The average U.S. household is in dire straits when it comes to retirement, according a study by the National Institute on Retirement Security, with the median retirement account balance among working-age households at just $3,000, and the median retirement account balance among near-retirement households at only $12,000. The study indicates that, depending on which methodology one uses, the collective retirement gap for all working U.S. households is somewhere between $6.8 trillion and $14 trillion.
What are the forces behind this collective shortfall? Commonly cited factors include the curtailment of corporate pensions, a lack of savings before the Great Recession, and meager post-recession wage increases among all age groups. The interactive charts below, developed by the Organization for Economic Co-operation and Development, or OECD, illustrate U.S. retirement preparedness. You can roll your cursor over the vertical bars to see the data:
The chart on the left indicates that U.S. retirement age, or "over age 65," poverty is nearly 20% (blue bar), which is more than 62% above the average 12.8% measure of all OECD countries (gray bar). In the second chart, "Transfers in retirement income," the U.S. also lags other OECD members. Public transfers to retirees (think Social Security and any state benefits) provide 37.6% of a retiree's annual income. This is well below the OECD average of 58.6%.
For much of the 20th century, the corporate-provided defined benefit pension plan was the primary source of a livable retirement income for legions of workers, in conjunction with Social Security. As corporations have watched unfunded liabilities for their pensions soar, this retirement vehicle, in which workers receive annual defined benefits in exchange for years of service, has fallen out of favor.
In the place of pensions, qualified profit-sharing plans, including 401(k) plans, are an increasingly popular tool. The plans are relatively inexpensive to administer and don't incur the high risk of underfunded liabilities that defined benefit pension plans do. 401(k) plans are advantageous to employees as well -- employers can match contributions up to certain government-mandated limits.
A simple message to employees of eligible plans: participate!
A simulation conducted by the Employee Benefit Research Institute (EBRI) earlier this year produced some intriguing results. Using a database developed jointly with the Investment Company Institute, the EBRI modeled future retirement adequacy for current wage earners between the ages of 25-29, who participated in a voluntary enrollment 401(k) plan and were projected to receive full Social Security benefits (based on current models).
The simulation converted the sum of projected 401(k) balances and available Social Security benefits into an inflation-adjusted annuity. Results showed that for 83% of highest-quartile wage earners, and 86% of lowest-quartile wage earners, 401(k) accumulations plus Social Security retirement benefits would replace 60% of the pre-retirement year's wages (wages at age 64).
In other words, participating in a voluntary enrollment 401(k) greatly increases your projected retirement income adequacy, assuming you're paying into the Social Security system and will receive full age-appropriate benefits.
The magic employers' tool: automatic enrollment
"While employees have the ability to opt out of such enrollment, it is clear that these [automatic enrollment] plans have had a substantial impact on increasing retirement plan-participation rates, especially for lower-income employees."
The EBRI's modeling exercise produces more significant results with one small but powerful tweak. When wage earners are assumed to belong to an automatic enrollment 401(k), the average for 60% income replacement jumps to 88% for the highest wage earners and 94% for the lowest wage earners.
An automatic enrollment plan turns the traditional "elective" deferral of 401(k) plans on its head. In automatic enrollment, workers participate in an employer's retirement plan by default; instead of opting in to participate, employees can elect not to contribute, or to adjust the amount of cash contributions made in each pay period.
It's fascinating how much better prepared for retirement wage earners were when the EBRI simulation simply included automatic 401(k) enrollment by employers.
We can theorize why automatic enrollment 401(k) plans lead to higher retirement funding. Many of us set our living expenses and savings based on the net cash we receive from each paycheck. It's often harder to begin contributing to a 401(k) plan (or to raise contributions) once an employee gets used to the net amount deposited into his or her checking account.
Enrolling an employee automatically, especially for those starting a new job, circumvents this psychological barrier to saving. Greater employee participation also benefits the employer, as employer contributions are tax deductible. Corporate America, are you paying attention?
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