The Saving Is the Hardest Part
Workers are stashing away cash. It just may not be enough to feather the nest egg for long once they retire.
There's no doubt that America is saving for retirement. Today, nearly 80 million workers have $5.6 trillion in defined contribution plans alone. But whether workers are actually participating in sufficient numbers, saving enough and investing correctly — all to retire comfortably — well, that’s another story.
The National Institute on Retirement Security claims the typical working-age household only has a few thousand dollars saved for retirement, and about 45 percent of the workforce has no retirement account funds. The institute’s research in June 2013 calls America’s abysmal retirement savings rate “staggering,” and says the American dream of retiring comfortably will be more like a nightmare for workers and potentially employers.
“Our findings confirm that the American dream of retiring comfortably after a lifetime of work will be impossible for many,” said Nari Rhee, author of the National Institute on Retirement Security report, “The Retirement Savings Crisis.” “Even when counting their entire net worth, 65 percent [of working Americans] still fall short.”
How U.S. workers save today for retirement is clearly the issue for those hoping to enjoy their senior years as well as for employers wanting a workforce that doesn’t overextend its stay — often referred to as the employee life cycle. And even though individual retirement accounts are available to everyone through various financial institutions, U.S. workers prefer to use what’s available at work: primarily defined contribution plans.
Digging Out of a Hole
America’s retirement savings rate appears to be pretty measly with the average worker contributing only 6 percent. But like many companies today, Tiller Corp. is steering participant results by making hefty company contributions and introducing comprehensive education sessions for workers.
“We have auto enrollment, but I’ve never had to use it,” said Steve Sauer, Tiller’s 401(k) plan administrator. After new employees go through the benefits primer, Sauer said they almost always join.
Tiller, a Maple Grove, Minnesota-based industrial sand and gravel provider, matches each dollar a participant contributes to the company 401(k) plan, up to 5 percent. Then it adds an extra profit-sharing component of 5 percent at the end of the year.
Consulting group Callan Associates’ 2014 Defined Contribution Trends Survey showed 1 in 10 plans either increased or restored their matching contribution last year. Plus, 6 percent say they will increase the match this year.
The typical Tiller worker is 45 years old and makes an average of $63,915 a year, Sauer said. There are about 170 participants in the plan, and the average account balance is $130,000, well above the 2012 reported average of $86,000 by Vanguard Group.
Ten years ago, Tiller hired an adviser to revamp fund offerings and educate workers on new options. At the time, the average account had 75 percent in bonds and cash and 25 percent in stocks. Today, the average worker has 32 percent in fixed income and 68 percent in equity, Sauer said.
Within the defined contribution arena, Americans held $4 trillion in 401(k) plans in the third quarter of 2013, according to the Investment Company Institute’s latest report.
It’s a lot of money, but is it enough for retirees to last throughout their retirement? There are plenty of skeptics who say 401(k)s, which were primarily designed to supplement employer-driven defined benefit plans, are not a strong enough savings tool. But 401(k)s are the primary way workers save for retirement today, and they are getting a lot of attention from the industry to make sure these worker-funded accounts will create optimal results.
“For those plan sponsors who have their goals established, and match their plan design to it, they can definitely get as many people as possible over the finish line as well as reach corporate goals,” said Catherine Peterson, director of retirement insights at J.P. Morgan Asset Management.
So how are U.S. workers with 401(k) accounts doing?
Using a model that assumes workers would have at least 30 years in a 401(k) plan and Social Security benefits would remain the same, the Employee Benefit Research Institute simulated final payouts for segmented incomes and found 86 percent of low-income earners would get at least 60 percent of their pay in retirement at age 64. The three higher groups of wage earners would see similar bottom-line results.
“I think that’s pretty good,” said Jack VanDerhei, the EBRI’s research director. “The analysis shows that even without a traditional [defined benefit] plan, a very large percentage of employees who are fortunate enough to work for 401(k) sponsors for most of their careers should be able to replace what many financial advisers consider to be a sufficient percentage of their pre-retirement income when combined with Social Security.”
Meanwhile, Fidelity Investments recently created its Retirement Preparedness Measure, a tool that gauges whether workers are saving enough today to cover retirement expenses tomorrow. Fidelity surveyed 2,200 households and ran through planning models to see where Americans stood. Overall, despite a rebounding economy, 55 percent of people with 401(k) plans are in fair or poor condition, and 45 percent are in very good or good shape.
Fidelity results show millennials are in the red zone, estimating that this group, born between 1978 and 1988, according to the study, would be able to cover just 62 percent of retirement expenses, under their current savings and spending rates.
Gen Xers, born between 1965 and 1977 fare better, covering 71 percent of retirement expenses. Baby boomers, those born between 1946 and 1964, are in good shape, and will be able to cover 81 percent of senior expenses.
John Sweeney, executive vice president of retirement and investment strategies at Fidelity says a large part of the problem is that America saves too little. Survey results showed 40 percent of respondents are saving less than 6 percent of their salaries today. Sweeney added that only about 10 percent are contributing to the Internal Revenue Service’s contribution ceiling, which is $17,500 for 2014.
Today, about 24 percent of 401(k) participants have taken a loan or cashed out early from their account, according to Purchasing Power.
“We want people to establish a lifestyle that incorporates savings,” Sweeney said. Action from all age groups “needs to be taken.”
Another drain on retirement savings is loans. Today, about 24 percent of 401(k) participants have taken a loan or cashed out early from their account, according to Purchasing Power, an employee purchase plan provider based in Atlanta. Nearly 40 percent of the loans go to general household expenses.
“If someone gets in the habit of borrowing from their 401(k), it isn’t going to be an effective tool to help them save for retirement,” said Elizabeth Halkos, chief marketing officer for Purchasing Power.
Installing an employee purchase plan steers workers away from snatching dollars that need to grow in 401(k) accounts. Workers are able to create payment plans to cover household items or other needs. “We see ourselves as the alternative to the 401(k) loan,” Halkos said.
Plan sponsors are the final decision-makers of 401(k) design. Over the years, plan sponsors have evolved their thinking as to what makes a successful plan. Things like participation rates, diversified investments or well-educated workers used to be top factors.
Today, outcomes or results are the buzzwords. For the first time, 18 percent of employers considered plans successful when they generate enough retirement income for participants, an October 2013 Aon Hewitt survey showed. The question has become: How do plan sponsors design a 401(k) so its workers participate, contribute as much as possible, increase that contribution and invest appropriately so, in the end, they can have a comfortable retirement?
“Increasingly, it is the plan sponsor who is driving how people save,” said Lori Lucas, executive vice president and defined contribution practice leader at Callan Associates.
Lucas said changes in thinking began in 2012 after the U.S. Labor Department required plan sponsors to get fee information from providers and to report certain costs to participants using 401(k) plans. This move caused lots of plan sponsors to look deep into their 401(k) design and figure out whether its components were worth the costs.
As a result, plan sponsors did their homework in 2012, reviewing investment policy statements, evaluating, and sometimes replacing managers and their investments, according to Callan’s 2014 Defined Contribution Trends Survey.The survey showed that, in 2012, 84 percent of plan sponsors made sure they were in step with the new regulations, 63 percent reviewed investment policy statement and 41 percent replaced managers or funds.
In 2013, the Labor Department stepped in again. It issued tips on how to select a target-date fund, a highly popular investment for automatically enrolling workers into 401(k) plans. Armed with better plan design knowledge and the tips, many plan sponsors moved from using a target-date fund from their record-keeper’s offerings to one that better suited the plan and its participants.
'Increasingly, it is the plan sponsor who is driving how people save.'
—Lori Lucas, Callan Associates
Callan’s survey showed only 46 percent of plan sponsors used their record-keeper’s target-date fund last year compared with 59 percent in 2012. Plus, about a third of respondents say they plan to make a change to this investment in 2014.
“It has definitely been an evolution with target-date funds,” Lucas said. “There are more sophisticated tools today from even a few years ago.” Going with a target-date fund will be directly related to how much participants will be able to save for retirement, she added.
Automatic tools are also on the rise, which will help more workers get into plans. Callan’s research shows the practice of automatically enrolling participants in defined contribution plans has almost doubled to 58 percent in 2013 from 32 percent in 2006.
But dovetailing this feature with automatic increases to workers’ contributions still seems to be stuck, experts say. For the past two years, only 43 percent of companies that have automatic enrollment combine it with automatic contribution increases, Callan’s study showed.
That can mean trouble for many workers because federal law says plan sponsors can automatically enroll workers using 3 percent of their pay to open accounts. Many studies have shown that most workers that enter the system at that rate stay there unless someone comes in and increases it for them. Even with a matching contribution from the employer, workers won’t save to the magic 15 percent of pay most industry experts say is necessary to retire comfortably.
A third of plan sponsors to J.P. Morgan’s 2013 Defined Contribution Plan Sponsor survey said they are in that holding pattern because they think employees don’t want an automatic increase in contributions each year. That isn’t surprising considering 80 percent said they consider employee satisfaction a critical factor in determining a successful plan.
Many plan sponsors have it wrong because J.P. Morgan’s survey also talked to participants. Sixty percent said they were either neutral or OK with employers bumping the pretax salary payment to their retirement accounts.
“It always goes back to the concern of the participants’ reactions,” J.P. Morgan’s Peterson said. “Employers don’t want to get complaints from employees.”
Another way employers are trying to improve worker retirement savings results is through re-enrollment. Today, employers are taking a harder look at where employees are investing their 401(k) assets. Through re-enrollment, plan sponsors tell participants that they plan to override their investment decisions (unless told not to), and then typically re-enroll workers into an age-appropriate target-date fund.
“Re-enrollment has become more of a best practice, as opposed to the anomaly it was a few years ago,” said J.P. Morgan’s Peterson.