Reuters Money
Workers stashing money in 401(k) plans at record rates
Thanks to automatic enrollment and an improved stock market, employees are stashing money in employer-sponsored retirement plans at a record-high rate, according to a new Aon Hewitt study.
The consulting firm’s analysis of three million employees across 120 large companies shows that 75.8 percent of eligible employees participated in their company’s defined contribution plan — usually a 401(k) plan — in 2010. That’s the highest level since 2002, when the firm began tracking defined contribution plans, the company reported. In 2009, participation was 73.7 percent.
Other key findings:
* The average employee’s total plan balance was $76,020 at the end of 2010, while the median balance was $24,680. (Fidelity Investments, which is the nation’s largest administrator of retirement plans, recently reported that the average U.S. 401(k) retirement-savings account had a record $74,900 in assets as of March 31.)
* Nearly three in 10 plan participants contributed below the company match threshold, up slightly from 2009.
* Pretax contributions to defined contribution plans were unchanged from 2009 at 7.3 percent of pay, but still down slightly from pre-recession levels in 2007 (7.7 percent).
* Nearly one-third (29.4 percent) of plan participants contributed below the company match threshold, up slightly from 2009 (28.2 percent).
The role for DC plans in the public sector
Alicia H. Munnell is the Director of the Center for Retirement Research at Boston College and the Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management. The opinions expressed here are her own.
In the wake of the financial crisis, policymakers have been chattering about moving to defined contribution (DC) plans in the public sector. Defined contribution plans may well have a role in the public sector, but not as an alternative to defined benefit (DB) plans. Defined benefit plans should remain as a secure base for the typical public employee and defined contribution plans could be “stacked on top” of them to provide additional retirement income for those at the higher end of the pay scale.
Before the financial crisis, ten states had introduced some kind of comprehensive DC plan. Many of these states provide stand-alone DC plans, either as a requirement (Alaska and Michigan) or an option. Two states (Oregon and Indiana), however, recognizing the value of offering some secure benefit, provide a combined DB/DC plan.
In the wake of the financial crisis, three states (Michigan’s public schools, Georgia, and Utah) have introduced such combined DB/DC plans, where new employees will get some of their retirement income from each type of plan. And an additional six states are discussing DC options.
Why the enthusiasm for DC plans? Some arguments are wrong; others hold water. Starting with wrong: Some supporters highlight the magnitude of the unfunded liabilities in public sector DB plans as justification for switching to a DC. The reality is that even with a new DC plan, states and localities are still left to deal with past underfunding. A new plan only addresses pension costs going forward, it does not help close the current gap between pension assets and liabilities.
Similarly, some contend that switching to a DC plan would save money in the future. But for any given level of benefits, DC plans have higher investment and administrative expenses than DB plans. Some proponents think that even if total costs increased, taxpayers could gain by shifting contributions from the government to the employee.
Transferring the burden to the employee provided a major economic incentive in the private sector to move from DB plans, where employees make no contributions, to 401(k) plans, where employees make the bulk of the contributions. But such a gain is difficult to achieve in the public sector where employees already make substantial contributions to their DB pensions.
Defined-benefit plans are a trap. Once you have a decade in the system, you literally cannot afford to leave. You may get your contributions back, but none of the investment earnings — which after contributing 11% of your paycheck for a decade ought to be substantial.
I’ve known several tired and bitter teachers, hanging on for five more years just to qualify for their full pension. What kind of “defined benefit” is that? On the flip side, I know a couple of teachers who worked a decade BEYOND maxing out their pension. A decade in which their contributions continued to earn money for the system but the benefits stagnated.
The biggest reason why DC plans don’t accumulate as much as DB plans is that participation is not forced. DC workers can opt out. DB workers cannot — I tried and was refused. All the control in the DB system rests with the state. But have no fear! Big Brother is generous. Big Brother is wise. Big Brother will take care of you. We all love Big Brother!
Retirement: 3 problems with automated 401(k)s
Automation of workplace retirement plans has spread rapidly in recent years. But don’t make the mistake of taking your foot completely off the gas pedal if your employer has installed retirement cruise control.
The Pension Protection Act of 2006 (PPA) set the stage for plan sponsors to step up automatic opt-in enrollment for new workers, and it’s resulted in much higher plan participation rates. Growing adoption of other automation features have helped to address the hard reality that most workplace retirement savers pay little or no attention to their contribution levels, rebalancing or mutual fund selection.
But automation comes with drawbacks that can hurt long-term performance of your retirement portfolio. If you’re using default options, it’s time to start paying attention — and watch out for these three potential potholes:
One: Low default contribution rates
More than half of large plans set initial contribution rates for auto-enrolled workers at three percent, according to a survey of large defined contribution plans by the the Defined Contribution Institutional Investment Association (DCIIA), a non-profit industry consortium focused on the institutional retirement industry. This despite the fact that survey respondents acknowledge that the optimal rate is 10 percent or more.
The disconnect stems from a PPA provision that defines three percent as the contribution rate that provides safe harbor protections for plan sponsors, says Cathy Peterson, director of retirement insights at J.P. Morgan Asset Management and co-author of the DCIIA study. “Many plan sponsors don’t want to be out of line with the industry,” she says. “The three percent rate is viewed as the benchmark.
The economy also plays a role. Eighteen percent of respondents said higher initial contribution rates would require them to make higher matching contributions that they can’t afford right now.
401k automation tools such as auto-enrollment, auto-escalation, and auto-default into an appropriate investment portfolio are merely tools that plan sponsors may use to reach a defined objective. Simply implementing any or all auto-features without a clear understanding of the desired result could actually do more harm than good to plan participants.
A number of considerations must be made when implementing auto-features because many plan features and provisions are interrelated. For example, most plan sponsors do not consider the impact of their current distribution provisions when considering a target date fund glidepath. Many target date fund glidepaths assume that a participant will stay invested throughout their retirement years. However, the vast majority of 401k plans do not allow for systematic withdrawal. Instead, once a retired participant needs to initiate a distribution, most 401k plan sponsors require the distribution to be taken in a lump sum, thereby causing disconnect between the intent of the target date fund glidepath and the plan’s distribution provision.
Automatic features are indeed terrific tools that help plan sponsors efficiently help their employees participate and invest in their 401k. However, like any tool, if misused, they can lead to unintended damage to participants’ retirement readiness.
Sanders Booze Capital Advisors, LLC
