sector. In fact, as a recent EBRI Notes article(5) points out, the data on employee tenure (the amount of time an individual has been with his or her current employer) show that so-called “career jobs” NEVER existed for most workers. Indeed, over the past nearly 30 years, the median tenure of all wage and salary workers age 20 or older has held steady, at approximately five years. Even with today’s accelerated vesting schedules, that kind of turnover represents a kind of tenure “leakage” that can have a significant impact on pension benefits—even when they work for an employer that offers that benefit, they simply don’t work for one employer long enough to qualify for a meaningful benefit.

So, which type of retirement plan is “better”? As the EBRI analysis illustrates, there is no single right answer—but the data suggests that ignoring how often people actually change employers can be as misleading as ignoring how much they actually save.

Notes

(1) In the days following publication of the EBRI Issue Brief, (“Reality Checks: A Comparative Analysis of Future Benefits from Private-Sector, Voluntary-Enrollment 401(k) Plans vs. Stylized, Final-Average-Pay Defined Benefit and Cash Balance Plans,” online here),  a number of individuals commented specifically on the chronicled difference in return in DB and DC plans; outside of some exceptions in the public sector, DB investment performance generally has no effect on the benefits paid.

(2) A recent EBRI analysis indicates that, even in DB plans, the rate of annuitization varies directly with the degree to which plan rules restrict the ability to choose a partial or lump-sum distribution. See “Annuity and Lump-Sum Decisions in Defined Benefit Plans: The Role of Plan Rules,” online here.

(3) While the DC plans modeled in this analysis draw from the actual design experience of several hundred VE 401(k) plans, in the interest of clarity it was decided to limit the comparisons for DB plans to only two stylized representative plan designs: a high-three-year, final-average DB plan and a cash balance plan. Median generosity parameters are used for baseline purposes but comparisons are also re-run with more generous provisions (the 75th percentile) as part of the sensitivity analysis.

(4) The report notes that a multitude of factors affect the ultimate outcome: interest rates and investment returns; the level and length of participation; an individual’s age, job tenure, and remaining length of time in the work force; and the purchase price of an annuity, among other things.

(5) The EBRI report highlights several implications of these tenure trends: the effect on DB accruals (even for workers still covered by those programs), the impact of the lump-sum distributions that often accompany job change, and the implications for social programs and workplace stability. “See Employee Tenure Trends, 1983–2012,” online here.

Starting (Over) Points

By Nevin Adams, EBRI

Adams

Earlier this week, an EBRI research report quantified the financial impact of setting a higher starting point for 401(k) default contributions—and it can be significant.

Most private-sector employers that automatically enroll their 401(k) participants do so at a default rate of 3 percent of pay,(1) a level consistent with the starting rate set out in the Pension Protection Act of 2006 as part of its automatic enrollment safe harbor provisions—but it’s a rate that many financial experts acknowledge is far too low to generate sufficient assets for a comfortable retirement.

EBRI has previously modeled the impact of automatic enrollment(2) (see “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,” online here).  In the most recent research, using EBRI’s proprietary Retirement Security Projection Model® (RSPM), the impact of raising the default contribution rate to 6 percent for younger workers (who might have 31–40 years of simulated 401(k) eligibility) in plans with automatic enrollment and automatic escalation was evaluated to see how many would be likely to achieve a total income real replacement rate of 80 percent at retirement.

As noted earlier, the higher starting default made a significant impact; more than a quarter of those in the lowest-income quartile who had previously NOT been simulated to have reached the initial replacement rate target (under the actual default contribution rates) would reach the target as a result of the increase in raising the starting deferral rate to 6 percent of compensation. Even those in the highest-income quartile would benefit, although not as much.(3)

But what about when those workers change jobs: Would they “start over” at the new employer’s starting default rate, or would they “remember” and carry their higher rate of savings at their prior employer into the new plan? The modeling actually looked at both those scenarios,(4) and found that 15–26 percent of the lowest-income quartile that would otherwise not have reached the target threshold under their existing plan-specific deferral rates would now do so at the 6 percent level, as would 13–22 percent of those in the highest-income quartile.

In life, “starting over” can be a painful, awkward process, as anyone who’s restarted a career or home can attest. But, depending on where you are starting from—and what kind of start you make—it can also be an opportunity.

Notes

(1) Which, it should be noted, also contemplates an annual 1 percent automatic escalation of that starting rate, up to a designated level. Neither the automatic enrollment nor automatic escalation provisions are mandated by the legislation, unless the plan sponsor wants to take advantage of the PPA safe harbor protections.

(2) One point that had been made clear in previous research was that some workers who were defaulted into a 401(k) auto-enrollment (AE) plan (without auto-escalation provisions) would continue to contribute at the defaulted contribution rate chosen, typically in the range of 3 percent of compensation. Traditionally, and in the absence of these AE provisions, many workers eligible for workplace retirement savings plans have voluntarily elected to start contributing at a 6 percent rate (a point commonly associated with the level of matching contribution incentive provided by employers). However, some participants in AE plans—who otherwise might have voluntarily chosen to participate at a higher contribution level—instead might simply allow their savings to start (and remain) at the default rate. As a result, they were likely contributing at a lower rate than if they had been working for a plan sponsor offering a voluntary enrollment (VE) 401(k) plan AND had made a positive election to participate.

(3) The modeling assumed actual plan-specific default contribution rates with (1) an automatic annual deferral escalation of 1 percent of compensation; (2) that employees opted out of that auto-escalation at the self-reported rates from the 2007 Retirement Confidence Survey findings; (3) that they “started over” at the plan’s default rate when they changed jobs and began participation in a new plan; and (4) that the plan imposed a 15 percent cap on employee contributions.

(4) Among other criteria, the modeling also considered auto escalation rates of 1 percent and 2 percent.

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

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^[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).