Monday, February 06, 2012

Above “Average”

Every so often an industry survey will come out with an “average” 401(k) balance(1). The specific numbers vary, but they are consistently less than even the most optimistic would see as sufficient to provide a financially viable retirement.

Now, in fairness, the validity of an “average,” while mathematically simple, depends heavily on its components. Most are no more than the total of all the balances of those in the 401(k), from those just entering the workforce (and thus, by definition, with negligible balances) – and with decades to go to retirement – to those who are perhaps just days away from that point. Looking at no more than the “average,” you can’t tell how many are in which category. So, while the average can, over time, provide a sense of the direction in which things are moving, it tells you very little about the adequacy of that savings to fund an individual retirement.

One way to help provide a more meaningful measure is to segment those balances by specific age demographics. In fact, EBRI has long provided not only an average 401(k) balance, but also totals for different groups. To give you a sense of the difference that can make, at year-end 2010, while the average 401(k) balance was $60,329, the average 401(k) balance for those in their 60s – at least for those with 20 years of tenure – was $159,654.

In fairness, $159,654 may not look like very much to have saved by someone in their 60s. But even then, there are many things we don’t know about that person’s individual circumstances. We don’t know if they have a defined benefit pension, for one thing, nor do we know if they have savings outside their workplace. Perhaps just as significantly, we don’t know if that average takes into account their accumulated savings in all defined contribution plans, including those savings that might have been rolled into individual retirement accounts (IRAs) along the way.

In testimony before the Senate Finance Committee last fall(2), EBRI Director of Research Jack VanDerhei noted that “[p]articipation in a retirement plan through current employment at a specific moment in time does not tell the full story of a worker’s preparedness for retirement or the availability of some form of retirement income from an employment-based retirement plan.” He went on to caution, “Unfortunately, the ‘success’ of these plans are sometimes measured by metrics that are not at all relevant to the potential for defined contribution plans to provide a significant portion of a worker’s pre‐retirement income. For example, some analysts will merely report the average balance in defined contribution plans (most commonly the 401(k) subset of this universe) and attempt to assess the value of these plans by determining the amount of annual income that this lump sum amount could be converted to at retirement age. Of course, this concept does not adjust for the fact that the vast majority of 401(k) participants are years, if not decades, away from retirement age. Moreover, even if one does look at the average balances for workers near retirement age, it is obviously not correct to look only at the 401(k) balance with the employee’s current employer. For example, an employee age 60 may have very recently changed jobs and rolled over a substantial account balance from his previous employer to an IRA.”

Sure enough, as I sit here today, I have three separate 401(k) accounts at three separate employers, a rollover IRA, and a SEP.

Anyone trying to glean a sense of my retirement prospects while looking only at my current 401(k) balance surely wouldn’t feel very optimistic.

But then, they’d only be looking at part of the picture.

- Nevin E. Adams, JD

(1) Including EBRI – see “401(k) Plan Asset Allocation, Account Balances, and Loan Activity In 2010”

(2) A copy of the testimony is available here. See also “Tax Reform Options: Promoting Retirement Security

No comments: