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Another Frightening Story About Your 401(k) And Retirement—Brace Yourselves

401(k) investments are analyzed carefully at The Center for Retirement Research in Boston College and the results are eye opening.

Another scary 401(k) story is upon us.

With baby boomers retiring a daily basis, the outlook for how much people will have once they retire, isn’t showing any sign of improvement in the wake of the Great Recession. We’ve seen the numbers. A whopping 26 percent of those 50 to 64 have saved nothing and 14 percent of those 65 and older have saved nothing.

The Center for Retirement Research at Boston College continues to crunch the numbers on 401(k) and IRA holdings that don’t paint a positive outlook for the future: Only half of households have any 401(k)-related holdings and the typical household approaching retirement has $111,000 in 401(k)/IRA assets as of 2013, which is down from $120,000 in 2010. As for the rest of households, they have no source of retirement income other than Social Security.

The $111,000 balance may sound like a lot, but it translates to $500 a month, and that purchasing power will decline over time with inflation, according to Alicia Munnell, the center’s director.

A number of factors contribute to low balances: less than full participation, low contributions, high fees and leakages, Munnell says. What could improve outcomes is lower fees, a clamp-down on leakages or early withdrawals, a fully automated 401(k) system—auto-enrollment for both existing and new employees and auto-escalation in the default contribution rate—and contribution rates set at a realistic level, Munnell says.

But that alone won’t deal with the all the problems people face once they retire.

“This whole discussion has focused on the accumulation stage of retirement saving, and hasn’t even considered what participants will do with their money when they reach retirement,” Munnell says. “Unlike defined benefit plans, which provide participants with steady benefits for as long as they live, 401(k) plans generally pay out lump sums. Lump-sum payments mean that retirees have to decide how much to withdraw each year. They face the risk of either spending too quickly and outliving their resources or spending too conservatively and depriving themselves of necessities.”

Munnell says those risks could be eliminated through the purchase of annuities, but the individual annuity market in the US is tiny.

“Individuals are on their own, and no one really knows what they will do,” Munnell says.

Munnell says that when 401(k) plans began to spread rapidly in the 1980s, they were viewed as supplements to employer-funded pension and profit-sharing plans. Since 401(k) participants were presumed to have their basic retirement income needs covered by an employer-funded plan and Social Security, they were given substantial discretion over 401(k) choices, including whether to participate, how much to contribute, how to invest and when and in what form to withdraw the funds, she says.

“In theory, workers should be able to accumulate substantial balances in a 401(k), but it soon became evident that many failed to sign up for their 401(k) and many of those who did participate contributed much less than they could, failed to diversify and cashed out balances when they changed jobs,” Munnell says.

The numbers show that in 1988, 43 percent of workers eligible for 401(k) plans participated in them, according to the center. That fell to 20 percent in 2007 before the financial crisis hit and since then has remained steady at 21 percent.

The amount of plans with automatic enrollment, meanwhile, continues to grow. It was 17 percent in 2005 and it grew to 24 percent in 2006, 36 percent in 2007 and 40 percent in 2008 when the financial crisis hit hard. It dropped to 38 percent in 2009 and has continued to grow since then. It was 42 percent in 2010 and reached 47 percent in 2012, the most recent number available, according to the center.

As for the median contribution rate—it was 9.2 percent in 2013—roughly 6 percent by the employee with a 50-percent employer match, the center says. Most employees are entitled to contribute $17,500 on a tax-deductible basis on their 401(k) plan. Those approaching retirement can contribute another $5,500 a year. Of those who earn $39,000 or less a year, 22 percent are enrolled in a 401(k) and their median balance is $13,000. For those who earn $39,000 to $60,999, 48 percent are enrolled with a median balance of $53,000. The balance goes to $100,000 for those who earn between $61,000 to $90,999. Some 60 percent of that group are enrolled in 401(k) plans. For those who earn between $91,000 and $137,999, the median balance is $132,000 and some 65 percent of that group are enrolled. For those who earn more than $138,000, the median balance is $452,000 and 68 percent are enrolled.

As for those without any retirement savings, Social Security will be all they have to rely on and the frightening reality is that Social Security will provide less in the future than it does today, Munnell says.

One concern is the full retirement age in which a person can get full benefits is moving to 67, Munnell says. Those who retire at 65 and prior to 67 will receive a cut in their monthly benefits relative to their pre-retirement earnings, she says.

Another issue is that Medicare Part B and D premiums are scheduled to increase from 11 percent of the average Social Security benefit today to 22 percent in 2088, Munnell says. These premiums are deducted before the check goes in the mail, so the net Social Security benefit will decline, she adds. In addition, more Social Security benefits will be taxed under the personal income tax, she says.

“With a declining role for Social Security and virtually no individual saving outside of pensions, employer-sponsored retirement plans are very important,” Munnell says. “Unfortunately, only half of private sector workers at any moment in time are participating in any form of employer-sponsored plan.The lack of universal coverage means that many move in and out of participating in a plan and a significant fraction will end up with nothing beyond Social Security.”




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