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.

Nursing Home Entry Rates Rise, Weigh on Wealth Levels

As more American senior citizens are entering nursing homes they face the likelihood that their household wealth will be quickly depleted, according to new research by EBRI.

The EBRI research notes that nursing home stays among older Americans have increased steadily during the past decade: Nursing home stays increased from 6 percent of those age 65 and older in 2000 to 8.5 percent in 2010.

Seniors face a number of retirement planning uncertainties like longevity risk, inflation risk, and investment risk, but perhaps none as critical to their retirement security as health risk. EBRI’s research also shows dramatic differences in wealth levels between those who enter a nursing home and those who do not, based on data from the Health and Retirement Study (HRS).

For instance, after respondents’ first entries into a nursing home, total household wealth fell steadily over a six-year period. By comparison, household wealth increased steadily over the survey periods for those who never entered a nursing home. The EBRI report notes that the average cost for a semi-private nursing home room in the United States is $207 a day (or $75,555 a year) and between 10–20 percent of those who enter a nursing home will stay there for more than five years.

“Given the potentially catastrophic expenditure shock associated with nursing home stays, it is very important to examine how those who entered nursing homes in the past or those who are still living in those facilities manage their portfolios following a nursing home entry,” said Sudipto Banerjee, EBRI research associate and author of the report. “Almost all types of assets decline fast and steadily for those who enter nursing homes. In contrast, similarly aged people who never enter nursing homes experience a steady increase in their assets.”

The full report is published in the June 2012 EBRI Issue Brief, “Effects of Nursing Home Stays on Household Portfolios,” online here. The press release is online here.

Returns “Engagement”

By Nevin Adams, EBRI

Adams

An acquaintance of mine once remarked, “you can’t solve a savings problem with investment returns.” Yet, participants frequently focus on the returns of their retirement savings investments.

Consider that during the month of May, major stock indexes like the Dow Jones Industrial Average and the S&P 500 were off 6 percent. But, according to an EBRI analysis, the estimated average 401(k) account balance¹ was down less than 3 percent during that same month, both due to the inflow of ongoing contributions and more diversified portfolio holdings.

That determination is based on estimates from the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project—the largest, most representative repository of information about individual 401(k) plan participant accounts. In fact, as of December 31, 2010, the EBRI/ICI database included statistical information on about 23.4 million 401(k) plan participants, in nearly 65,000 employer-sponsored 401(k) plans, representing $1.414 trillion in assets.

Using that database, which includes demographic, contribution, asset allocation, and loan and withdrawal activity information for millions of participants, EBRI has produced estimates of the cumulative changes in account balances—both as a result of contributions and investment returns— for several combinations of participant age and tenure.

While the estimated monthly movements² are interesting, they aren’t nearly as important as the perspective the database offers on long-term trends. For example, while the financial crisis of 2008 had a significant impact on retirement savings balances, as of June 5, 2012, more than 94 percent of the consistent participants in the database are estimated to have balances higher than they did at the pre-recession market peak (October 9, 2007).

During election cycles, voters are frequently asked “are you better off now than you were four years ago?” The answer, at least when it comes to consistent participants and their retirement savings accumulations, would seem to be “yes.”

Notes

¹ For “consistent” participants, that is, participants assumed to be in the 401(k) plan at the beginning and end of the specific reporting period.

² EBRI updates the change in 401(k) balances each month at http://www.ebri.org/index.cfm?fa=401kbalances . Here you will find both a listing of “Cumulative Change,” a projected cumulative percentage change in account balances for consistent participants since the last annual update of the database. Additionally, the monthly rate of change in average account balances is presented for those same individuals. For assistance on interpreting these results, please contact Jack VanDerhei at vanderhei@ebri.org

“Better” Pill?

By Nevin Adams, EBRI

Adams

As a growing number of Americans near and enter retirement, concerns about the cost of post-retirement health care expenses loom larger. In fact, worker confidence about their ability to pay for medical expenses after retirement was just half what they expressed about their ability to pay for basic retirement expenses (see EBRI’s 2012 Retirement Confidence Survey).

Little wonder, since a recent EBRI Issue Brief noted that health-related expenses are not only the second-largest component in the budget of older Americans, they are the only component which steadily increases with age (see “Expenditure Patterns of Older Americans, 2001‒2009″).

Recognizing the potential financial impact, recent industry surveys have put a figure on the cost of post-retirement health care expense(1)—a figure above and beyond that of merely living in retirement. EBRI has gone to great lengths to model the major risks to retirement income adequacy—all the way back to the introduction of the EBRI Retirement Savings Projection Model (RSPM)® in 2003, including the incorporation of stochastic health care risks, such as nursing home and home health care costs.(2)

The RSPM has incorporated those expenses because, while those events will not be experienced by all retired households, or experienced to the same extent, when they do occur they can have catastrophic financial consequences for a household’s future retirement income adequacy. Many attempts to model retirement income adequacy either ignore this risk altogether, or just assume that all households purchase long-term care insurance at retirement—the former ignores a significant financial reality, while the latter glosses over reality.

Indeed, a major limitation of using income replacement rates as an accumulation target is that doing so generally fails to take into account these potentially catastrophic costs. How much difference does this make? A recently updated version of the RSPM(3) shows that, with the financial impacts of long-term care (nursing home and home health care costs) modeled, 68 percent of single male Gen Xers are projected to have no financial shortfall in retirement. On the other hand, if those long-term care costs are ignored, fewer than 1 in 10 would be projected to run short of funds in retirement. Similar results were found for single female and married Gen Xers.

The gaps are even more noticeable if you focus only on the situation of individuals with projected shortfalls in excess of $100,000. Ignoring long-term care costs, fewer than 1 percent of single male or married Gen Xers are projected to have shortfalls in excess of $100,000; however when you take those costs into account, approximately 18 percent of single males and 10 percent of families are now in this range, according to the model. The results are even more pronounced for single females, where ignoring those long-term care costs would indicate that fewer than 5 percent are modeled to experience shortfalls of more than $100,000, compared with approximately 34 percent when this reality is factored in.

It’s clear that those long-term care costs can be significant, and can have a dramatic impact on retirement security.

What’s less clear is why projections of retirement income needs and preparedness would continue to overlook them.

Notes

(1) For more information, see “The Impact of Repealing PPACA on Savings Needed for Health Expenses for Persons Eligible for Medicare,” EBRI Notes, August 2011, online here.

(2) The Retirement Security Projection Model® (RSPM) was developed in 2003, and in 2010 it was updated it to incorporate several significant changes, including the impacts of defined benefit plan freezes, automatic enrollment provisions for 401(k) plans, and the recent crises in the financial and housing markets. EBRI has recently updated RSPM to account for changes in financial and real estate market conditions as well as underlying demographic changes and changes in 401(k) participant behavior since January 1, 2010. For more information on the RSPM, check out the May 2012 EBRI Notes, “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model,®” online here.

(3) More information about this update will be published in June 2012 EBRI Notes.

Average IRA Balances a Third Higher When Multiple Accounts are Considered

The average IRA balance is about a third higher and the median (mid-point) balance is almost 42 percent larger when multiple individual retirement accounts (IRAs) owned by an individual are taken into account, according to a new report by the nonpartisan Employee Benefit Research Institute (EBRI).

EBRI’s new analysis, based on its unique EBRI IRA Database,™ shows that in 2010 the average IRA individual balance (all accounts from the same person combined) was $91,864, while the median balance was $25,296. By comparison, the average and median account balance of all IRAs was $67,438 and $17,863, respectively. Compared with 2008, the average and median individual balances are up 32 and 26 percent, respectively.

“The results show the importance of being able to look at an aggregation of an individual’s combined account balances to determine the potential total retirement savings he or she has,” said Craig Copeland, EBRI research associate and author of the report. The report provides results for the second year of data available from the EBRI IRA Database.™

The full report is published in the May 2012 EBRI Issue Brief, “Individual Retirement Account Balances, Contributions, and Rollovers, 2010: The EBRI IRA Database,™” online at http://www.ebri.org It analyzes 2010 data from the more than 11 million individuals with more than $1 trillion in the EBRI IRA Database™ and highlights the distribution of IRA owners by IRA types, account balances, rollovers, and contributions to IRAs. A unique aspect of the EBRI IRA Database™ is the ability to link the balances of individuals with more than one account in the database, providing a more complete picture of their IRA-based retirement savings.

The press release is online here. The full report is online here.

Halfway Honed

By Nevin Adams, EBRI

Adams

This week we published(1) the results of an update of EBRI’s Retirement Readiness Rating from the Retirement Security Projection Model® (RSPM). That model, which has been modified over the years to take into account certain structural and market changes,(2) projects that more than half (56 percent) of Boomers and Gen Xers will be able to retire with enough money to cover the cost of basic retirement needs as well as uninsured health care costs, including stochastic expenses from nursing home and home health care.(3)

On the other hand, that same model projects that about 44 percent won’t have “enough” to cover those expenses.

It’s worth noting that the trends are positive. Even after the toll of the 2008 financial crisis, the 2012 number of those at risk of running short is some 5−8 percentage points “better” than what was found in 2003. Moreover, the analysis is able to point to some important trends; eligibility for a workplace retirement plan remains a significant factor in reducing the risk of running short,(4) while the more recent broad-based advent of automatic enrollment plan designs makes it ever more likely that those eligible to participate—particularly lower-income workers—do so.

The research does point out that lower-income households are much more likely to be at risk for insufficient retirement income,(5) even though basic retirement expenses are modeled as a function of the household’s expected retirement income. In fact, the 2012 baseline ratings for Early Boomers range from a projection that 87 percent of the simulated lifepaths for the lowest-income households are at risk in retirement to only 13 percent of retired highest-income households.

Obviously, the reality of more than 4 in 10 Americans not having sufficient post-retirement wealth is of concern, though I find that many are pleasantly surprised at how high a percentage is expected to have sufficient assets. Indeed, whether one draws comfort from that finding likely depends on your expectations (and perhaps on which side of that line you think you might find yourself post-retirement).

Regardless of those expectations—and whether you find the picture to be one of a glass half full or half empty—the data give us all something to work with, and to work toward.

Notes

(1) EBRI Notes May 2012, “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model,®” online here. 

(2) The Retirement Security Projection Model® (RSPM) was developed in 2003, and in 2010 it was updated it to incorporate several significant changes, including the impacts of defined benefit plan freezes, automatic enrollment provisions for 401(k) plans and the recent crises in the financial and housing markets. EBRI has recently updated RSPM for changes in financial and real estate market conditions as well as underlying demographic changes and changes in 401(k) participant behavior since January 1, 2010.

(3) 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 meet aggregate minimum retirement expenditures, defined as a combination of deterministic expenses from the Consumer Expenditure Survey (as a function of income) as well as some health insurance and out‐of‐pocket health‐related expenses, plus stochastic expenses from nursing home and home health care (at least until the point such expenses are picked up by Medicaid). The resources in retirement are assumed to consist of Social Security (status quo benefits for the baseline version of the simulation); account balances from defined contribution plans; individual retirement accounts (IRAs) and/or cash balance plans; annuities or lump-sum distributions from defined benefit plans; and 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 and other thresholds.

(4) For an idea of just much of an impact plan eligibility makes, consider that, according to the simulation results, Gen Xers with no future years of eligibility would run short of money in retirement 60.7 percent of the time, whereas fewer than 1 in 5 (18.2 percent) of those with 20 or more years of future eligibility would run this risk.

(5) In addition to underlining the importance of automatic enrollment for the lowest income, this also underlines the importance of Social Security as a post-retirement income source for this group.

EBRI: Auto-Enrollment Trend Boosts Retirement Readiness Ratings

More than half of Baby Boomers and Generation Xers are projected to have adequate retirement income to cover basic expenses and uninsured health care costs, according to the latest projections by the nonpartisan Employee Benefit Research Institute (EBRI).

While roughly 44 percent of Baby Boomers and Generation Xers are still projected to be “at risk” of running short of money in retirement, that’s still some 5–8 percentage points better than what was found in 2003, largely due to the increased adoption of auto-enrollment plan design features by 401(k) plan sponsors. “These latest results are a significant improvement,” noted Dr. Jack VanDerhei, EBRI research director and author of the report. The new EBRI projections, based on its proprietary Retirement Income Security Projection Model® (RSPM), update previous estimates from 2003.

According to the RSPM, lower-income households remain at greatest risk of insufficient retirement income: 87 per-cent of retired lowest-income households are projected to be at risk, compared with 13 percent of highest-income households. EBRI’s analysis finds that the aggregate national retirement income deficit number, taking into account current Social Security retirement benefits and the assumption that net housing equity is utilized “as needed,” is currently estimated to be $4.3 trillion for all Baby Boomers and Gen Xers.

Eligibility for a workplace defined contribution retirement plan was found to have a significant positive impact on these “at risk” levels: Simulation results show that Gen Xers with no future years of eligibility would run short of money in retirement 60.7 percent of the time, whereas fewer than 1 in 5 (18.2 percent) of those with 20 or more years of future eligibility would run this risk.

EBRI’s updated 2012 RSPM looks at Early Baby Boomers (individuals born between 1948–1954), Late Baby Boomers (born between 1955–1964), and Generation Xers (born between 1965–1974), to determine each group’s likelihood of running short of money to cover basic expenses and uninsured health costs in retirement.

EBRI’s analysis also provides Retirement Savings Shortfalls—the additional amount that individuals would have save by age 65 to eliminate their expected deficits in retirement—by age group, family status, and gender for both Baby Boomers and Gen Xers. For those on the verge of retirement (Early Boomers), the average cash shortfalls at retirement age range from approximately $22,000 (per individual) for married households, to $34,000 for single males and $65,000 for single females. However, when taking into account only those projected to run short of funds, the average shortfalls at retirement age are higher: approximately $70,000 (per individual) for married households, $95,000 for single males and $105,000 for single females.

The full report is published in the May 2012 EBRI Notes, “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model,®” online at www.ebri.org

State “Capital”

By Nevin Adams, EBRI

Adams

This past week I had the opportunity to attend the National Financial Capability Study Roundtable, where a variety of researchers (including EBRI’s Sudipto Banerjee) presented, discussed, and challenged a variety of research papers on topics ranging from financial literacy and retirement planning to financial advice, and from financial literacy and financial behavior to “Prohibition, Price Caps and Disclosure.” Taken as a whole, the day’s discussions focused on ways to better understand and measure the factors that appear to influence individual behaviors regarding their finances.

Simply stated, financial literacy is generally described as the ability to understand finance. More recently, some have begun to focus on financial capability.¹ Research has shown that people with higher levels of financial literacy approach retirement with much higher levels of wealth. However, a growing body of research also suggests that most Americans have limited knowledge about concepts such as inflation, compound interest, and risk diversification at a time when they face an increasingly complex financial planning process alongside an expanding set of saving, investment, and decumulation options.

Drawing on data from the National Financial Capability Study (NFCS),² designed by the FINRA Investor Education Foundation (an ASEC-member firm), Dr. Banerjee’s report³ noted that the chances of having a bad financial behavior decreases with age, and that the chances of exhibiting a bad financial behavior go down with education and income. Interestingly enough, full-time and part-time workers, homemakers, sick or disabled, and unemployed or laid-off individuals were all more likely to have bad financial behavior than self-employed people.

That said, the report specifically examined the role of where you live—specifically the state in which individuals live—in explaining financial literacy and behavior. It also ranked all U.S. states in terms of financial literacy and financial behavior of its residents.

Financial literacy and financial behavior are strongly associated with an individual’s age, income, education and other demographic characteristics. The study shows that, after controlling for the effect of these individual demographic characteristics, most bottom-ranked states had a statistically significant effect on their residents’ financial literacy and almost all states have a statistically significant effect on their residents’ financial behavior. However, the chance of exhibiting “worse” financial behavior increased as the financial behavior ranking dropped.

According to the report, this suggests that there might be factors shaping individual financial literacy and behavior other than individual demographic characteristics–and they might be influenced by the state in which people live.

Notes

¹ The National Financial Capability Study identifies four key components of financial capability as (1) making ends meet, (2) planning ahead, (3) managing financial products, and (4) financial knowledge and decision-making. The report is online here.

² The National Financial Capability Study is available online here.

³ Banerjee’s paper, including the state rankings, is online here.  See also “How Do Financial Literacy and Financial Behavior Vary by State?” in EBRI Notes, November 2011, 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.

What’s Next?

By Nevin Adams, EBRI

Adams

In just a couple of weeks, tens of thousands of students (including a daughter of mine) will graduate from college. For most, it’s a journey of joys, trials and tribulations, an education, not just from a textbook or a professor’s wisdom, but the insights that one can only get from actually living through a different stage of life. Those students set out upon that journey years ago, and, doubtless following careful deliberation and the counsel of friends, families, and a few trusted advisors, a course was set. A course that many “adjusted”—by choice and sometimes of necessity—over the course of the last few years, but a course for their future, nonetheless.

Now the question is—what will they do next?

As parents, we spend a lot of time, energy, and money trying to help our children make good choices, but at a certain point, most of us step back, grit our teeth (and sometimes close our eyes), and hope that they do. Those decisions aren’t always the ones we would make—but, ready or not, they are made, sometimes for the better, sometimes not.

Similarly, this industry has expended a lot of time, energy, and money over the years to try and help individuals make good decisions about preparing for retirement. A growing number of individuals are now entering this new stage in their lives, and we ask ourselves, “Are they ready?”

In answer to that question, we can look at their individual situations and make certain projections about that readiness, based on their health, their gender, their income levels pre-retirement, and their likely levels of spending post-retirement, among other things.(1)   But what will ultimately matter is what they do next—and that’s a factor not just of how much savings they have (or think they have) at the point of retirement, or the amount of other resources they may have available then (and thereafter), but how those resources are now invested, how they are invested over time, and how—and when—those resources are spent.

The factors that influence those decisions, as well as their results and potential consequences will, of course, continue to be a key focus for EBRI(2)  in the years to come—just as EBRI’s nonpartisan gathering, analyzing, and modeling the impact of behavioral, plan design, and regulatory influences has provided critical insights on those individual preparations for nearly 35 years now.

It matters because knowing what this generation does “next” is likely to be an important part of helping the next generation do better.

Endnotes

1) See the July 2010 EBRI Issue Brief for more information on the EBRI Retirement Readiness Rating,™ online here.  The 2010 update uses the most recent data and considers retirement plan changes (e.g., automatic enrollment, auto-escalation of contributions, and diversified default investments resulting from the Pension Protection Act of 2006) as well as updates for financial market performance and employee behavior (based on a database of 24 million 401(k) participants). Results will be updated next month, in our May EBRI Notes.

2) More information on the EBRI Center for Research on Retirement Income is available online here. For information about becoming a Research Partner, contact Nevin Adams, at nadams@ebri.org