Two retirement and economic policy analysts from opposite ends of the policy spectrum have come together to agree that the 401(k) system has not lived up to its capability.
Andrew Biggs, a resident scholar at the American Enterprise Institute and Alicia Munnell, Director of the Center for Retirement Research at Boston College (CRR), along with Anqi Chen of the CRR, join forces to argue in a new white paper that four aspects of the U.S. retirement system have made it difficult for workers to accumulate substantial retirement savings.
Biggs has written extensively and testified before Congress, arguing that claims of an oncoming retirement crisis are overblown. Munnell has taken the opposite position, contending that there is a brewing retirement crisis that must be addressed.
In “Why Are 401(k)/IRA Balances Substantially Below Potential?,” Biggs, Munnell and Chen posit that the immaturity of the 401(k) system, the lack of universal coverage, leakage and fees may help explain why most workers have 401(k) and IRA balances at retirement that are substantially below their potential.
Using the Survey of Income and Program Participation, linked with administrative tax records, they calculate in their analysis that a 25-year-old median earner in 1981 who contributed regularly would have accumulated about $364,000 by age 60, but the typical 60-year-old in 2016 had less than $100,000.
The analysis assumes that in a “perfect system,” coverage would be universal and workers would save consistently from ages 25-64, which, as the authors acknowledge, may not be realistic since many workers do not start saving until their 30s and some workers are covered by DB plans. Nevertheless, of the four factors, the authors suggest that the main culprits causing this apparent discrepancy are the immature system and lack of coverage.
Immaturity
As one would expect, to accumulate substantial retirement saving, workers must contribute regularly, keep their money in the account and maximize after-fee returns. But as the authors explain, the so-called “immaturity of the 401(k) system” means that many 60-year-olds nearing retirement did not have access to a plan in the early part of their careers, so they would have accumulated less than workers covered throughout their working lives.
Still, Biggs, Munnell and Chen also observe that – even after the 401(k) system is fully mature – a “large gap between potential and actual assets is likely to persist.” The discrepancy is somewhat less if those under 30 and those with DB plans are excluded, but is still significant, according to the analysis.
Universal Coverage
Secondly, the authors observe that the lack of universal coverage means that workers are not always in jobs that offer retirement plans and, consequently, not always able to contribute. What’s more, they note that, while 401(k) plans have expanded considerably since the 1980s, many workers still do not participate. This they say is primarily because their employer does not offer a plan, but also to a lesser extent because some workers are not eligible for the plan or they decline to participate.
The paper observes that determining the overall coverage rate remains a “controversial topic” that is subject to debate and can vary depending on what definitions are used (e.g., all workers versus private sector or full-time versus part-time, etc.). Even so, the authors note that, regardless of how the uncovered are defined, “the group without an employer-provided plan is large.”
“This lack of universal coverage means that workers will move in and out of 401(k) plans and that their 401(k) accumulations will be much lower than projections based on the prospect of a steady lifetime of contributions,” Biggs, Munnell and Chen write.
Leakage
Cited as the third factor is the ability of participants to gain access to their account before retirement. Estimates of leakage vary by source, from as low as 1.2% of assets, under 2013 data by Vanguard, to as high as 2.9% of assets, based on estimates using tax data.
Vanguard’s data show that cash-outs at job change are the largest source of leakage, accounting for 0.5% of assets, followed by hardship withdrawals at 0.3% of assets and post-age 59½ withdrawals and loans each accounting for 0.2% of plan assets. The authors note that, while Vanguard’s data is useful in identifying the various leakage paths, it likely understates leakage rates because the firm’s clients tend to be larger plans with higher-paid workers with lower leakage rates.
Fees
The final factor is fees, which the authors say can “significantly erode” net returns on investments. Citing data from the Investment Company Institute, the paper shows that average fees in 2017 were 0.48% of assets for bond mutual funds and 0.59% for equity mutual funds. These fees have declined from 0.84% and 1.04% respectively in 1997, likely reflecting the rise in passive mutual funds, the Labor Department’s fee disclosure requirements and 401(k) fee litigation.
The authors emphasize, however, that even though fees have dropped, the “retirement plan balances of households nearing retirement today reflect the higher fee rates that were charged in past years as these households were building their savings.”
As for the overall policy implications of the findings, the authors observe that:
- providing continuous access to a workplace-based saving vehicle for all workers could substantially increase retirement saving; and
- encouraging less leakage by modifying pre-retirement withdrawal rules could also increase 401(k) and IRA balances at retirement.
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