Saturday, October 27, 2018

5 Steps to Retirement Security

While it might not be on your calendar, this happens to be National Retirement Security Week – and in the spirit of the week, here are five things that can provide just that.

Retirement security – or more precisely, preparing so that you do have retirement security – is a year-long activity, of course. But this week is devoted to making employees more aware of how critical it is to save now for their financial future, promoting the benefits of getting started saving for retirement today, and encouraging employees to take full advantage of their employer-sponsored plans by increasing their contributions.

So, for those looking to shore up your own retirement security – or those you may work with – here are some things to keep in mind.

Don’t default to the plan default.

While most education materials provided with your 401(k) emphasize the benefit of the employer match (generally referencing that you don’t want to leave “free money” on the table), a growing number try to make it easier for you by automatically enrolling you in the plan. That’s the good news.

The bad news? That default savings rate (generally 3%) will almost certainly be less than you need to save to get the full employer match (see above). And it will almost certainly be less than you need to achieve your retirement goals/needs. So, if you do take advantage of the convenience of the default, make sure that you remember to make the change to the savings rate at the first opportunity.

You should save to at least the level of the employer match.

Many employers choose to encourage your decision to save for retirement by providing the financial incentive of an employer matching contribution. That match is often referred to as “free money” because you get it just for saving for retirement. That match is not actually “free” of course – but it is free for you. If it’s 25 cents for every dollar you save, it’s like getting a 25% return on your investment.

You can save more than the match.

A lot of people save only as much as they need to receive the full employer match. As noted above, while that’s certainly a good starting point, it may not be the right amount for you. There are a number of factors that go into determining the amount and level of the match – however, the amount you need to set aside for your own personal retirement goals is almost certainly not one of those factors. You certainly don’t want to leave any of that match on the table by not contributing to at least that level. But if that’s where you stop saving, you’re probably going to come up short.

Older workers can save (even) more.

Thanks to a provision in the tax code, individuals who are age 50 or older at the end of the calendar year can make annual “catch-up” contributions. In 2018, up to $6,000 in catch-up contributions may be allowed by 401(k)s, 403(b)s, governmental 457s, and SARSEPs (you can do this with IRAs as well, but the limits are much smaller).

The bottom line: If you haven’t saved enough over your working career, these catch-up provisions can help you… well, “catch up.” You can find out more here.

You can save for retirement even if you don’t have a plan at work.

Discussions about the retirement coverage “gap” often focus on the number of workers who don’t have access to a retirement plan at work (though the oft-repeated notion that “more than 50%” of workers who ostensibly don’t is a bit exaggerated). Not having a plan at work can be a hindrance to saving – there’s no employer match, ease of payroll deduction, or workplace education and access to advisors, for starters. And data suggests that workers are significantly more likely to save if they have the opportunity to do so via a workplace retirement plan like a 401(k) – 12 times more likely, in fact.

All in all, when it comes to building retirement security, there’s little question that saving for retirement at work is the way to go – there are tax advantages, the support of the employer matching contributions, and access to investment choices that are screened and reviewed on a regular basis by the plan fiduciaries.

But you can save for retirement on your own – open an IRA at your local bank or financial institution. And you can probably set it up for regular payroll deduction at work as well. It’s not as convenient as having a plan at work, but it can be done.

Don’t forget that while the steps above provide a way to achieve retirement security, saving for retirement without some idea of how much you’ll actually need for retirement is like heading out on a long trip with a broken fuel tank gauge. Take the time this week to do a retirement needs calculation. It doesn’t have to take long or be complicated. If you have a retirement plan at work, there’s probably a calculator available for that purpose – or you can check out the BallparkE$timate® online at

It’ll be good for your peace of mind – will likely improve your retirement security prospects and confidence – and, who knows – you might even enjoy it.

- Nevin E. Adams, JD

Saturday, October 20, 2018

Multiplication ‘Fables’

Did you hear the one about loan defaults adding up to $2.5 trillion in potential retirement savings shortfalls over the next 10 years? How about the “$210 Billion Risk in Your 401(k)”?

Those reports were based on an “analysis” by Deloitte that claims to find that “…more than $2 trillion in potential future account balances will be lost due to loan defaults from 401(k) accounts over the next 10 years…” That’s right, $2 trillion lost “due to loan defaults” (the Wall Street Journal apparently picked the figure that matched the impact on a “typical 401(k) borrower” – more on that in a minute).

Now, when you see headlines putting a really big number on what you already suspect is a problem – in this case “leakage” – roughly defined as a pre-retirement withdrawal of retirement savings – well, you could hardly be blamed for simply accepting at face value the most recent attempt to quantify the impact of the problem.

A closer look at the assumptions behind that analysis, however, puts things in a different light.
The Deloitte paper leads with the question “How can we keep loan defaults from draining $2 trillion from America’s 401(k) accounts?” – but despite the positioning of the premise that this is a leakage issue, the loan default turns out to be only a small part of the problem.

The Deloitte authors outline the assumptions underlying their conclusions in the footnote of the 12-page document. Specifically, they draw many of their starting points from a 2014 study, “An Empirical Analysis of 401(k) Loan Defaults,” which found that with 86% of the participants that terminated employment with loans outstanding defaulted on those loans – and took their entire account balance out at the time of loan default. That report also noted that the average age1 of the loan defaulter was 42. The Deloitte authors also draw from Vanguard’s “How America Saves 2018” that the average loan default was approximately 10.1% of the total account balance.

And then, with that as a foundation, the Deloitte authors begin to build.

The Deloitte modeling assumption relies on the notion that the vast majority of participants who default on these loans take their whole balance out of the plan. Rather than using the 86% assumption from the 2014 study, they scaled it back to a more conservative assumption that (only) 66% of participants that defaulted on their loan also took their entire account balance. They then back into the total account balance that those individuals would ostensibly have ($47.8 billion, assuming that their loan is 10% of their total balance) that they claim, based on the earlier assumptions, would be withdrawn in addition to the outstanding loan amounts. They then project growth in those totals assuming that everyone in that group is 42 (the average age of a loan defaulter) all the way out to age 65, assuming a 6% return over that period – and wind up with $2.5 trillion!

Now, there are so many assumptions imbedded in that calculation – and so many that act as multipliers on the original assumptions – it’s hard to know where to start.

To put it in individual terms, the Deloitte analysis assumes that every borrower is 42 years old, that two-thirds of these that default not only do so on a loan of $7,081 (the average outstanding loan amount), but go on to cash out their remaining account balance of $70,106 (assuming, of course, that the loan amount is approximately 10% of the balance). They then assume – and this is the assumption based on complete speculation – that there was no subsequent rollover, nor any renewal of contributions anywhere over the rest of their working lives – while also assuming that they could have attained a 6% return on those monies over that extraordinary period of time if only they hadn’t cashed out.

Still with me?

What’s obvious is that the bulk – indeed, the vast majority – of that projected impact comes not from the highlighted loan defaults – which are, in fact, a mere fraction of the terminating participants’ 401(k) balance – but from what the Deloitte authors term the “leakage opportunity cost” – basically it’s the “magic” of compounding applied to both the defaulted loan and the other 90% of the participant account balance… at a 6% rate of return over nearly a quarter century.

They say that two “wrongs”2 don’t make a right – and that’s particularly true when multiplication is involved.

It’s not that the math isn’t accurate. It’s just that the answer doesn’t “figure.”

Nevin E. Adams, JD
  1. There are always potential problems with extrapolating conclusions from averages. That said, the 2014 study from which those averages are drawn note that participants who defaulted on their loan were more likely to have larger loan balances than those who repaid, and to have lower household incomes and smaller 401(k) balances – in sum, not exactly “average.”
  2. The paper also makes some curious comments about loans and fiduciary liability – but we’ll deal with those in a future post.

Saturday, October 13, 2018

The ‘Storm’ of Your Lifetime

The tail end of hurricane season — and more specifically the disastrous flooding of Hurricane Florence — brings to mind my last serious brush with nature’s fury.

It was 2011, and we had just dropped our youngest off for his first semester of college in North Carolina, stopped off long enough in Washington, DC to check in with our daughters (both in college there at the time), and then sped home up the east coast to Connecticut with reports of Hurricane Irene’s potential destruction and probable landfall(s) close behind. We arrived home, unloaded in record time, and rushed straight to the local hardware store to stock up for the coming storm.

We weren’t the only ones to do so, of course. And what we had most hoped to acquire (a generator) was not to be found — there, or at that moment, apparently anywhere in the state.

What made that situation all the more infuriating was that, while the prospect of a hurricane landfall near our Connecticut home was relatively rare, we’d already had one narrow miss with an earlier hurricane and had then, as on several prior occasions, been without power, and for extended periods. After each I had told myself that we really needed to invest in a generator — but, as we know, inertia is a powerful force, and reasoning that I had plenty of time to do so when it was more convenient, I simply (and repeatedly) postponed taking action. Thankfully my dear wife wasn’t inclined to remind me of that at the time, but the regrets loomed large in my mind.

Retirement Ratings?

People often talk about the retirement crisis in this country, but like a tropical storm still well out to sea, there are widely varying assessments as to just how big it is, and — to borrow some hurricane terminology — when it will make “landfall,” and with what force. Most of the predictions are dire, of course — and while they often rely on arguably unreliable measures like uninformed levels of confidence (or lack thereof), self-reported financials and savings averages — it’s hard to escape a pervasive sense that as a nation we’re in for some rough weather, particularly in view of the objective data we do have — things like coverage statistics and retirement readiness projections based on actual participant data.

Life is full of uncertainty, and events and circumstances, as often as not, happen with little if any warning. Even though hurricanes are something you can see coming a long way off, there’s always the chance that they will peter out sooner than expected, that landfall will result in a dramatic shift in course and/or intensity, or that, as with some (like Florence) — the most devastating impact is what happens afterward. In theory, at least, that provides time to prepare — but, as I was reminded when Irene struck, sometimes you don’t have as much time as you think you have.

Doubtless, a lot of retirement plan participants are going to look back at their working lives as they near the threshold of retirement, the same way I thought about that generator. They’ll likely remember the admonitions about (and their good intentions to) saving sooner, saving more, and the importance of regular, prudent reallocations of investment portfolios. Thankfully — and surely because of the hard work of advisors and plan sponsors — many will have heeded those warnings in time. But others, surely — and particularly those without access to a retirement plan at work — may find those post-retirement years (if indeed they can retire) to be a time of regret.

As retirement advisors are well aware, the end of our working lives inevitably hits different people at different times, and in different states of readiness. But we all know that it’s a “landfall” for which we need to prepare while we still can.

- Nevin E. Adams, JD

Saturday, October 06, 2018

'Puzzle' Pieces

Academics have long agonized over something they call the annuitization puzzle.

Simply stated, the thing academics can’t quite understand is the reluctance of American workers to embrace annuities as a distribution option for their retirement savings. Some of that is because they assume workers are “rational” when it comes to complex financial decisions, specifically because “rational choice theory” suggests that at the onset of retirement, individuals will be drawn to annuities because they provide a steady stream of income and address the risk of outliving their income.

Compounding, if not contributing to that belief, are surveys – albeit surveys generally published, if not conducted by, annuity providers (or supporters) that consistently find support from participants for the notion of reporting benefits as a monthly payout sum, if not the notion of providing a retirement income option. And yet, despite those assertions, in the “real” world where participants actually have the option to choose between lump sums and annuity payments, they pretty consistently choose the former.

That said, a study by the non-partisan Employee Benefit Research Institute (EBRI) also supports the notion that plan design matters, and matters to a large extent, in those annuitization decisions.

Over the years, a number of explanations have been put forth to explain this reluctance: the fear of losing control of finances; a desire to leave something to heirs; discomfort with entrusting so much to a single insurer; concern about fees; the difficulty of understanding a complex financial product; or simple risk aversion. All have been studied, acknowledged and, in many cases, addressed, both in education and in product design, with little impact on take-up rates.

Yet today the annuity “puzzle” remains largely unsolved. And, amid growing concerns  about workers outliving their retirement savings, a key question – both as a matter of national retirement policy and understanding the potential role of plan design and education in influencing individual decision-making – is how many retiring workers actually choose to take a stream of lifetime income, versus opting for a lump sum.

‘Avail’ Ability

Some of that surely can be attributed to the lack of availability. Even today, industry surveys indicate that only about half of defined contribution plans provide an option for participants to establish a systematic series of periodic payments, much less an annuity or other in-plan retirement income option. Indeed, I’ve never met a plan sponsor who felt that the official guidance on offering in-plan retirement income options was “enough.”

Enter the bipartisan Retirement Enhancement and Security Act (RESA), which includes a provision to require lifetime disclosures – and while its prospects seem bright, it remains only a prospect. Closer to a current reality is Tax Reform 2.0, but the retirement component of the legislation approved by the House Ways and Means Committee on Sept. 13 did not address the subject – or at least didn’t until the Chairman Kevin Brady introduced a Managers’ Amendment that largely, if not completely, mirrors RESA’s.

That 8-page addition outlines a “fiduciary safe harbor” for the selection of a lifetime income provider, which, as its name suggests, binds the liability to a consideration “at the time of the selection” that the insurer is financially capable of satisfying its obligations under the guaranteed retirement income contract. It also clarifies that there is no requirement to select the lowest cost contract, and that a fiduciary “may consider the value of a contract, including features and benefits of the contract and attributes of the insurer” in making its determination. Moreover, there is language that notes that “nothing in the preceding sentence shall be construed to require the fiduciary to review the appropriateness of a selection after the purchase of a contract for a participant or beneficiary.”

At this point, it’s impossible to say whether this legislation will be signed into law, much less whether it will prove sufficient to assuage the concerns that have continued to give most plan sponsors pause in adopting this feature.

A couple of things seem clear, however. First, as long as plan fiduciaries continue to feel vulnerable to a generation of potential liability for provider selection beyond the initial selection, they aren’t likely to provide the option.

And participants who are not given a lifetime income choice as a distribution option will surely not (be able to) take it.

- Nevin E. Adams, JD

See 5 Reasons Why More Plans Don’t Offer Retirement Income Options