Reality “Checks”

A recent opinion piece by Teresa Ghilarducci in the New York Times took on what she termed a “ridiculous approach to retirement,” drawn from what appears to be a series of “ad hoc” dinner conversations with friends about their “retirement plans and prospects.”

Most of the op-ed focused on the perceived shortfalls of the voluntary retirement savings system: People don’t have enough savings, don’t know how much “enough” is, make inaccurate assumptions about the length of their lives and their ability to extend their working careers, and aren’t able to find qualified help to help them make more appropriate savings decisions. In place of the current system, which Ghilarducci maintains “will always fall short,” she proposes “a way out” via mandatory savings in addition to the current Social Security withholding. Consider that, just three sentences into the op-ed, she posits the jaw-dropping statistic that 75 percent of Americans nearing retirement age in 2010 had less than $30,000 in their retirement accounts.

“You don’t like mandates? Get real,” she declares.

When we looked across the EBRI database of some 2.3 million active¹ 401(k) participants at the end of 2010 who were between the ages of 56 and 65, inclusive – people who have chosen to supplement Social Security through voluntary savings – we found only about half that number (37 percent) with less than $30,000 in those accounts. Moreover, when looking at those in that group who have more than 30 years of tenure, fewer than 13% are in that circumstance – and neither set of numbers includes retirement assets that those individuals may have accumulated in the plans of their previous employers, or that they may have rolled into Individual Retirement Accounts (IRAs), as well as pensions or other savings (see Average IRA Balances a Third Higher When Multiple Accounts are Considered).

That’s not to say that the financial challenges outlined in the op-ed won’t be a reality for some. In fact, EBRI’s Retirement Security Projection Model® (RSPM) developed in 2003, updated in 2010², finds that for Early Baby Boomers (individuals born between 1948 and 1954), Late Baby Boomers (born between 1955 and 1964) and Generation Xers (born between 1965 and 1974), roughly 44 percent of the simulated lifepaths were projected to lack adequate retirement income for basic retirement expenses plus uninsured health care costs (see “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model”) .

The op-ed declares that a voluntary Social Security system “would have been a disaster.” Indeed, an objective observer might conclude that that is why Congress originally established Social Security as a mandatory system, to provide a base of income for retirees as it still does today. With the underpinnings of that mandatory foundation of Social Security, the current voluntary system was established to allow employers and individuals to supplement that base. In recent decades Social Security’s benefits have been “reduced” by increases in the definition of normal retirement age, and a partial taxation of benefits, despite increases in the mandatory withholding rates, in order to adjust to the realities of rising costs from changing demographics. Even before the recent two-year partial withholding “holiday,” Congress was, and is still today, discussing additional adjustments to that mandatory system.

The voluntary system should be judged as just that, a voluntary system. As noted above, the data makes it clear that voluntary employer-based plans are, in fact, leading to a great deal of real savings accumulated to supplement Social Security. Many in the nation work every day to encourage those savings to be increased (see www.choosetosave.org ).

The “real” questions, certainly as one reflects on the debate over the Affordable Care Act mandate, amidst today’s political and economic turmoil, are whether the Congress and the nation will be willing – and able – to pay the price of an expanded or new retirement savings mandate, and, regardless of that outcome, how can a voluntary system be moved to higher levels of success?

Nevin E. Adams, JD

¹ Active in this case is defined as anyone in the database with a positive account balance and a positive total contribution (employee plus employer) for 2010.

² The RSPM was updated for a variety of 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.”

Last June EBRI CEO Dallas Salisbury participated in an “Ideas in Action with Jim Glassman” program discussion with Ghilarducci and Alex Brill from the American Enterprise Institute titled “America’s Retirement Challenge: Should We Ditch 401(k) Plans?” You can view it online here.

“Premature” Conclusions

A couple of months back, my wife noticed a water spot on the ceiling of our dining room. Now, it didn’t look fresh, but considering that that ceiling was directly underneath the master bath, she had the good sense to call a plumber. Sure enough, there was a leaky gasket—and from the look of it, one that had been there for some time before we took ownership. Fortunately, the leak was small, and the damage was minimal. Even more fortunately, we took the time to have the plumber check out the other bathrooms, and found the makings of similar, future problems well before the “leakage” became serious.

Homes aren’t the only place with the potential for problems with leakage. A recent report on 401(k) loan defaults suggests that “leakage”—the money being drawn out of retirement plans prior to retirement —is a lot larger than a number of industry and government reports have indicated. In fact, the report (online here) claims that “the leakage could be as high as $37 billion per year,” although it completes that sentence by acknowledging that the estimate depends “…on the source of the data on loans outstanding and the assumed default rate.”

The paper promotes a recommendation that ERISA be amended so that plans could choose to allow those who take out 401(k) loans to be defaulted into insurance that would repay those loans on default. It looks at a number of different sources to conclude that the available data do not really capture all the loan leakage (because some of it is obscured as part of distribution upon termination/separation from service), and that the available data do not (yet) capture the impact of the prolonged economic slowdown that is evidenced in other, non-401(k) loan trends.

Setting aside the validity of those conclusions, and the scale of their impact on the analysis, the issue of “leakage” remains a focus for many in our industry.

Late last year, an EBRI Issue Brief examined the status of 401(k) loans, noting that in the 2010 EBRI/ICI 401(k) database, 87 percent of participants in that database¹ were in plans offering loans, although as “has been the case for the 15 years that the database has tracked 401(k) plan participants, relatively few participants made use of this borrowing privilege.”

Indeed, from 1996 through 2008, on average, less than one-fifth of 401(k) participants with access to loans had loans outstanding. At year-end 2009, the percentage of participants who were offered loans with loans outstanding ticked up to 21 percent, but it remained at that level at year-end 2010 (see the full report, online here). This hard data, by the way, measuring activity by more than 23 million 401(k) participants.

If loan levels and amounts outstanding have remained relatively constant during this period (which included the “Great Recession”), one might nonetheless wonder about the overall impact on retirement readiness.

If you define “success” as achieving an 80 percent real replacement rate from Social Security and 401(k) accumulations combined, looking at workers ages 25–29 (who will have more than 30 years of simulated eligibility for participation in a 401(k) plan), then the decrease in success resulting from the COMBINATION of cashouts, hardship withdrawals, and loans is just 6.1 percent.² The impact when you add in the impact of loan defaults is less than 1 percentage point higher (approximately 7.1 percent for all four factors combined).

Looking at the overall impact another way, more than three-fifths of those in the lowest-income quartile³ with more than 30 years of remaining 401(k) eligibility will still be able to retire at age 65 with savings and Social Security equal to 80 percent of their real pre-retirement income levels, even when factoring in actual rates of cashout, hardship withdrawals, and loans—INCLUDING the impact of loan defaults.

The impact at an individual level can, of course, be more severe—something that will be explored by future EBRI research.

A Problem to Fix?

There is, however, a potentially larger philosophical issue: whether the utilization of these funds prior to retirement constitutes a “leakage” crisis that cries out for a remedy. We don’t know how many participants and their families have been spared true financial hardship in the “here-and-now” by virtue of access to funds they set aside in these programs. Nor do we know that individuals chose to defer the receipt of current compensation specifically for retirement, rather than for interim (but important) savings goals—such as home ownership or college tuition—that make their own contributions to retirement security. It’s hard to know how many of these participants would have committed to saving at all, or to saving at the amounts they chose, if they (particularly the young with decades of work ahead of them) had to balance that against a realization that those monies would be unavailable until retirement.

In fixing the recent leakage problem in our home, the plumber replaced the worn gaskets, but at the same time sought to improve on things by tightening (as it turns out, over-tightening) some of the connections further up the line. That extra step produced an unanticipated outcome that didn’t show up until the next day, in dramatic fashion. Like my plumbing problem, retirement plan “leakage,” unminded, has the potential to cause damage—to deplete and undermine retirement savings. However, a view that all pre-retirement distributions from these programs are a problem that requires redress not only ignores the law and regulations as written, it also has the potential to create unanticipated changes in savings behaviors.

And the data—based on hard data from actual participant balances and activity—indicate that such concerns are at least somewhat premature.

- Nevin E. Adams, JD


Notes

¹ The EBRI/ICI Participant-Directed Retirement Plan Data Collection Project is the largest, most representative repository of information about individual 401(k) plan participant accounts in the world. As of December 31, 2010, the EBRI/ICI database included statistical information about 23.4 million 401(k) plan participants, in 64,455 employer-sponsored 401(k) plans, representing $1.414 trillion in assets. The 2010 EBRI/ICI database covered 46 percent of the universe of 401(k) plan participants.

² Workers are assumed to retire at age 65 and all 401(k) balances are converted into a real annuity at an annuity purchase price of 18.62. Additionally, the projections assume no break in contributions occurs with a change in employers, that the maximum employee contribution is 6 percent of compensation.

³ Those in the higher income quartile have more trouble reaching the success threshold, given the PIA formula in Social Security. Cashouts, loans and hardship withdrawals have approximately the same impact as for those in the lowest income quartile.

Facts and “Figures”

A recent paper from the Center for Retirement Research at Boston College was titled “401(k) Plans in 2010: An Update from the SCF.” The SCF¹ (perhaps better known to non-researchers as the Survey of Consumer Finances) is, as its name suggests, a survey of consumer households “to provide detailed information on the finances of U.S. families.” It’s conducted every three years by the Federal Reserve, and is eagerly awaited and widely used—from analysis at the Federal Reserve and other branches of government to scholarly work at the major economic research centers. The 2010 version was published in June.

As valuable as the SCF information is, it’s important to remember that it contains self-reported information from approximately 6,500 households in 2010, which is to say the results are what individuals told the surveying organizations on a range of household finance issues (typically over a 90 minute period); of those households, only about 2,100 had defined contribution retirement accounts. Also, the SCF does not necessarily include the same households from one survey period to the next.

The CRR analysis incorporated some of the SCF data (ownership of a retirement plan account, participation, median 401(k)/IRA account balances, asset allocations within those accounts, and distribution/loan patterns). The report then brings in data from other sources on features such as automatic enrollment, hardship withdrawals, and IRAs to complete its assessment, summarized on its website as “Progress in the 401(k) system stalled in the wake of the economic crisis.”

The summary went on to note that “despite an increase in auto-enrollment, the percent of employees not participating ticked up,” “401(k) contributions slipped, while leakages through cash outs, loans, and hardship withdrawals increased”—and that, “…the typical household approaching retirement had only $120,000 in 401(k)/IRA holdings in 2010, about the same as in 2007.” Setting aside for a moment the question of what “typical” is, a logical research question arises: Are these statements a researcher’s extrapolation, or based upon hard data, and thus “facts”?

What We Know

EBRI research has previously noted that, while the financial crisis of 2008 had a significant impact on retirement savings balances, as recently as just a month ago, more than 94 percent of the consistent participants in the EBRI/ICI 401(k) database² are estimated to have balances higher than they did at the pre-recession market peak of October 9, 2007 (see “Returns Engagement”). According to a number of industry surveys, participation rates have remained relatively consistent, despite the soft economy and tumultuous market environment, and EBRI research finds comparable trends in loan activity (see “401(k) Plan Asset Allocation, Account Balances, and Loan Activity In 2010”). Also, at year-end 2010, the data show that 401(k) loan balances outstanding declined slightly from those in the past few years.

What else do we know?

We know that the number of future years that workers are eligible to participate in a defined contribution plan makes a tremendous difference in their at-risk ratings (See “Opportunity Costs”).

We know that automatic enrollment, where deployed, has a significant positive impact on retirement readiness (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”; “EBRI: Auto-Enrollment Trend Boosts Retirement Readiness Ratings”).

We know that “averages” are easy to understand, and relatively easy to calculate—but they don’t always provide an accurate³ portrayal of the real world (see “Above Average”).

We also know that it’s important to understand the source and composition of data—particularly when using self-reported results, drawing from multiple sources, and creating a composite perspective.

Nevin E. Adams, JD

(1) The 2010 Survey of Consumer Finances is available here.

(2) 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. The 2010 EBRI/ICI database covered 46 percent of the universe of 401(k) plan participants, and 47 percent of 401(k) plan assets.

(3) When analyzing the change in participant account balances over time, it is important to have a consistent sample. Comparing average account balances across different year-end snapshots can lead to false conclusions. For example, the addition of a large number of new plans (arguably a good event) to the database would tend to pull down the average account balance, which could then be mistakenly described as an indication that balances are declining, but actually would tell us nothing about consistently participating workers.

“Consistent” Messages

By some accounts, inertia has long been the bane of the voluntary retirement system—and a great deal of money and time has been spent overcoming the reluctance of workers to become savers, and of savers to do so at levels sufficient to achieve their retirement goals. 

That same inertia likely accounts for the fact that, once set on a savings course, or better still, set on one that improves on that initial setting,¹  participants in overwhelming numbers appear to “stay the course”—and do so through good times and times that aren’t as good. 

So, what happens to those participants who stay the course, those “steady,” consistent participants?  

The Employee Benefit Research Institute (EBRI), through the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project, has long tracked the changes in consistent participant accounts in a database that is the largest, most representative repository of information about individual 401(k) plan participant accounts in the world.² The EBRI/ICI project is unique because it includes data provided by a wide variety of plan recordkeepers and, therefore, portrays the activity of participants in 401(k) plans of varying sizes—from very large corporations to small businesses—with a variety of investment options.

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

And, for those millions of individual participant accounts in the database, we are able to project changes in those average balances based on actual individual rates of contribution and the investment choices in place at a specific point in time.³

As a result, we are able to estimate that the average account balance of an individual ages 25‒34, with one to four years of tenure at his or her current employer,⁴ increased 4.6 percent in June, while a participant ages 55‒64 with 20‒29 years of tenure had an average account increase of 2.5 percent.⁵ 

This capability is significant for several reasons.  It provides a monthly update of a comprehensive perspective on 401(k) account movement.  It has provided the ability to quickly and accurately estimate the impact of major market swings on a broad swathe of the 401(k) market.⁶ 

And it serves to remind us that those 401(k) balances are affected not just by the investment markets, but by the savings we invest—consistently.

-Nevin E. Adams, JD

You can access reports of both cumulative and monthly average account changes at http://www.ebri.org/?fa=401kbalances

¹ Via plan design devices such as automatic enrollment, contribution acceleration, or asset allocation funds that rebalance automatically over time.

² As of December 31, 2010, the EBRI/ICI database included statistical information on about 23.4 million 401(k) plan participants, in 64,455 employer-sponsored 401(k) plans, representing $1.414 trillion in assets.

³ That specific point in time being the annual update of recordkeeping information from data providers, currently 12/31/2010. The projections assume no change in behavior (such as deferral rates or interfund transfers).

⁴ For individual participants in the database from December 31, 2010 to the valuation date of June 30, 2012.  

⁵ Note that that increase is based on not just investment returns, but also new contributions.  Note also that contributions tend to have a larger percentage impact on the rate of growth in smaller accounts. 

⁶ Perhaps most notably for an Oct. 7, 2008, congressional hearing on “The Impact of the Financial Crisis on Workers’ Retirement Security.” See EBRI’s testimony online here.

The Good Old Days

There’s been a lot of talk lately about the need to fix the “broken” 401(k) plan.  Some say it disproportionately benefits higher-paid workers, some claim it can’t provide a level of retirement income sufficient to meet lower-income needs, and still others maintain it can’t provide that level of security for anyone.  And, as often as not, those sentiments arise as part of a discussion where folks wistfully talk about the “good old days” when everybody had a defined benefit pension, and people didn’t have to worry about saving for retirement. 

Only problem is—those “good old days” never really existed, nor were they as good as we “remember” them.

Consider that only a quarter of those age 65 or older had pension income in 1975, the year after ERISA was signed into law.  The highest level ever was the early 1990s, when fewer than  4 in 10 (both public- and private-sector workers) reported pension income, according to EBRI tabulations of the 1976–2011 Current Population Survey (in 2010, 34 percent had pension income).

Perhaps more telling is that that pension income, vital as it surely has been for some, represented just 20 percent of all the income received by those 65 and older in 2010.  In the “good old days” of 1975, it was less than 15 percent.

In fact, in 1979, just 28 percent of private-sector workers were covered “only” by a defined benefit (DB) plan (another 10 percent were covered by both a DB and a defined contribution plan), according to Department of Labor Form 5500 Summaries.  In other words, even in the “good old days” when “everybody” supposedly had a pension, the reality is that most workers in the private sector did not. 

Even among those who worked for an employer that offered a pension, most in the private sector weren’t working long enough with a single employer to accumulate the service levels you need for a full pension.  Nor is this a recent phenomenon; median job tenure of the total workforce has hovered about four years since the early 1950s (in fact, as EBRI’s latest research points out, the average median job tenure has now risen, 5.2 years).[i]  For private-sector workers, fewer than  1 in 5 have ever spent 25 years or more with one employer. Under pension accrual formulas, those kind of numbers mean that even among the workers who qualify for a pension, many are likely to receive a negligible amount because their job tenure is so short.

Ultimately what this suggests is that, even when defined benefit pensions were more prevalent than they are today, most Americans still had to worry about retirement income shortfalls. 

Indeed, Americans today do have some additional concerns: longer lives and longer retirements to fund, as well as the attendant issues of higher health care costs and long-term care.  For most workers—past and present—the more savings options they have, the better; and the easier we make it for them to save, the better.  That is the power of payroll deduction, matching contributions, and employer action. 

When all is said and done, we’re all still challenged to find the combination of funding—Social Security, personal savings, and employment-based retirement programs—to provide for a financially satisfying retirement.

Just like in the “good old days.”

- Nevin E. Adams, JD

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[i] EBRI Notes, December 2010, http://www.ebri.org/pdf/notespdf/EBRI_Notes_12-Dec10.Tenure-CEHCS.pdf