In Emergency Only...

Back when I was in school (OK, so it was way back), there were these little red fire alarm boxes strategically placed throughout the building. Their purpose was clearly indicated in big white letters… but, inevitably, as the school year wound to a close…  

Well, it seemed that someone was always pulling those levers, and no, not because of any actual fire—but rather because some hapless soul had been pressured to create a nuisance, but more commonly just because some upper classman was looking to avoid a test for which they weren’t prepared, or wanted to get outside and enjoy the fresh air.

Initially these emergency calls got the expected response, and we all dutifully filed down the stairs and out to our designated areas. And, sure enough, by the time the building was evacuated, the premises sufficiently investigated, and the student body returned to our respective classrooms—well, it left little time for actual instruction, for a period, at least. And then afterwards we’d get the loudspeaker reminder that these were “for emergency only.”

Last week the Wall Street Journal ran a piece titled, “Should You Tap Retirement Funds in a Crisis? Increasingly, People Say Yes”, and then proceeded to outline the circumstances of several individuals who have, following a variety of hardships imposed by the COVID-19 pandemic (and subsequent economic shutdown) tapped into their 401(k) for some financial sustenance. The article[ii] proceeded not only to chronicle the recent legislation that has loosened the restrictions on loans, and created a whole new category of distributions to help stave off financial catastrophe in the wake of the pandemic, but that has, ever since Hurricane Katrina, become something of a pattern of relief—well, pretty much every time there is some kind of regional calamity.

Indeed, the lowering of the barriers to a pre-retirement withdrawal of these ostensibly for retirement funds has become so routine that it seems that every time there is a wildfire, flood, tornado, hurricane, earthquake, or natural disaster that impacts more than a local neighborhood, our industry queues up for the inevitable relief announcement like a Pavlovian pack.

Don’t get me wrong. I am pleased and proud of a system that, at a time of severe and extraordinary financial hardships, can provide an essential financial lifeline. Moreover, unlike the mammoth amounts of government aid and assistance already targeted, these funds provide relief that is literally funded by the very pockets of those impacted by the disaster.[iii]

And yet, while appreciating both the need and positive potential impact that these programs can have, as we look ahead to the future they’re “borrowing” from, one can’t help but hope that most won’t be forced to. Indeed, the WSJ article notes that from late March through May 8, (just) 1.5% of eligible people with 401(k) accounts handled by Fidelity Investments took some money out, while Empower Retirement notes that (only) about 1% of 401(k) savers in plans it administers that allow the withdrawals took money out through May 31, while Alight Solutions LLC, puts the figure at 1.2%, though it notes that more than half of those withdrew $100,000 (or their whole balance if it was less than that). Similarly, a recent survey of the ASPPA TPA community suggests that loan and withdrawal volumes are, in fact, largely, in line with traditional trends.[iv]

Even now, however, there are voices encouraging and enticing ostensibly COVID-impacted individuals who don’t have a financial emergency to take advantage of this new “opportunity” to pull money out of those retirement savings accounts, doubtless preying on their concerns, and—in some cases surely—greed.

Here’s hoping that individuals remember that these accounts—as with those school building fire alarms,—should be “pulled” only “in case of emergency.”

- Nevin E. Adams, JD

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[ii]To their credit, the WSJ article includes cautionary voices, noting that pulling out retirement money now might undermine their future financial security, that pulling that money out during volatile markets might well be a “sell low” decision, and that encouraging withdrawals now is, at best, a mixed message about the retirement focus of these accounts. The title may suggest a groundswell of voices “increasingly” calling for pre-retirement access, but even those featured in the article whose hands have been forced by circumstances beyond their control largely express caution and concern at having done so—and a commitment to continued prudent preparations once their current economic turmoil ends.

[iii]Indeed, that’s quite different from the government or employer-funded international pension systems (Australia and Malaysia, of all places) cited in the WSJ article as now permitting pre-retirement access.

[iv]The WSJ article also reports that retirement savings programs sponsored by California, Oregon and Illinois reported increases in distributions following state shutdowns. As of the end of May, 13.7% of IRAs that Illinois residents funded through the state’s Illinois Secure Choice program had been fully or partially liquidated, up from 10.7% on Jan. 1.

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'Tacts' Treatment?

Roth 401(k)s are more prevalent—and popular—than ever. But is that good—or bad—for retirement?

A recent op-ed[i] in The Wall Street Journal explored the potential implications—“What ‘Rothifying’ 401(k)s Would Mean for Retirees”— (subscription required), though the focus is on tax policy as well.

You’ll remember that so-called “Rothification”—essentially the elimination of the pre-tax treatment currently accorded 401(k) contributions—was quite the controversial issue back in 2017 when the Republican-controlled House of Representatives was looking for ways to raise revenue to help pay for tax cuts.[ii] And while it’s not been an active focus of late, it seems likely to resurface as the nation’s budget deficit widens, and the field of 2020 presidential aspirants seem determined to find ways to spend more or, in the case of the incumbent, collect less in taxes.

‘Out’ Comes 

As for the WSJ treatment, I’ll spare you the short read (longer if you actually check out the 36-page paper it was based upon), and summarize it thusly: later retirements (not by choice, but of necessity), less retirement income, and more wealth inequality. Though, at least in the short run, more tax revenue for Uncle Sam.[iii]

Now most of this comes from a key assumption; as the WSJ piece puts it, “Over their lifetimes, workers would accumulate one-third less in their 401(k)s under a Roth system. This is because, with no tax advantage from contributing to a 401(k), workers would save less and those lower contributions would earn less over the years.”

Said another way, without the tax break, the authors conclude that workers won’t save as much, and saving less means that they’ll have less invested, and that  means that they’ll have less retirement income. They also argue that, with Rothified savings, workers would tap into Social Security later—a year later, on average, they claim. They note that with their retirement savings already taxed, wealthier individuals would be inclined to defer taking Social Security (increasing their benefit), widening income inequality.[iv]

‘Less’ on Plan?

The concern about mandatory Rothification was always that workers would, in fact, save less—and this is a concern that employers have expressed, though this was in the context of the ability to save on a pre-tax basis being taken away. That, in turn, seems to be predicated on the notion that workers have a specific dollar amount in mind that they can afford to save, and that if some of that certain dollar amount goes to taxes, there is a dollar-for-dollar offset. Doubtless that’s true for some, particularly among lower-income workers. However, when I have seen savings data, what seems to be the norm is that individuals save a specific percentage of pay, one generally driven either by what’s necessary to earn the employer match, or perhaps that rate at which default contributions are set. In other words, people choose to save 3% of pay, not $50/paycheck.

Now, if that  perception is accurate (feel free to disagree in the comments below if you see things differently), then it seems to me that most individuals might actually save the same amount, regardless of whether it’s pre- or post-tax. And if they were to same at the same rate (and admittedly that’s a big “if”), their retirement outcome might actually be more  secure—because withdrawals (and taxation) wouldn’t be forced on them by RMD calculations, because they wouldn’t have to worry about those contributions—and the earnings that have accumulated on those contributions—being taxed, and, significantly, because the reduction in taxable income wouldn’t undermine (through “means testing”) Social Security benefits.

But key to the analysis is how participants would respond, and the study cited in the WSJ isn’t the only academic consideration on the subject; one in 2015 found no change in savings rates with a voluntary addition of a Roth feature, and in 2017, the non-partisan Employee Benefit Research Institute (EBRI) found that it might help—or hurt—retirement security—and this is key—depending on the response of participants.

It appears that more participants are being presented with that option. Nearly 70% of plans now provide a Roth 401(k) option, according to the most recent survey by the Plan Sponsor Council of America. Perhaps more significantly, that survey, reporting 2018 plan activity, finds that nearly a quarter of participants (23%) elected to contribute to a Roth when given the opportunity, up from 19.5% in 2017 and 18.1% in 2016—an increase of nearly 30% in just three years.

Academic studies notwithstanding, it’s worth remembering that retirement security isn’t just a matter of how much you have saved at  retirement; it’s how much you have available to spend throughout retirement.

- Nevin E. Adams, JD

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[i]The authors of the WSJ article, Olivia S. Mitchell and Raimond Maurer, previously authored a research paper upon which the WSJ piece was based (albeit with a slightly different title, “How Would 401(k) ‘Rothification’ Alter Saving, Retirement Security, and Inequality?”). 

[ii]They weren’t, however, the first to propose such a shift. President Obama did so in 2015.

[iii]However, the authors state that the taxes collected on withdrawals of that money exceed the amount of additional income taxes that would be collected during people’s working lives under Rothification.

[iv]As a side note, the authors in the WSJ article note that not only would this be bad for Social Security funding, but they also conclude that the taxes collected on withdrawals would exceed the amount of additional income taxes that would be collected during people’s working lives under Rothification—ostensibly because of their previous assumption that it would be a larger accumulation of money to be taxed. 

Unforget Able?

A recent headline in The Wall Street Journal started off: “Forget the 401(k).” And then, unintentionally, proceeded to explain why that would be… nuts.

Not that the author (Jason Zweig) didn’t throw in some digs at the subject, making a glancing reference to what he termed “the rigid and often paltry 401(k)s that workers have today” before going on to berate America’s retirement plan, dismissively claiming that “there’s little question that the 401(k) as we know it just isn’t getting the job done.”

That, of course, depends on what one considers “the job” – though, to his credit - and I generally appreciate Jason's perspectives - he didn’t fall into the common journalistic device of pining for the “good old days of the defined benefit plan.” Quite the contrary, he bluntly proclaims (in language that one rarely sees attributed to DB plans) that even in their heyday, “defined-benefit plans were, in fact, sporadic, arbitrary and unfair.” (This is a pervasive myth – see “‘Myth’ Understandings.”)

That said, the issue might be that he’s not very well acquainted with “the 401(k) as we know it.” Consider that his recommendations for a “new retirement plan” aren’t exactly “new,” nor are they the kind of thing that would seem to “reinvent retirement-savings plans from scratch.” Rather, the article calls for:

1. making “it easier to convert savings into regular income” (by providing incentives to workers to take distributions as annuity income, since, left to their own devices, individuals don’t); 
2. implementing solutions so that “retirement income should last well past 65 (a.k.a. deferred longevity annuity); and 
3. making it harder for folks to tap into their retirement savings prior to retirement (by directing some initial contribution funding into rainy day accounts). 

Indeed, perhaps the most radical notion – and one that might well push aside the 401(k) with a government-run version. Put forth by former Assistant Secretary of Labor Phyllis Borzi, this is a program that would be voluntary for employer contributions, but mandatory for employees – “regardless of whether you were self-employed, a full-time employee, an independent contractor or a leased employee” where a “professionally managed not-for-profit company with an independent board of directors would collect and invest retirement contributions from you and your employers.” An idea that sounds awfully (and I do mean “awfully”) similar to an idea proposed in the House late last year. 

But the idea that the author devoted the most space to was, ironically enough, the notion of taking the “forgettable” 401(k) – and making it universally available! This, ironically enough, from Ted Benna who, of late, has mostly been touting a new book and dissing the program he’s often credited with “discovering.” 

Ultimately, headline notwithstanding, it’s hard to imagine any of these “new” ideas as a reality without the underpinning of the 401(k). In fact, apparently the only thing holding the “forgettable” 401(k) from doing “the job”… is that everyone doesn’t have one.

But I’d say that makes the 401(k) pretty UN forgettable!

- Nevin E. Adams, JD

‘Automatic’ Transmission: Does Auto-Enrollment Create Leakage?

Most people view automatic enrollment in a 401(k) as a good thing¹ – but apparently it has a heretofore unappreciated “dark” side.

At least that was the focus of a headline in a recent Wall Street Journal article (subscription required) that asked (and answered) the provocative question: “401(k) or ATM? Automated Retirement Savings Prove Easy to Pluck Prematurely.”

That is at least how the Journal chose to position its coverage of a study based on a single firm’s experience with automatic enrollment. That study, according to the Journal, serves to “answer a question that has long concerned employers that put workers into 401(k) plans and give them the option to drop out, rather than requiring them to sign up on their own: Will auto-enrolled workers treat their 401(k)s like automated-teller machines?”

Now, I’ve heard a lot of questions over the years from plan sponsors about automatic enrollment – but never that one.

Regardless, the Journal says that the study provides an affirmative response to the question – but (and you can almost hear the disappointed sigh) “…not to the extent that the workers spend all their gains from auto-enrollment.” Nor is it the first time that the Journal has taken aim at automatic enrollment.²

Now the researchers themselves – John Beshears, David Laibson and Bridget Madrian of Harvard, and James Choi of Yale – have solid retirement plan researcher “cred.” And, comparing employees hired in the 12 months after the introduction of automatic enrollment to those hired in the 12 months prior, they find that automatic enrollment increases total potential retirement system balances by 7% of starting pay eight years after hire.

On the other hand, they also find that leakage “in the form of outstanding loans and withdrawals that are not rolled over into another qualified savings plan” (more on that in a minute) also increase – by 3% of starting pay, which they say offsets approximately 40% of the potential increase in savings from automatic enrollment. Of course, even then, they acknowledge that the “net effect is that automatic enrollment increases retirement system balances by 4-5% of first year pay eight years after hire.”

‘Ample’ Turnover?

Here’s the thing: This is the experience at a single firm. Granted, it’s described as a large (approximately 7,500-participant), Fortune 500 financial services firm – but it’s one that the researchers concede has high turnover. It’s also, based on the salary information provided, one with relatively modest income workers. And automatic enrollment did “work” – transforming the plan’s participation rate from 62% to 98%.

So, this employer adopts automatic enrollment in a plan of modest income workers – creating more, albeit arguably smaller account balances – for a workforce that has high turnover – and since they have smaller balances, more likely to be below the cashout thresholds, and thus resulting in a higher number of termination payout “leakage.”

Cash Out ‘Cache’?

The Journal tries to craft a picture that automatically enrolled participants are more likely to cash out than other participants – and arguably they may well be less committed to the savings proposition. In fact, the study found (and the Journal article notes) that more than half of the auto-enrolled participants – 59% – cashed out their savings (largely driven by terminations), while among those who signed up for the plan on their own, the figure was 43%.

But was it automatic enrollment – or the smaller balances that resulted from a 3% default contribution rate at termination – that produced that result? I think we can all sense what the answer is – but the researchers note that a greater proportion of the automatically enrolled workers had balances below the $1,000 cashout threshold. Lest we need any further affirmation, even then, the researchers note that those net results “mask substantial differences across those who remain employed at the firm versus those who separate” – with the former seeing relatively little impact from leakage.

Change ‘Ranges’

And while the researchers don’t make much distinction in the impact of different types of leakage, the nonpartisan Employee Benefit Research Institute (EBRI) has previously considered the issue, and found that cashouts at job change were found to have a much more serious impact on 401(k) accumulation than either plan loan defaults or hardship withdrawals (even with the impact of a six-month suspension of contributions included). How much more? Well, cashouts at termination were approximately two-thirds of the leakage impact.

Even the best researchers are limited by the amount and quality of the data. While they are careful to outline those factors in the study, the coverage of such things tends to gloss over the details that might impact the broad-based applicability of the results – things like the fact that these results are from a single employer, with high turnover and modest-incomes, a combination that may well mean that the amount – and impact – of the leakage is exacerbated.

Ultimately, the point of the study might well be a call to make it easier for individuals with smaller balances to leave their employer without cashing out their savings.

That’s hardly the fault of a plan design that helped a third more workers who weren’t saving do better. But it seems that if there’s the slightest possibility of a potential downside, the negative coverage is… automatic.

- Nevin E. Adams, JD

Footnotes

1. There are some administrative issues with automatic enrollment – see Why Your Recordkeeper Might Not Be an Automatic Enrollment Fan. ↩
2. Earlier this year the Journal, in an article plainly titled, “Downside of Automatic 401(k) Savings: More Debt” (subscription required), cited another academic study noting that automatic enrollment has “pushed” millions of people who weren’t previously saving for retirement into those plans – but quickly cautioned that “many of these workers appear to be offsetting those savings over the long term by taking on more auto and mortgage debt than they otherwise would have.” And back in 2013, the Journal had an article titled, “Mixed Bag for Auto-enrollment,”  claiming that “employees who are automatically enrolled in their workplace savings plans save less than those who sign up on their own initiative.” That article, in turn, built on – and cited – a 2011 article that suthoir Anne Tergesen jaw-droppingly titled, “401(k) Law Suppresses Saving for Retirement.” In the case of the latter, Tergesen glommed on to one of 16 possible scenarios, and focused on the notion that some workers would simply rely on the mechanics of automatic enrollment’s 3% default, rather than picking the higher rate that they might if they filled out an enrollment form (encouraged by things like education meetings and incentivized by things like a company match). ↩