Rely-Able?

Last week the Center for Retirement Research at Boston College provided an update on its National Retirement Risk Index (NRRI).¹ The impetus for the update was the triennial release of the Federal Reserve’s Survey of Consumer Finance (SCF), published in June, reflecting information as of December 2010.

Now, many things have changed since 2007, and in the most recent iteration of the NRRI, the authors note five main changes: the replacement of households from the 2007 SCF with those from the 2010 SCF; the incorporation of 2010 data to predict financial and housing wealth at age 65; a change in the age groups (because a significant number of Baby Boomers have retired, according to the report authors); the impact of lower interest rates on the amounts provided by annuities; and changes in the Home Equity Conversion Mortgage (HECM) rules that lowered the percentage of house value that borrowers could receive in the form of a reverse mortgage at any given interest rate.

And, when all those changes are taken into account, the CRR analysis concludes that, as of December 2010, anyway, the percentage of households (albeit those from a partially different cohort) at risk of being unable to maintain their pre-retirement standard of living in retirement increased by 9 percentage points² between 2007 and 2010 (from 44 percent at risk to 53 percent).

When the baseline for your analysis is updated only every three years, it’s certainly challenging to provide a current assessment of retirement readiness. In previous posts, we’ve covered the limitations of relying solely on the SCF data³and, to some extent, the apparent shortcomings of the NRRI (see “’Last’ Chances”), and retirement projection models, generally (see “’Generation’ Gaps”).

On the other hand, the impact of the decline in housing prices and the stock market were modeled by EBRI in February 2011 (see “A Post-Crisis Assessment of Retirement Income Adequacy for Baby Boomers and Gen Xers”), while the impact of the rising age for full Social Security benefits has been incorporated in EBRI’s Retirement Savings Projection Model (RSPM) since 2003. Moreover, EBRI has also included the potential impact of reverse mortgages in our model for nearly a decade now.

Meanwhile, as a recent EBRI report noted (see “Is Working to Age 70 Really the Answer for Retirement Income Adequacy?”), the NRRI not only assumes that everyone annuitizes at retirement, and continues to ignore the impact of long-term care and nursing home costs (or assumes that they are insured against by everyone), but it also seems to rely on an outdated perspective of 401(k)-plan designs and savings trends, essentially ignoring the impact of automatic enrollment, auto-escalation of contributions, and the diversification impact of qualified default investment alternatives.

It’s one thing to draw conclusions based on an extrapolation of information that, while dated, may be the most reliable available. It’s another altogether to rely on that result in one’s retirement planning, or the formulation of policies designed to facilitate good planning.

Nevin E. Adams, JD

¹ The report, “The National Retirement Risk Index: An Update” is available online here.

² The report notes that, between 2007 and 2010, the NRRI jumped by 9 percentage points due to: the bursting of the housing bubble (4.5 percentage points); falling interest rates (2.2 percentage points); the ongoing rise in Social Security’s Full Retirement Age (1.6 percentage points); and continued low stock prices (0.8 percentage points).

³ As valuable as the SCF information is, it’s important to remember that it contains self-reported information from approximately 6,500 households in 2010, which is to say the results are what individuals told the surveying organizations on a range of household finance issues (typically over a 90-minute interviewing period); of those households, only about 2,100 had defined contribution (401(k)-type) retirement accounts. Also, the SCF does not necessarily include the same households from one survey period to the next. See “Facts and ‘Figures.’”

Reality “Checks”

A recent opinion piece by Teresa Ghilarducci in the New York Times took on what she termed a “ridiculous approach to retirement,” drawn from what appears to be a series of “ad hoc” dinner conversations with friends about their “retirement plans and prospects.”

Most of the op-ed focused on the perceived shortfalls of the voluntary retirement savings system: People don’t have enough savings, don’t know how much “enough” is, make inaccurate assumptions about the length of their lives and their ability to extend their working careers, and aren’t able to find qualified help to help them make more appropriate savings decisions. In place of the current system, which Ghilarducci maintains “will always fall short,” she proposes “a way out” via mandatory savings in addition to the current Social Security withholding. Consider that, just three sentences into the op-ed, she posits the jaw-dropping statistic that 75 percent of Americans nearing retirement age in 2010 had less than $30,000 in their retirement accounts.

“You don’t like mandates? Get real,” she declares.

When we looked across the EBRI database of some 2.3 million active¹ 401(k) participants at the end of 2010 who were between the ages of 56 and 65, inclusive – people who have chosen to supplement Social Security through voluntary savings – we found only about half that number (37 percent) with less than $30,000 in those accounts. Moreover, when looking at those in that group who have more than 30 years of tenure, fewer than 13% are in that circumstance – and neither set of numbers includes retirement assets that those individuals may have accumulated in the plans of their previous employers, or that they may have rolled into Individual Retirement Accounts (IRAs), as well as pensions or other savings (see Average IRA Balances a Third Higher When Multiple Accounts are Considered).

That’s not to say that the financial challenges outlined in the op-ed won’t be a reality for some. In fact, EBRI’s Retirement Security Projection Model® (RSPM) developed in 2003, updated in 2010², finds that for Early Baby Boomers (individuals born between 1948 and 1954), Late Baby Boomers (born between 1955 and 1964) and Generation Xers (born between 1965 and 1974), roughly 44 percent of the simulated lifepaths were projected to lack adequate retirement income for basic retirement expenses plus uninsured health care costs (see “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model”) .

The op-ed declares that a voluntary Social Security system “would have been a disaster.” Indeed, an objective observer might conclude that that is why Congress originally established Social Security as a mandatory system, to provide a base of income for retirees as it still does today. With the underpinnings of that mandatory foundation of Social Security, the current voluntary system was established to allow employers and individuals to supplement that base. In recent decades Social Security’s benefits have been “reduced” by increases in the definition of normal retirement age, and a partial taxation of benefits, despite increases in the mandatory withholding rates, in order to adjust to the realities of rising costs from changing demographics. Even before the recent two-year partial withholding “holiday,” Congress was, and is still today, discussing additional adjustments to that mandatory system.

The voluntary system should be judged as just that, a voluntary system. As noted above, the data makes it clear that voluntary employer-based plans are, in fact, leading to a great deal of real savings accumulated to supplement Social Security. Many in the nation work every day to encourage those savings to be increased (see www.choosetosave.org ).

The “real” questions, certainly as one reflects on the debate over the Affordable Care Act mandate, amidst today’s political and economic turmoil, are whether the Congress and the nation will be willing – and able – to pay the price of an expanded or new retirement savings mandate, and, regardless of that outcome, how can a voluntary system be moved to higher levels of success?

Nevin E. Adams, JD

¹ Active in this case is defined as anyone in the database with a positive account balance and a positive total contribution (employee plus employer) for 2010.

² The RSPM was updated for a variety of significant changes, including the impacts of defined benefit plan freezes, automatic enrollment provisions for 401(k) plans, and the recent crises in the financial and housing markets. EBRI has recently updated RSPM to account for changes in financial and real estate market conditions as well as underlying demographic changes and changes in 401(k) participant behavior since January 1, 2010. For more information on the RSPM, check out the May 2012 EBRI Notes, “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model.”

Last June EBRI CEO Dallas Salisbury participated in an “Ideas in Action with Jim Glassman” program discussion with Ghilarducci and Alex Brill from the American Enterprise Institute titled “America’s Retirement Challenge: Should We Ditch 401(k) Plans?” You can view it online here.

Titanic Proportions

This weekend marks the 100th anniversary of the sinking of the now iconic RMS Titanic, at the time the world’s largest ocean liner. Its passengers included some of the wealthiest people in the world, as well as a large number of emigrants seeking a new life in North America. On the ocean liner’s maiden—and only—voyage, it carried 2,244 people, 1,514 of whom would perish as a result of a decision to carry only enough lifeboats to accommodate about half those on board. Despite that, the tale of Titanic’s closing hours is generally one of an orderly, “women and children first” evacuation, with the band playing on while passengers stood in line and waited their turn.

In an NPR report this week titled “Why Didn’t Passengers Panic on the Titanic?” David Savage, an economist and Queensland University in Australia, compared the behavior of the passengers on the Titanic with those on the Lusitania, another ship that also sunk at about the same time. Both involved luxury liners, both had a similar number of passengers and a similar number of survivors. But on the Lusitania, passengers panicked—and the survivors were mostly those who were able to swim and get into the lifeboats. The biggest difference in the reactions in these two similar circumstances, Savage concludes in the report, was time: The Lusitania, struck by a U-Boat torpedo, sank in less than 20 minutes, while the Titanic took approximately two and a half hours. Time enough, in the case of Titanic, according to Savage, for social order to prevail over “instinct.”

I’ve not yet seen anyone link the nation’s retirement prospects to the Titanic, though the importance of starting to save early, establishing a plan, and having a goal all fit within the moral of that example: Act while you have time, as you may not always have all the time you need, or the resources to take advantage of it. But what kind of time do Americans have?
The concept of measuring retirement security—or retirement income adequacy—is an extremely important topic, and EBRI has been working with this type of measurement since the late 1990s. When we modeled the Baby Boomers and Gen Xers in 2012, approximately 44 percent of those households were projected to have inadequate retirement income for basic retirement expenses plus uninsured health care costs; so the glass is more than half full, but just a bit. That’s a big percentage, but it’s still an improvement of 5‐8 percentage points over what we found in 2003, when the glass was, indeed, half empty. The improvement occurred despite the impact of the 2008 financial crisis, and the subsequent “great recession.”

In part, that is because the passage of time allowed more funds to be saved, but that improvement is largely due to the fact that in 2003 very few 401(k) sponsors had automatic enrollment (AE) provisions in place, and participation rates among the lower-income workers (those most likely to be at risk) was quite low. However, with the uptick in adoption of AE the past few years after passage of the Pension Protection Act (PPA), participation rates have often increased to the high 80 or low 90 percent—and that stands to make a big difference in shoring up the retirement financial security of many of those who need it the most. In fact, EBRI simulation results show that approximately 60 percent of the AE-eligible workers would immediately be better off in an AE plan than in a plan design relying on voluntary enrollment, and that over time (as automatic escalation provisions took effect for some of the workers) that number would increase to 85 percent.

The tragic loss of life on the Titanic is generally attributed to a shortage of lifeboats, while on the Lusitania, it was the lack of time to get people into the lifeboats available. For many of those looking ahead to retirement, plan design changes such as automatic enrollment and contribution acceleration look to be a real retirement life-saver, as they encourage both early action and the effective use of time.

- Nevin E. Adams, JD


While the lack of retirement income adequacy for the lowest-income households is a matter of concern, so is the rate at which they will run “short” of money during retirement. Indeed, as documented in our July 2010 Issue Brief (“The EBRI Retirement Readiness Rating:™ Retirement Income Preparation and Future Prospects,”41 percent of early boomers in the lowest income quartile could run short of money within 10 years after they retire.

More information is included in recent testimony by Jack VanDerhei, EBRI research director, before the Senate Banking Committee, on "Retirement (In)security: Examining the Retirement Savings Deficit" (T-171), available online here.

“Counter” Intuitive?

When one considers the impact of changes in tax policy on retirement plan savings, it is perhaps natural to assume that those who pay more taxes would respond to changes in the taxation of their contributions and/or savings. However, what’s probably not as obvious to many is that lower-income workers could also be significantly impacted. Indeed, as noted in the March 2011 EBRI Notes, “…behavioral economics has shown that the reaction of employees in situations similar to this are often at odds with what would have been predicted by an objective concerned simply with optimizing a financial strategy.”(1)

As part of the 2011 Retirement Confidence Survey, workers were asked about the importance of tax deferrals in encouraging them to save for retirement. Quoting from the November 2011 EBRI Issue Brief, “If one were to look at this from a strictly financial perspective, one would assume that the lower-income individuals (those most likely to pay no or low marginal tax rates and therefore have a smaller financial incentive to deduct retirement savings contributions from taxable income) would be least likely to rate this as ‘very important.’ However, those in the lowest household income category ($15,000 to less than $25,000) actually have the largest percentage of respondents classifying the tax deductibility of contributions as very important (76.2 percent).”

Additionally, asked how they would likely respond if their ability to defer those taxes was eliminated, it was the lowest-income category ($15,000 to less than $25,000) that reacted most negatively—with 56.7 percent indicating they would reduce the amount they would save in these plans (see http://www.ebri.org/publications/notes/index.cfm?fa=notesDisp&content_id=4785).

As part of the 2012 Retirement Confidence Survey,(2) participants were asked about their likely response to a different set of federal tax modifications included in a specific proposal. (3) Those participant responses were subsequently integrated with those of plan sponsor respondents to a 2011 AllianceBernstein survey(4) to the changes contemplated under that same proposal. The proposal author’s analysis had largely assumed status quo in terms of plan design changes (by plan sponsors) and contribution flows (by both individual participants and employers) in response to those changes.

In fact, the average percentage reduction for 401(k) participants in the two smallest plan size categories (less than $1 million and $1–$10 million in assets) were more than 1.5 times the value of the average percentage reduction for participants in any of the larger plan-size categories (regardless of the income level of the 401(k) participants). Striking as those results are, there is a ripple effect on participant savings to be considered as well.

A new EBRI study uses the EBRI-ERF Retirement Security Projection Model® (RSPM), and with a database of tens of thousands of 401(k) plans and millions of participant accounts, to provide baseline analysis. That analysis indicates that the cumulative impact of reported plan sponsor modifications and individual participant reactions would result in an average percentage reduction in 401(k) balances of between 6–22 percent at Social Security normal retirement age for workers currently ages 26–35. That analysis also indicates that an even larger average percentage accumulation reduction would result for participants in small plans.(5)

Those participant and plan sponsor responses may be counter-intuitive to some—but it’s the type of response - and impact - that shouldn’t be overlooked.

- Nevin E. Adams, JD

(1) See “The Impact of Modifying the Exclusion of Employee Contributions for Retirement Savings Plans From Taxable Income: Results from the 2011 Retirement Confidence Survey.”

(2) See “The 2012 Retirement Confidence Survey: Job Insecurity, Debt Weigh on Retirement Confidence, Savings.”

(3) It’s not the first time EBRI has undertaken such an analysis, of course. EBRI has looked at preliminary evidence of the impact of these “20/20 caps” on projected retirement accumulations under a set of assumptions—see “Capping Tax-Preferred Retirement Contributions: Preliminary Evidence of the Impact of the National Commission on Fiscal Responsibility and Reform Recommendations”, and “Tax Reform Options: Promoting Retirement Security,” EBRI Issue Brief, No. 364, November 2011. EBRI also provided testimony before the Senate Finance Committee on the issue, online here. Research Director Jack VanDerhei also submitted testimony to the Senate Finance Committee on “The Impact of Modifying the Exclusion of Employee Contributions for Retirement Savings Plans From Taxable Income: Results From the 2011 Retirement Confidence Survey," .

(4) AllianceBernstein, 2011, “Inside the Minds of Plan Sponsors” Research.

(5) That integration of sentiment with EBRI’s extensive 401(k) database and modeling capabilities provided a unique perspective on the full potential impact of these changes on cumulative savings amounts, which was outlined in our recent March 2012 EBRI Notes article, “Modifying the Federal Tax Treatment of 401(k) Plan Contributions: Projected Impact on Participant Account Balances.”

“Difference” Strokes

In response to concerns that tomorrow’s retirees will run short of money, we are often told to save more, to work longer, or – as often as not these days – to work longer AND save more. Certainly working and saving longer can do wonders in terms of stretching your retirement nest egg.

However, the timing of the retirement decision is often not within an individual’s control. In fact, the Retirement Confidence Survey has consistently found that a large percentage of retirees leave the work force earlier than planned. In fact, nearly half (45 percent) of retirees reported that they were in this situation in 2011 (see EBRI Issue Brief No. 355, March 2011, The 2011 Retirement Confidence Survey: Confidence Drops to Record Lows, Reflecting “the New Normal”).

Real-world data have shown (and shown for some time now) that the median retirement age for Americans is not even as old as 65 (it’s been 62). Still, EBRI research has shown that working longer – even working past the age of 65 – is no guarantee of a financially satisfying retirement. In fact, a June 2011 Issue Brief titled “The Impact of Deferring Retirement Age on Retirement Income Adequacy” ) notes that, even if a worker delays his or her retirement until age 80, just 61.7% of the lowest preretirement income quartile households would have a 50 percent probability of not running out of money in retirement.

What Matters


The research notes that how workers fare financially after retirement is directly tied to three factors: their salary level at retirement, how long they work beyond 65, and whether they save in a defined contribution retirement plan during their working lifetime. In fact, the report notes that “a major factor that makes a difference” in their ability to meet basic and uninsured health-care costs in retirement is “whether they are still participating in a defined contribution plan after the age of 65.” How much difference? At least a 10 percentage point difference in the majority of the retirement age/income combinations.

Ultimately, the research should remind us of a couple of things: first, that the assumption that we’ll be able to work past “normal” retirement age is just that—an assumption. Second, and more important, even if that assumption pans out, it cannot be assumed that it will, in and of itself, prove to be sufficient.

But finally, and significantly, there is at least one thing individuals can exercise some control over in the “here and now” – their current—and continued—participation in defined contribution plans.

And that’s something that can directly—and significantly—make a difference in building a financially viable retirement.

- Nevin E. Adams, JD

(1) Admittedly, except for those in the lowest income quartile, this would be a small percentage of the population, depending on your expectations of success (see “Short” Comings ). Still, according to the EBRI Retirement Security Projection Model (RSPM) baseline results, the lowest preretirement income quartile would need to defer retirement age to 84 before 90 percent of the households would have a 50 percent probability of success.

You can read more about how these factors impact retirement income adequacy HERE