How are Americans doing when it comes to retirement? What can people do to improve their retirement security? Those questions are tackled in a recent article in The Actuary entitled Improving Retirement Security. The article is a summary of research in the area of retirement security, and it contains many prescriptions for how we can better secure our futures.
One of the bigget challenges that we face is the fact that retirement is in our own hands. In theory, most of our retirement income comes from what are known as Defined Contribution (DC) plans. These are plans where the amount you contribute to the plan is known, but the amount you will get out of the plan in the future is undetermined - think 401(k) or IRA. Contrast this with the Defined Benefit (DB) plans of the past where amount of money you received in retirement was known in advance. In a DC environment, there are many pitfalls faced by participants. Some of the big ones are:
- Not saving enough.
- Poor investment strategy.
- Cashing out funds for non-retirement purposes.
- Using retirement money too quickly.
Overcoming these pitfalls is very difficult for many. It should come as no surprise that people are not saving enough for retirement. The article quotes a study by benefits consultant Hewitt Associates of participants in large employer plans which concludes that only 20% of people are on track to save enough for retirement by age 65. This is probably higher than the total population as it only includes people who work at large corporations which tend to offer better plans than those offered at smaller companies.
What is the solution?
The article offers various suggestions for employers. First, they can encourage savings through the use of auto-enrollment and automatically increases in contributions. This will allow people who are not natural savers to increase their savings without having to do anything. Many companies already are doing this (mine does), and it makes sure that the default choice is "save" rather than "not save". Obviously people can opt-out, but this requires taking an extra step.
Second, they recommend improvements to investment options. They model several different portfolios and used stochastic modeling to determine the likely outcomes from investing in these portfolios. The so-called "safe" investments (stable value fund, TIPS only) had the worst outcome. The median replacement ratio (the % of salary could be replaced in retirement from savings) was the lowest for these two options. Meanwhile, the target date fund options replaced the most. Interestingly, the more diversified the portfolio, the better the outcome (no surprises there).
Third, they recommend recasting fund balances in terms of the probability of replacing X% of income in retirement. This also makes a lot of sense. If you see a balance of $100,000 in your 401(k), you might think that you are on track. After all, that could seem like a lot of money. However, if instead your statement said that you have a 5% chance of replacing 80% of your income in retirement, you might be more motivated to increase your savings.
Fourth, they offer suggestions to get people to think of their retirement account as a retirement account and not a emergency fund to be drained before retirement. To this end, they offer suggestions on how fund design could be changed to encourage loans rather than withdrawals by making loans more portable. Currently, if you leave your job, you must repay any loan against your 401(k) otherwise the loan is treated as a withdrawal. By making it portable from job to job, people would be more likely to repay their loan. They also suggest improving education to get people to think about the impact of even a small hardship withdrawal. As we know, a small amount can grow to a big amount over time, so a small withdrawal now can have a big impact come retirement.
My takeaway from the article is that our current environment puts the onus on individuals to save for their own retirement. Defined Benefit pensions have gone the way of the Passenger Pigeon. Certainly, there are changes the employers and our government can make to improve retirement security. However, at the end of the day, it is up to individuals to educate themselves and take charge of their own fate.