“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.

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

By Jack VanDerhei, EBRI

VanDerhei

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

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

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

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

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

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

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

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

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

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

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

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

News coverage:

PlanSponsor Perspectives: “Starting Points”

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

Endnotes


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

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

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

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

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

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

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

See also:

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

Latest EBRI/ICI 401(k) Database Update

The average 401(k) retirement account balance rose 31.9 percent in 2009, according to a report released today by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) analyzing a group of consistent participants. The rise in 2009 was in line with the 2003–2007 pattern of steady increase in account balances and in contrast to the 27.8 percent decline in 2008.

The EBRI/ICI report, 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2009, is based on the largest database of its kind, with records on 20.7 million participants at year-end 2009, including 4.3 million consistent participants—those who have had 401(k) accounts with the same 401(k) plan each year from year-end 2003 through year-end 2009.

The full report is being published simultaneously by EBRI and ICI and is on their websites (EBRI’s is here, ICI’s is here).

The joint press release is here.

The Nov. 29 webinar where co-authors Jack VanDerhei (EBRI) and Sarah Holden (ICI) presented the results is online here.

Some initial media coverage of the report:
* Bloomberg/ Business Week
* Reuters
* Minneapolis Star-Tribune
* Financial Planning

The National Retirement Income Adequacy Deficit: $4.6 Trillion

The total aggregate national deficit in U.S. retirement income adequacy is an estimated $4.6 trillion—or about $48,000 per-individual average, according to congressional testimony by the nonpartisan Employee Benefit Research Institute (EBRI).

Reflecting the importance of Social Security, the EBRI analysis finds that if Social Security retirement benefits were eliminated, the aggregate retirement income deficit would almost double, to $8.5 trillion, or an individual average of approximately $89,000.

“These numbers show that the national retirement income deficit—which is already quite large—would almost double without current-level Social Security benefits,” said Jack VanDerhei, EBRI research director, testifying at a hearing Oct. 7 by the Senate Committee on Health, Education, Labor and Pensions.

VanDerhei’s full testimony is online here. The press release is online here. The Senate HELP Committee’s website for the hearing is online here.

EBRI’s analysis is based on its unique Retirement Income Security Projection Model (RSPM®), which EBRI has developed since the late 1990s to estimate how much money Americans will need for “basic” expenses (food, shelter, etc.) and uninsured health care costs in retirement, and what financial resources they are likely to have at retirement age. Earlier this year, EBRI released its 2010 Retirement Readiness Rating,™ (online here) which showed the degree to which Baby Boomers and GenXers are likely to be “at risk” of running short of money in retirement.

New EBRI IRA Database Finds Owners With Multiple IRAs Raise Average Balance by 25%

A new and unique EBRI database on individual retirement accounts (IRAs) — just released — for the first time will allow researchers to more accurately measure IRA assets and ownership across multiple data providers, and to track retirement assets as they move through different types of retirement plans.

For instance, the EBRI IRA DatabaseTM finds that when owners of more than one IRA are identified and their assets are combined, their total IRA balance is about 25 percent higher than the unaggregated account average within the database.

The press release is online here. The full report is published in the September 2010 EBRI Issue Brief, “IRA Balances and Contributions: An Overview of the EBRI IRA Database,” and is online here.

IRA Balance by Type and Gender

The EBRI IRA DatabaseTM is unique in that it can link the accounts of individuals with more than one account in the database, thus aggregating total IRA assets and giving a more realistic picture of their IRA-based retirement savings. Not only will EBRI be able to link individuals within and across data providers in the database, but in the near future it will also be able to link the data with participants in 401(k) plans, allowing retirement funds to be tracked as they are generated, rolled over, and ultimately used. The data security techniques used by data providers assure that EBRI has no ability to identify individuals, so that all privacy is assured.

“IRAs are an incredibly important piece of the retirement puzzle, since they hold the largest single share of the $13 trillion in U.S. retirement assets,” said Craig Copeland, senior research associate at EBRI and author of the study. “This new database will allow us to generate unique and extremely valuable information about how Americans are using IRAs, including rollover IRAs which hold funds that were accumulated in employment-based defined benefit and defined contribution plans, for retirement.”

The full report provides data on the four major types of IRAs, average and mean balances (including by gender), contributions and rollovers, and owners who max out on their IRA contributions.