“Out” Takes

Nevin AdamsBy 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.

“Short” Changed?

Nevin AdamsBy Nevin Adams, EBRI

My wife is fond of recounting one of our early dates when we ran out of gas.  Now, we were in the heart of a Chicago suburb at the time, not the middle of nowhere, and while the hour was late, I continue to maintain that it was a simple case of my misreading the gas gauge in a relatively new car with which I hadn’t yet gained a full appreciation for just how far I could push such things.  My wife, of course, has always accused me of a more “nefarious” purpose.

It would be more difficult to explain such an outcome these days.  We’ve gone from vehicles that simply had a floating gauge and a range of red at the 1/8 tank line, to those that have a solid and then a blinking yellow light, to ones that beep and flash and tell you how many miles you have left before you run out.

As inconvenient as running out of gas late at night can be, it surely pales in comparison to the prospects of running short of money in retirement.  EBRI has, for more than a decade now, used highly sophisticated modeling techniques to gauge the retirement readiness of baby boomers and Gen Xers.  One of the primary outputs of EBRI’s Retirement Security Projection Model (RSPM)[i] is the production of Retirement Readiness Ratings (RRRs), which represent the percentage of simulated life-paths that do not run short of money in retirement.  The 2014 version of RSPM found that over half of baby boomer and Gen Xer households would not run short of money in retirement.  However, when the results were analyzed by preretirement wage quartile, we found that while 86.4 percent of the highest income quartile were projected to not run short, just 16.8 percent of the lowest income quartile would not.

While it is useful, certainly from a public policy perspective, to know not only how many but also what types of individuals are projected to run short of money in retirement, it begs the question: when will they run short?

A recent EBRI Notes article[ii] provides new results showing how many years into retirement baby boomer and Gen Xer households are simulated to run short of money, by preretirement income quartile and for a variety of assumptions, as well as taking into account the impact of the potentially catastrophic expenses of nursing home and home health care expenses.  Not surprisingly, it finds that those in the lowest income brackets are most likely to run short.

Moreover, while some in all income brackets—including the highest—may run short at some point during their retirement, the EBRI analysis also found that, when nursing home and home health care expenses are factored in, the number of households in the lowest income quartile that are projected to run short of money within 20 years of retirement is considerably larger than those in the other three income quartiles combined.

The EBRI analysis provides valuable insights for policymakers, providers and employers alike because, whether you’re concerned about running out of gas short of your destination – or short of money in retirement – it’s important that your gauges be accurate, and appropriate to the vehicle in which you’re riding there.

  • Notes

[i] A Brief Description of EBRI’s Retirement Security Projection Model® is available here.

[ii] The June EBRI Notes article, ““Short” Falls: Who’s Most Likely to Come up Short in Retirement, and When?” is available online here.

“Off” Putting

By Nevin Adams, EBRI

Nevin Adams

I’ve never been very keen on going to the dentist.  As important as I believe dental hygiene to be, I’ve come to associate my visits with the dentist with bad things: some level of discomfort, perhaps even pain, a flossing lecture from the hygienist, at the very least.  Most of which is readily avoided by doing the things I know I should be doing regularly – brushing, flossing, a better diet.  And knowing that I haven’t done what I should have been doing, I have good reason to believe that my visit to the dentist will be a negative experience – and so I put it off.

However, it’s not as though the postponement makes the situation any better; if anything, the delay makes the eventual “confrontation” with reality worse.  That’s what retirement planning is like for many: They know they should be saving, know that they should be saving more, but they hesitate to go through the process of a retirement needs calculation because they are leery of the “pain” of going through the exercise itself, or perhaps even afraid that their checkup will confirm their lack of attentiveness to their fiscal health.  And, like the postponed dental visit, putting it off not only does nothing to rectify the situation, the passage of time (without action) may even allow the situation to worsen.

Indeed, the Retirement Confidence Survey (RCS)[i] has previously found that workers who have done a retirement needs calculation tend to be considerably more confident about their ability to save the amount needed for a financially comfortable retirement than those who have not done so, despite the fact that those doing a calculation tend to cite higher retirement savings goals.  In the 2013 RCS, 31 percent who have done a calculation, compared with 14 percent who have not, say they are very confident that they will be able to accumulate the amount they need, while 12 percent who have not done a calculation, compared with 3 percent who have, report they are not at all confident in their ability to save the amount needed for a financially comfortable retirement.

Next week we’ll commemorate America Saves Week[ii], an annual opportunity for organizations to promote good savings behavior[iii] and a chance for individuals to assess their own saving status.  Not because saving is something you should do once a year, or that reconsidering your financial goals and progress is well-suited to a particular week on the calendar, but because it IS something that should be done regularly in order to be effective.

Over time, I have found that when I make (and keep) regular dentist appointments, those visits are much less painful, and considerably less stressful than the times when I have gone “too long” between appointments.

Similarly, regular savings checkups – like those inspired by events like America Saves Week – can be a lot less “painful” than you might think.

Notes

You can assess your savings plan here.

For a list of six reasons why you—or those you care about—should save, and specifically save for retirement now, see “Sooner or Later“:


[i] Information from the 2013 Retirement Confidence Survey (RCS) is available online here. Organizations interested in underwriting the 2014 RCS can contact Nevin Adams at nadams@ebri.org.  

[ii] America Saves Week is an annual event where hundreds of national and local organizations promote good savings behavior and individuals are encouraged to assess their own saving status. Coordinated by America Saves and the American Savings Education Council, America Saves Week is February 24–March 1, 2014, a nationwide effort to help people save more successfully and take financial action. More information is available at www.americasavesweek.org.

[iii] Organizations interested in building/reinforcing a workplace savings campaign can find free resources at www.asec.org  including videos, savings tips, and the Ballpark E$stimate® retirement savings calculator, courtesy of the American Savings Education Council (ASEC).

Safety “Net”

By Nevin Adams, EBRI

Nevin Adams

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.

A Year-End Review

By Nevin Adams, EBRI

Nevin Adams

This is the time of year when many people both look back at the year just past—and ahead to the next with a fresh perspective. It’s also that time of year when many make lists.

So, whether you’re looking to make some New Year’s resolutions, or just looking to improve your overall financial situation, here are 10 things to check off your 2013 list—and to get your 2014 list off to a strong start.

 

  1. Deal with debt (see Savings Resolutions for the New Year).
  2. Establish a savings goal for retirement (see Estimate “Ed”).
  3. Save for retirement—at work, or on your own (see Saving for Retirement Outside of Work).
  4. Save early so that your savings can work for you (see The “Magic” of Compounding).
  5. If you do have a retirement plan at work, make the most of it (see Making the Most of your Retirement Plan).
  6. Maximize your savings—see if you’re eligible for the Savers’ Credit (see Credit Where Credit is Due).
  7. See if a Roth 401(k) makes sense for your situation (see To Roth or Not?).
  8. Know how much you’re paying for your retirement savings (see Shedding Some Light on your Workplace Retirement Plan Fees).
  9. Keep an eye on your retirement savings investments (see Are Your Savings Investments Over-weighted?).
  10. Don’t forget that you may have other important savings goals as well (see College “Education”–Saving For College).

Of course, a good place to start—any time—is to Choose to Save.® You can find a wide variety of tools and resources—including the popular and widely recommended BallparkE$timate—at www.choosetosave.org[1]

If you are interested in, or working on, issues of financial literacy or savings education, you’ll want to check out $avings Account$, a free monthly update from the American Savings Education Council (ASEC) on the latest research and updates on new (and old but relevant) tools, as well as keep you up-to-date on various events, conferences, and symposiums relevant to ASEC’s Mission: To make saving and retirement planning a priority for all Americans.  You can sign up online here.

Notes


 

[1] Organizations interested in building/reinforcing a workplace savings campaign can also find a variety of free resources there, courtesy of ASEC.  Choose to Save® is sponsored by the nonprofit, nonpartisan Employee Benefit Research Institute Education and Research Fund (EBRI-ERF) and one of its programs, the American Savings Education Council (ASEC). The website and materials development have been underwritten through generous grants and additional support from EBRI Members and ASEC Partner institutions.

Take it or Leave it?

By Nevin Adams, EBRI
Nevin Adams

Nevin Adams

While each situation is different, in my experience leaving a job brings with it nearly as much paperwork as joining a new employer. Granted, you’re not asked to wade through a kit of enrollment materials, and the number of options are generally fewer, but you do have to make certain benefits-related decisions, including the determination of what to do with your retirement plan distribution(s).

Unfortunately, even in the most amicable of partings, workers have traditionally lacked the particulars to facilitate a rollover to either an individual retirement account (IRA) or a subsequent employer’s retirement plan—and thus, the easiest thing to do was simply to request that distribution be paid to him or her in cash.

Over the years, a number of changes have been made to discourage the “leakage” of retirement savings at job change: Legal thresholds for mandatory distributions have been set; a requirement established that distributions between $1,000 and $5,000 on which instructions are not received either be rolled over into an IRA or left in the plan; and even the requirement that a 20 percent tax withholding would be applied to an eligible rollover distribution—unless the recipient elected to have the distribution paid in a direct rollover to an eligible retirement plan, including an IRA. All these have doubtless served to at least give pause to that individual distribution “calculus” at job change.

Indeed, a recent EBRI analysis¹ indicates that workers now taking a retirement plan distribution are doing a better job at holding on to those retirement savings than had those in the past. Among those who reported in 2012 ever having received a distribution, 48.1 percent reported rolling over at least some of their most recent distribution into another tax-qualified savings vehicle, and among those who received their most recent distribution through 2012, the percentage who used any portion of it for consumption was also lower, at 15.7 percent (compared with 25.2 percent of those whose most recent distribution was received through 2003, and 38.3 percent through 1993).

As you might expect with the struggling economy, there was an uptick in the percentage of recipients through 2012 who used their lump sum for debts, business, and home expenses, and a decrease in the percentage saving in nontax-qualified vehicles relative to distributions through 2006. However, the EBRI analysis found that the percentage of lump-sum recipients who used the entire amount of their most recent distribution for tax-qualified savings has increased sharply since 1993: Well over 4 in 10 (45.2 percent) of those who received their most recent distribution through 2012 did so, compared with 19.3 percent of those who received their most recent distribution through 1993.

The EBRI report also notes that an important factor in the change in the relative percentages between the 1993 and 2012 data is the percentage of lump sums that were used for a single purpose. Consider that among those who received their most recent distribution through 2012, nearly all (94.0 percent) of those who rolled over at least some² of their most recent distribution did so for the entire amount.

There is both encouraging and disappointing news in the EBRI report findings: The data show that improvement has been made in the percentage of employment-based retirement plan participants rolling over all of their LSDs on job change, along with less frequent pure-consumption use of any of the distributions. However, the data also show that approximately 55 percent of those who took a lump-sum payment did not roll all of it into tax-qualified savings.

In common parlance, “Take it or leave it” is an ultimatum—an “either/or” proposition that frequently comes at the end, not the beginning, of a decision process. However, as the EBRI analysis indicates, for retirement plan participants it is a decision that can (certainly for younger workers, or those with significant balances) have a dramatic impact on their financial futures.

Notes
¹ The November 2013 EBRI Notes article, “Lump-Sum Distributions at Job Change, Distributions Through 2012,” is online here. 
² Two important factors in whether a lump-sum distribution is used exclusively for tax-qualified savings appear to be the age of the recipient and the size of the distribution. The likelihood of the distribution being rolled over entirely to tax-qualified savings increased with the age of the recipient at the time of receipt until age 64. Similarly, the larger the distribution, the more likely it was kept entirely in tax-qualified savings.

Use It or “Lose” It

By Nevin Adams, EBRI

nevinadams

At the time that EBRI was founded 35 years ago, I was about six months into a job doing pension accountings for a large Midwestern bank. At the time, I didn’t realize I’d still be working with those kinds of issues in 2013—in fairness, like most recent college graduates, I wasn’t really thinking about anything that was 35 years in the future. I had a job, a car that ran, and a reasonably nice stereo in an apartment in the Chicago suburbs that didn’t have much else.

My employer had a nice defined benefit (DB) pension, and an extraordinarily generous thrift-savings plan, but those weren’t big considerations at the time. I had to wait a year to participate in the latter (pretty much standard at the time), and as for the former—well, you know how exciting pension accruals are to 22-year-olds (even those who get paid to do pension accountings). Turns out, I worked there for nearly a decade, and walked away with a pretty nice nest egg in that thrift savings plan (that by then had become a 401(k)), and a pension accrual of…$0.00.

At the time, I didn’t think much about that.  Like many private-sector workers, I hadn’t contributed anything to that pension, and thus getting “nothing” in return didn’t feel like a loss.

By the time I left my second employer (this time after 13 years), the mandated vesting schedules had been shortened by legislation—but even then, the benefit I hope to collect one day won’t amount to much on an annual basis, and won’t be anything like the benefit that plan might have provided if only I had remained employed there – for the past 20 years. Instead, like my service with that prior employer, that DB benefit is frozen in time. That result stands in sharp contrast with the 401(k) balances I have accumulated and that continue to grow, despite having changed employers twice since then.

Of course, national tenure data suggest that my job experience was something of an anomaly.  When you consider that median job tenure in the United States  has hovered in the five-to-seven-year range going back to the early 1950s[i], there have doubtless been many private-sector workers who were, for a time, like me, participants in a traditional defined benefit pension plan, only to see little or nothing come of that participation[ii].

I often hear people say that 401(k)s were “never designed to replace pensions,” a reference to the notion that the benefit defined by most traditional pension plans stood to replace a significant amount of pre-retirement income at retirement.  Now, there’s no question that the voluntary nature of the 401(k) programs, as well as their traditional reliance on the investment direction and maintenance by participants, can undermine the relative contribution of the employer-sponsored plan “leg” to a goal of retirement income adequacy.

However, what often gets overlooked in the comparison with 401(k)s is that when you consider the realities of how most Americans work, traditional defined benefit realities frequently fell short of that standard as well. Indeed, in many cases, based on the kinds of job changes that occur all the time, and have for a generation and more, they could provide far less[iii].

In both cases, it’s not the design that’s at fault—it’s how they are used, both by those who sponsor these programs, as well as those who are covered by them.

Notes 


[i] See “Employee Tenure Trends, 1983–2012” available here.  

[ii] And a great number of private-sector workers never participated in a defined benefit plan.  See “Pension Plan Participation” available here.  

[iii] A recent EBRI Issue Brief provides a direct comparison of the likely benefits under specific types of defined contribution (DC) and DB retirement plans. See “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”.