The Gaps in Retirement Savings "Gaps"

As spring follows winter, so apparently do dire predictions about the nation’s retirement prospects.

For example, the Center for Retirement Research (CRR) at Boston College now claims we are looking at a $7.7 trillion dollar “retirement gap” for American workers, up from $6.6 trillion five years ago. Meanwhile, a new report by the National Institute on Retirement Security (NIRS) on what it called the “Continuing Retirement Savings Crisis” didn’t cite a specific aggregate gap, but a year ago NIRS employed a similar approach to suggest that that gap was likely somewhere between $6.8 trillion and $14 trillion.

While these outcomes are cited widely (the CRR’s as recently as last week in a U.S. Senate hearing), the underlying methodologies and assumptions are worth understanding. Both rely heavily on self-reported numbers from the Federal Reserve’s Survey of Consumer Finances (SCF), and while both track the progress of American retirement readiness by examining how individuals in the SCF did over time, they fail to acknowledge that doing so compares the balances and readiness of two completely different groups of individuals at different points in time. The NIRS analysis builds on that shaky foundation by incorporating some assumptions about defined benefit assets and extrapolating target retirement savings needs based on a set of age-based income multipliers — income multipliers, it should be noted, that have no apparent connection with actual income, or with actual spending needs in retirement. But then, the math is easier.

There’s no question that there is a gap between what Americans are likely to need to live comfortably in retirement and the resources available to fund it. The non-partisan Employee Benefit Research Institute (EBRI) recently updated its EBRI Retirement Readiness Rating and found that the retirement savings gap was $4.13 trillion for all U.S. households (not just those who have retirement plan balances, though it uses actual 401(k) data for those who do have such plans, rather than relying on self-reported estimates), where the head of the household is between 25 and 64, inclusive. That may be well short of the projections offered by the NIRS and CRR, but it’s a big number, nonetheless.

Indeed, considering the enormity of that gap, policymakers — and Americans generally — might well feel like throwing up their hands and despair of ever closing it (indeed, earlier this month NIRS published a survey indicating that 86% of Americans believe the nation faces a retirement crisis).

What is unfortunately often lost in the trillion-dollar gap headlines (and the concurrent surveys that, unsurprisingly, talk about our deteriorating confidence about our retirement) is that not everyone has a retirement savings gap. Ironically, considering their differing methodologies, the CRR, NIRS and EBRI all put the number at about 50%. (EBRI’s number, which in its assumptions and use of actual data seems more conservative, says the number at risk of running short of money in retirement is in the low 40% range.)

How big is the gap at an individual level? The EBRI analysis breaks it down into manageable numbers: For those on the verge of retirement (Early Baby Boomers), the deficits vary from an aggregate of $19,304 (per individual) for married households, to $33,778 for single males and $62,734 for single females. If you look only at the individuals who do have gaps (EBRI’s projections, which take into account the potential costs of nursing home care and living expenses based on real experience, rather than arbitrary replacement ratios, indicate that about 57% will have sufficient retirement income), the gap for Early Boomers ranges from $71,299 per individual for married households to $93,576 for single males and $104,821 for single females.

Not surprisingly, those eligible to participate in workplace retirement plans fare better. Also not surprisingly, those who have jobs are more likely to have incomes and access to a workplace retirement plan — and those who work for larger employers are more likely to have both larger incomes and access.

However, even EBRI’s estimates include a wide range of personal circumstances, from individuals projected to run short by as little as a dollar to those projected to fall short by tens of thousands of dollars. For those seeking to understand, and perhaps craft solutions for, the current projected shortfalls, this is an important distinction, and one given short shrift by a headline’s focus on the aggregate.

There are, of course, broad policy changes that can, and have, made a big difference, nationally and at a plan level — things like automatic (and immediate) enrollment, contribution acceleration and prudent selection of a default investment option, not to mention ideas (or legislation) that expand access to those plans.

That said, ultimately the retirement savings gap is an aggregation of individual savings gaps. And as advisors well know, you close those one individual at a time.

- Nevin E. Adams, JD

"Left" Overs

I’ve never been big on leftovers. Now, I know that many relish the taste of cold pizza for breakfast, while others swear that a desirable marinating takes place during storage. As for me, no matter how good the original dish, and despite the wonders of microwaving, I have a hard time getting excited about sitting down to a meal comprised of things that (at least in some cases) weren’t good enough to finish the first time.

When it comes to retirement savings, most still seem to “begin” with whatever is “left over” — after bills, living expenses, food and the like.

Not that we’re comfortable with that approach. A recent Wells Fargo/Gallup survey found that, taking their savings and Social Security income into consideration, more than two-thirds (69%) of investors say they are “highly” or “somewhat” confident they will have enough money to maintain their desired lifestyle throughout their retirement years. However, nearly half (46%) are still “very” or “somewhat” worried about outliving their savings, including 50% of non-retirees and 36% of retirees.

Nor is it a uniquely American issue; the Towers Watson Global Benefit Attitudes Survey found that in developed economies typically two-thirds of respondents believe their financial resources will support 15 years of retirement, but less than half are confident when considering 25 years into retirement.

So, how are we dealing with this worry about running out of money? Well, surveys are beginning to indicate that this uncertainty is already translating into extended work lives — or at least some expectation of being able to do so. Simply stated, for some, the “answer” to not having enough saved to retire is simply to work longer. Mathematically, those assumptions can produce a satisfying projected outcome. Unfortunately, like an assumption that your retirement investments will return 12% annually for the next 30 years, the data suggests that the reality of working longer is often undermined by circumstances beyond the individual’s control.

On the path toward more realistic assumptions, a growing number of providers now make available a projection as to how much monthly income a participant’s retirement savings would produce, and in May 2013, the U.S. Department of Labor’s Employee Benefits Security Administration (EBSA) has proposed that a participant’s pension benefit statement (including his or her 401(k) statement) would show his or her current account balance and an estimated lifetime income stream of payments based on that balance. These efforts will doubtless make it easier for today’s workers to anticipate how much retirement income they will have available, based on certain assumptions.

As for those already in retirement — and unable to adjust assumptions— some studies have shown that retirees are adjusting to their income realities — though arguably those are the kind of reality adjustments most would rather not be forced to make.

For those with time to prepare ahead, while we know that the requirements of the “here and now” frequently intrude on our preparations for the “there and then,” there’s something to be said for taking the time now to think about what those retirement savings “leftovers” could taste like — and how small the portions could be.

- Nevin E. Adams, JD

“Gamble” Gambit

This past week PBS’ Frontline ran a segment on retirement titled “The Retirement Gamble.”

During that broadcast several individual cases were profiled—a single mother who lost her job (and a lot of money that she had apparently overinvested in company stock); a middle-aged couple whose husband had lost his job (and a big chunk of their 401(k) investment in the 2008 financial crisis); a couple of teachers who had seen their retirement plan investments do quite well (before the 2008 financial crisis); a 32-year-old teacher who had lost money in the markets and found herself in an annuity investment that she apparently didn’t understand, but was continuing to save; and a 67-year-old semi-retiree who had managed to set aside enough to sustain a middle-class lifestyle. The current income and/or working status of each was presented, along with their current retirement savings balance.

Much of the promotional materials around the program focused on fees, and doctoral candidate Robert Hiltonsmith featured prominently in the special. Hiltonsmith, as some may recall, was the author of a Demos report on 401(k) fees released about a year ago—one that claimed that “nearly a third” of the investment returns of a medium-income two-earner family was being taken by fees (Demos report online here), according to its model—which, it should be noted, assumed that each fund had trading costs equal to the explicit expense ratio of the fund.

A fair amount of the program was devoted to the trade-offs between active and passive/index investment strategies, and the lower fees generally associated with the latter. Participant savers might not always choose them, but PLANSPONSOR’s 2012 Defined Contribution Survey found that nearly 8 in 10 (77.4 percent) of the nearly 7,000 plans surveyed already include index fund(s) on their menu, and that nearly 9 in 10 of the largest plans do. Similarly, the Plan Sponsor Council of America’s 55th Annual Survey lists “indexed domestic equity funds” as one of the fund types most commonly offered to participants (82.8 percent of plans).

“Balance” Perspectives

Hiltonsmith, 31, “had no savings to lose” in the 2008 financial crisis, according to the Frontline report, but after entering the workforce he began saving in his workplace 401(k). However, “even in a relatively good market, he began to sense that something was wrong,” the voiceover notes. Hiltonsmith explained: “I have a 401(k), I save in it, it doesn’t seem to go up… I kept checking the statement and I’d be like, why does this thing never go up?”

For some time now, EBRI has tracked the actual experience in 401(k) accounts of consistent participants, by age and tenure. Looking at the experience of workers age 25–34, with one to four years of tenure, and considering the period Jan. 1, 2011, to Jan. 1, 2013, the average account balance of consistent participants (those who continued to participate in their workplace 401(k) plan during that time period) experienced a nearly 84 percent increase (see graphic, online here). Granted, at that stage in their career, most of that gain is likely attributable to new contributions, not market returns—but it is an increase in that savings balance, and one that Hiltonsmith,(1) as a consistent participant-saver should have seen as well.

Pension Penchant

The framing of the retirement “gamble” was that “it used to be much easier,” in 1972 when, the Frontline report states, “…42 percent of employees had a pension…” But one point the Frontline report ignores (as do many general media reports on this topic) is that there’s a huge difference between working at an employer that offers a pension plan (the apparent source of the Frontline statistic), and actually collecting a pension based on that employment. Consider that only a quarter of those age 65 or older actually had pension income in 1975, the year after ERISA was signed into law (see “The Good Old Days,” online here). Perhaps more telling is that that pension income, vital as it surely has been for some, represented less than 15 percent of all the income received by those 65 and older in 1975.

In explaining the shift to 401(k) plans, the Frontline report notes that, “over the last decade, the rules of the game changed…” and went on to note that people started living longer, there were changes in accounting rules, global competition, and market volatility that affected the availability of defined benefit pension plans. While all those factors certainly did (and still do) come into play, another critical factor—one unmentioned in the report, and one that hasn’t undergone significant change in recent years—is that most Americans in the private sector weren’t working long enough with a single employer to accumulate the service levels required to earn a full pension.

For years,(2) EBRI has reported that median job tenure of the total workforce—how long a worker typically stays at a job—has hovered around four years since the early 1950s, and five years since the early 1980s. Under standard pension accrual formulas, those kind of tenure numbers mean that, even among the minority of private-sector workers who “have” a pension, many would likely receive a negligible amount because they didn’t stay on the job long enough to earn a meaningful benefit from that defined benefit pension.(3) Consequently, one could argue that American private-sector workers have been “gambling” with their pension every time they made a job change.

The Gamble?

It is, of course, difficult to evaluate the individual circumstances portrayed in the Frontline program from a distance, and via the limited prism afforded by the interviews. Nonetheless, even those in difficult financial straits were still drawing on their 401(k): the single mother had apparently managed to hang on to her underwater mortgage by tapping into her 401(k) savings, as had the couple who incurred a surrender charge by prematurely withdrawing funds from what appeared to be some kind of annuity investment. While this “leakage” was described as a problem, it does underline the critical role a 401(k) plan can play in the provision of emergency savings and financial security during every “life-stage.” Moreover, while the report focused on the circumstances of several individuals who had saved in a workplace retirement plan, one can’t help but wonder about the circumstances of those who don’t have that option.

The dictionary defines a gamble is a “bet on an uncertain outcome.” While the characterization might seem crude, retirement planning—with its attendant uncertainties regarding retirement date, longevity risk, inflation risk, investment risk, recession risk, health care expenses, and long-term care needs(4)—could be positioned in that context.

However, the data would also seem to support the conclusion that this retirement “gamble” isn’t new—and that it may be one for which, because of the employment-based retirement plan system, tomorrow’s retirees have some additional cards to play.

Nevin E. Adams, JD

You can watch the Frontline program (along with some additional materials, and expanded transcripts of some of the program interviews) online here.

(1) The Frontline investigation also seemed to represent something of a voyage of discovery for correspondent Martin Smith, who apparently has dipped into his 401(k) several times over the years. In a moment of subtle irony, he notes that he runs a small company with a handful of employees, but was too busy to look at the “fine print” of his own company’s retirement plan, going on to express confusion as to how these funds got into his plan in the first place. Of course, as the business owner, he was likely either the plan sponsor, or hired/designated the person(s) who made that decision.

(2) EBRI provided all of the data referenced here—and much more—to the Frontline producers. In fact, Dallas Salisbury was interviewed on tape for nearly two hours, so we know they had the full picture on tape. That may be what makes the Frontline program the most disappointing, knowing that the program could have presented a balanced picture of “The Retirement Gamble” and the diversity of plans, fees, and outcomes, yet its producers chose not to do so. EBRI’s most recent report on job tenure trends was published in the December 2012 EBRI Notes, online here.

(3) As EBRI has repeatedly noted, the idea of holding a full-career job and retiring with the proverbial “gold watch” is a myth for most people. That’s especially true since so few workers even qualify for a traditional pension anymore (see EBRI’s most recent data on pension trends, online here).

(4) EBRI’s Retirement Security Projection Model® (RSPM) 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 the May 2012 EBRI Notes, “Retirement Income Adequacy for Boomers and Gen Xers: Evidence from the 2012 EBRI Retirement Security Projection Model”).

Single Best Answer?

A mainstay of multiple-choice test instruction is the admonition to select the “single best answer.” Now, generally there really is only one valid answer, but there are times when the questions posed are sufficiently imprecise, or the potential answers specific, that more than one response is viable. That’s where the test architect can always fall back on their notion of “best” answer– because, even if a credible argument can be made for an alternative, it’s a lot easier to grade when there’s only a single, pre-determined result.

When it comes to projecting possible outcomes in situations where there might be hundreds, perhaps thousands, or even millions of different results, it’s not uncommon to pick a single point to focus on. For example, projections in financial analysis might use the most likely rate of claim, the most likely investment return, or the most likely rate of inflation, whereas projections in engineering analysis might use both the most likely rate and the most critical rate. That choice provides a point estimate, one that ostensibly provides a best single estimate for purposes of analysis.

The downside of this approach, of course, is that it does not fully cover the fact that there is a whole range of possible outcomes, some more probable, some less. The alternative, a stochastic modeling, doesn’t just pick a single likely result, but uses random variations to look at what a broad range of conditions might be like. It does this based on a set of random outcomes, projects results, and then repeats with a new set of random variables. In fact, this process is repeated thousands of times.
When the modeling is done, you can look at a distribution of outcomes – and with that not only consider the most likely estimate, but what ranges are reasonable as well. It is, quite simply, a more complete and realistic assessment of potential outcomes, because, unlike so-called “deterministic” models that rely on picking a single point of experience, it includes a wide range of possibilities.

Deterministic models can predict outcomes under a few economic and demographic scenarios but don’t generally present a distribution of the wide range of scenarios that could arise from different combinations of economic and demographic variable values. Only stochastic models – like that embodied in the EBRI Retirement Security Projection Model® (RSPM) - can measure the "risk" of their performance measure values, because stochastic models, using Monte Carlo methods, are based on probability distributions. Said another way, stochastic modeling brings into account the volatility and variability of experience that are part of living in the real world.

Those deterministic models may offer a “single” answer, but life is rarely that simple – and projections that attempt to help us make better decisions about the future needn’t be.

- Nevin E. Adams, JD

1. The EBRI Retirement Security Projection Model®(RSPM) simulates 1,000 alternative retirement paths for each household to explicitly model investment, longevity and stochastic healthcare risks (i.e., nursing home and home healthcare costs).

2. More information on stochastic versus static/deterministic modeling can be found here.

Returns “Engagement”

An acquaintance of mine once remarked, “you can’t solve a savings problem with investment returns.” Yet, participants frequently focus on the returns of their retirement savings investments.

Consider that during the month of May, major stock indexes like the Dow Jones Industrial Average and the S&P 500 were off 6 percent. But, according to an EBRI analysis, the estimated average 401(k) account balance¹was down less than 3 percent during that same month, both due to the inflow of ongoing contributions and more diversified portfolio holdings.

That determination is based on estimates from the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project—the largest, most representative repository of information about individual 401(k) plan participant accounts. In fact, as of December 31, 2010, the EBRI/ICI database included statistical information on about 23.4 million 401(k) plan participants, in nearly 65,000 employer-sponsored 401(k) plans, representing $1.414 trillion in assets.

Using that database, which includes demographic, contribution, asset allocation, and loan and withdrawal activity information for millions of participants, EBRI has produced estimates of the cumulative changes in account balances—both as a result of contributions and investment returns— for several combinations of participant age and tenure.

While the estimated monthly movements² are interesting, they aren’t nearly as important as the perspective the database offers on long-term trends. For example, while the financial crisis of 2008 had a significant impact on retirement savings balances, as of June 5, 2012, more than 94 percent of the consistent participants in the database are estimated to have balances higher than they did at the pre-recession market peak (October 9, 2007).

During election cycles, voters are frequently asked “are you better off now than you were four years ago?” The answer, at least when it comes to consistent participants and their retirement savings accumulations, would seem to be “yes.”

- Nevin E. Adams, JD

Notes

¹ For “consistent” participants, that is, participants assumed to be in the 401(k) plan at the beginning and end of the specific reporting period.

² EBRI updates the change in 401(k) balances each month at http://www.ebri.org/index.cfm?fa=401kbalances. Here you will find both a listing of “Cumulative Change”, a projected cumulative percentage change in account balances for consistent participants since the last annual update of the database. Additionally, the monthly rate of change in average account balances is presented for those same individuals. For assistance on interpreting these results, please contact Jack VanDerhei at vanderhei@ebri.org

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.