Last Friday, Slate.com, New America Foundation, and Arizona State University hosted a series of panels discussing the implications of increasing life expectancy on public policy, retirement, and family planning.
Savings defaults, auto-enrollment, and financial literacy were hot topics. Nudges, “guardrails,” and redefining “retirement” are discussed at length.
Life Expectancy Rate and Impact on Retirement (~40 minutes)
A new study by the Stanford Center for Longevity and the Society of Actuaries finds that most employers view their 401(k) plans purely as savings vehicles rather than as a means of generating income for their employees post-retirement. The authors see this mindset as one of the major problems with retirement planning today.
While employees may have money set aside in a 401(k) account, most don’t know what to do with it to generate enough income to see them through their retirement. A volatile stock market and uncertainty over longevity complicates this problem and all too often leaves retirees with inadequately budgeted savings.
As a response to this situation, the study proposes a number of options for employers to help help increase retirement income for their employees, such as annuities and systematic withdrawals. Most importantly, they argue, there needs to be a cultural shift away from the idea of “retirement savings” and towards “retirement income.”
A new study by Bankrate.com finds that employers at small businesses are paying significantly more in fees on their 401(k) plans than their counterparts at large companies. This happens because fees are divvied out among the members of a plan, and so naturally plans with fewer members will have higher fees per member. Additionally, large businesses have the resources and clout to negotiate lower fees with plan providers, an ability not shared by their smaller competitors.
This is a troubling statistic, as relatively small discrepancies among fee rates can lead to huge differences in a worker’s total savings when they are paid out over a period of thirty-five years. Furthermore, small businesses employ nearly half of the American workforce, so it is worrisome to find that they are so disadvantaged when it comes to retirement plans.
There have been a number of recent studies detailing the ways in which automatic enrollment in 401(k) plans could boost retirement savings and help address the shortfalls we are now witnessing throughout the economy. Yet private employers remain reluctant to include these features in their retirement plans. Only 27% of employers According to new research by J.P. Morgan, only 27% of employers feature automatic enrollment in their 401(k) plans.
Asked why this was the case, employers said that they fear automatic savings will be unpopular with employees. Plan sponsors are also being advised against implementing automatic savings by their financial advisers, with only 14% receiving a recommendation to use automatic savings as an effective retirement tool.
Perhaps there is some legitimacy to the worry that employees will disapprove of auto enrollment. There remains little reliable polling on worker attitudes towards these plans in the U.S. In Britain, more than two thirds of workers are not even aware that auto enrollment exists, and it seems likely that a similar level of unfamiliarity is hindering such plans domestically.
A survey by Schwab Retirement Plan Services finds that, while most workers plan on taking charge of their own retirement rather than relying on the government for help, they are also confused by the 401(k) procedures offered by their employers, which they find to be more complicated than health care benefits.
Since 61% are counting on 401(k) savings as their largest source of post-retirement income, it is import that they understand how to fully take advantage of these programs and save wisely. Nearly half of survey respondents said they didn’t know what their best investment options were.
Financial confidence increases dramatically when workers have access to some sort of professional investment adviser, and 61% of survey participants said they felt the need for personalized advice to help them manage their money. Today, many 401(k) programs are starting to offer this and similar services, but the trend may need to continue a bit longer before we see workers more comfortable with their saving decisions and their prospects for retirement security.
Due to a provision in the 2012 Taxpayer Relief Act, younger workers are able to move money over from traditional 401(k) plans into Roth 401(k), a choice that is gaining popularity, especially among the young.
A study by Wells Fargo finds that seventeen percent of workers under age thirty are opting for Roth 401(k) plans when their employers make the option available, an increase of two percentage points from last year.
The main difference between a Roth 401(k) and a traditional plan is that the money deposited in a traditional plan is taxed upon withdrawal at whatever the current tax rates may be. In a Roth plan, deposits are taxed immediately at current rates, and then allowed to accrue interest with no further tax burden, and are not retaxed upon withdrawal.
This is an attractive option for young workers, who tend to be in lower tax brackets early in their careers and can expect a much lower overall tax bill when they retire in several decades.
Participants in 401(k) plans have a clear priority for their retirements – a consistent and reliable stream of income. According to a study by State Street Global Advisers, eighty percent of participants value a guaranteed monthly payment over other concerns such as access to their entire savings.
Only twenty-four percent feel confident that they have saved as much as they need to, with many workers planning on delaying retirement, fifteen percent saying they don’t intend to retire until at least age seventy.
Still, there could be a positive side to all this. Studies like these show that American workers are at least cognizant of the need for a plan to ensure a comfortable retirement. This is in contrast with a survey that shows only ten percent of Britons viewing saving for retirement as a priority, an attitude that we certainly cannot afford in this country.
Fidelity Investments is sending information to its clients on the all too common problem of workers borrowing from their 401(k) plans before retirement. Fidelity found that one in five participants has an outstanding loan against their 401(k) balances and that one in nine took out a new loan in the past year.
This sort of borrowing has a significant negative impact on retirement savings, since workers who take out loans often reduce their contribution rates at the same time, and while a loan is outstanding, that money is not earning the interest that will be needed later in life.
It is likely that at some point, employers will place restrictions on the number and types of loans workers can withdraw from their retirement accounts. Currently, about a quarter of plans have no restrictions on the number of loans. A third of plans have a one loan limit, and 42% allow two simultaneous loans. Employers may opt to increase these limits or else enact a restriction on the minimum length of time between subsequent loans.
In a recent article in Barron’s Magazine, financial adviser and investment specialist Charles Zhang gave his opinion on the Obama Administration’s budget proposal to cap retirement savings for the wealth at $3.4 million starting in 2014.
“You should encourage people to save for retirement, not penalize them. People with $3 million, or $5 million, in a retirement account aren’t taking advantage of the system,” Xhang stated. “Leave them alone.”
Of course, $3.4 million is just the current estimate for the cap, which will vary over time. The capped amount would be equivalent to the amount needed to buy an annuity starting at age 62 worth $205,000 a year, so as interest rates rise making other investments more profitable, annuity prices should fall, causing the cap to lower.
Of the retirement savings cap proposal, IRA expert Ed Slott said the following: “It probably sounded good in a think tank, but in the real world it doesn’t make sense. It’s not solving a problem like people not paying taxes or companies moving money overseas. The only reason this affects people is that they put money away for retirement. But they’re just building a bigger tax bill for later.”
Aleta Sprague of the New America Foundation has a nice write-up on the California Secure Retirement Savings Program. In essence, this program mandates that every California worker contribute to a state-run 401(k) program. This is in response to the demise of defined-benefit pension plans and the reluctance of many to save for their retirement. Currently the program requires that each worker contribute 3 percent of his or her own salary into the savings program.
At first glance the program is a good thing. Data shows that many Americans are not saving enough for retirement. Though it raise some concerns:
(1) Currently employers are not required to contribute to the fund (which is good). How long before they are required to match workers contributions? This would raise labor costs and make California businesses less competitive.
(2) The savings program is run by trustees appointed by the state government. What happens if the rate of return on the contributions are not what was expected? Will taxpayers have to bailout the system?
The good thing about this is that it is a state program. If it doesn’t work, the citizens of the other 49 states don’t suffer. If it succeeds, the others will follow. Too often programs are created at the federal level and forced upon the entire country.
Check out an update to this post on May 20.
In response to new studies illustrating how inadequate America’s retirement savings accounts really are, combined with President Obama’s proposed budget calling for a cap on employees’ contributions to their 401k plans, several analysts are launching new proposals to combat the retirement savings shortfall.
Chris Farrell, on Bloomberg News, outlined a suggestion to remove the tax incentives from 401k plans and IRAs, and replace them with an automatic enrollment program. This, he argues, would increase aggregate retirement savings while simultaneously reducing costs to the federal government.
Farrell is not the only one who thinks mandatory savings could be answer to the retirement crisis. Alicia Munnell, director of the Center for Retirement Research, has stated that voluntary savings plans are inadequate to meet the needs of modern retirees, and columnist Dan Kadlec has pointed out that mandatory retirement savings seem to have rescued Australia from a similar dilemma.
Other proposals involve increasing 401k contributions, setting up a Federal Retirement Board or allowing people to simply be “bought out” of their Social Security plans early.
However, some advocates are pushing back against talk of eliminating the tax incentives from current retirement plans, demonstrating that 71% of the money from such incentives flows to families making less than $150,000 a year. A report from the American Society for Pension Professionals and Actuaries concludes that these incentives are the most efficient way to help the average American save for retirement, and that reductions in these incentives would damage the retirement security of workers. About two-thirds of workers currently hold jobs that offer retirement plans, the report says, and incentives such as these are necessary to maintain, and indeed increase that number in the future.
The Senate Health, Education, Labor and Pension (HELP) Committee held a hearing on Tuesday to investigate the causes, incentives, and possible remedies to workers’ withdraws and borrowing of retirement assets for non-retirement costs. There is a large percentage of American workers that are saving for retirement, but they don’t have savings for other milestone “purchases” (ie buying a home or paying for college). These non-retirement withdraws are called “leakage.”
Only two percent of savers withdraw for catastrophic need, this is “leakage”, but wouldn’t be considered as abuse of retirement savings by any reasonable measure. However, borrowing against retirement savings has a varied degree of “necessity,” and preventing the use of these accounts for non-essential borrowing should be a goal of any retirement policy. “Cash outs” during job transitions are the major culprit for mismanagement of retirement finances. Cash outs happen most often when retirement accounts have relatively small investments, leaving workers with frequent job change at a systematic disadvantage for retirement preparedness. Creating incentives to roll-over these accounts, or allowing “cashing in” these withdraws into a new retirement account should be a simple process to avoid liquidation and spending of retirement assets as a result of a job change. Continue reading
The WSJ says the increase in middle-aged workers planning to work past age 65 has significantly increased because of recent investment losses, stagnating wages, and spells of unemployment. These may be catalysts for individual decisions about retirement, but with ever-increasing longevity, retiring at 65 should cost more, since it is more retirement.
The Motley Fool thinks public pensions are not the appropriate place to double down on riskier investments.
Bloomberg sheds some light on Governor Coumo’s pension “reforms.”
Lawmakers’ retirement hay-day coming to an end in Kentucky… for future lawmakers, maybe.
The Economists‘ Buttonwood blog comments on retirement, longevity, and inherent inequity in a universal pension age.
Michael Barone of American Enterprise Institute foresees an end to the entitlement age, while his AEI colleague Andrew Biggs discussed public pension reform with former San Diego city councilman Carl DeMaio, after San Diego made some painful, but needed reforms.
Some wise words about personal responsibility in planning for retirement from the Wall Street Journal… let’s just say these resolutions are obviously sound practice, but easier said than done.
According to the Washington Post‘s Michael Fletcher the American worker is borrowing from tomorrow to pay for today–which means less leisure, retirement, what-have-you tomorrow.
The Washington Post‘s Jim Tankersley writes that the global economy has pulled American manufacturing into an age of weak labor, and thus weak unions… something to keep in mind during the Social Security and pension reform discussion.
Video with Chuck Jaffe of WSJ‘s MarketWatch in re avoiding the Personal Retirement Cliff.
NPR finds that the government isn’t only struggling with the question of homo sapien retirement as a growing population of research chimps are hanging up their lab coats for country living.