Why Are 401(k)/IRA Balances Substantially Below Potential? Andrew G. Biggs, Alicia H. Munnell, and Anqi Chen American Enterprise Institute and Center for Retirement Research at Boston College 21 st Annual Retirement and Disability Research Consortium Meeting August 1-2, 2019 Washington, DC
An excel spreadsheet shows that the average worker could have close to $350,000 in their 401(k)/IRAs. Potential Balances for a Median Worker Ages 55-64, 2014 $400,000 $364,000 $300,000 $200,000 $100,000 $0 Potential Notes: Excludes money contributed directly to IRAs. Assumes the average worker earns $58,000 near retirement, consistently contributes 9 percent of earnings, and earns average market returns. Source: Authors’ calculations. 1
But in reality, the average worker has only accumulated $92,000 in their accounts. Potential vs Actual Balances for Workers Ages 55-64, 2014 $400,000 $364,000 $300,000 $200,000 $92,000 $100,000 $0 Potential Actual Note: Excludes money contributed directly to IRAs. Source: Authors’ calculations using U.S. Board of Governors of the Federal Reserve System. Survey of Consumer Finances (SCF) , 2016. 2
One reason for this gap is that those approaching retirement today were covered by an immature system. Percentage of Time Workers Spend Contributing to Workers with Pension Coverage by Type of Plan, 1983-2016 a Retirement Account, By Age Group 100% 50% 44.0% 42.1% 40% 75% 34.6% 30% 50% 20% Defined contribution only 25% 10% Defined benefit only Both 0% 0% 35-44 45-54 55-64 1983 1989 1995 2001 2007 2013 Note: Contributions are projected for younger cohorts. Source : Authors’ calculations based on SCF (1983-2016). Source : Authors’ calculations using SIPP-linked Administrative Tax Data. 3
A second reason is that, even while 401(k) plans have expanded, workers move in and out of coverage. Percentage of Private Sector Workers Ages 25-64 Participating in an Employer-sponsored Plan, 1980-2013 100% 75% 50% 25% 0% Source : Authors’ calculations from U.S. Census Bureau, Current Population Survey (1980-2014). 4
A third reason for the gap is that workers have the ability to tap accounts before retirement. Annual Leakages Out of Defined Contribution Accounts as a Percentage of Assets, 2013 1.6% 1.5% 1.2% 0.8% 0.6% 0.3% 0.4% 0.2% 0.2% 0.0% Cashed-out Hardship Post 59 1/2 Loan Total Post 59½ withdrawl withdrawal Sources : Authors’ estimates based on Vanguard (2014); and Munnell and Webb (2015). 5
A fourth reason is that fees erode net returns on investments. Average Expense Ratios for Long-Term Mutual Funds, By Asset Type, 1996-2017 1.5 Equity Bond Money market 1.0 0.59 0.5 0.48 0.25 0.0 1996 2001 2006 2011 2016 Source : Investment Company Institute (2018). 6
This paper explores the relative importance of each factor. • Factors like the system’s immaturity will dissipate, while inconsistent contributions are likely to continue. • Understanding the role of each factor can provide insight into the best ways to encourage more saving. 7
Data • The analysis uses Survey of Income and Program Participation (SIPP) linked to W-2 and Schedule C records on earnings and contributions. • The focus of the analysis is workers from the 2008 SIPP panel who were ages 55-64 in 2014 and made a tax-deferred contribution. • Account balances include 401(k)s and rollover IRAs. 8
Methodology • Step 1: Estimate potential balances based on universal coverage and consistent contributions of 9 percent of earnings (6 percent employee plus 3 percent employer). • Step 2: Document actual balances, as reported in the SIPP. • Step 3: Calculate actual lifetime contributions and accumulated balances for each individual in the SIPP sample, assuming no leakages or fees. • Step 4: Use the contributions of younger cohort to separate the lack of contributions from the immaturity of the system. • Step 5: Divide remaining difference between fees and leakages using ICI fees data. 9
The main culprits are the immaturity of the system and inconsistent coverage/contributions. Impact of Various Factors on 401(k)/ IRA Balances for a Typical Worker Ages 55-64 in 2014 $400,000 $364,000 Immature system $300,000 $247,800 Inconsistent coverage/ $200,000 contributions $136,200 Fees Leakages $122,800 $92,000 $100,000 $0 Potential Actual Note: Individuals must have worked at some point between ages 55-64 and contributed at least $1 to a 401(k) plan over their careers. Sources : Authors’ calculations using SIPP (1984-1986); and SIPP-linked Administrative Tax Data. 10
In a mature system, inconsistent coverage/contributions is the main reason for the gap. Estimated Impact of Various Factors on 401(k)/ IRA Balances for a Typical Worker Ages 55-64 in a Mature System $400,000 $364,000 Inconsistent coverage/ contributions $300,000 $252,400 Fees $227,568 Leakages $200,000 $170,490 $100,000 $0 Potential Actual Note: Individuals must have worked at some point between ages 55-64 and contributed at least $1 to a 401(k) plan over their careers. Sources : Authors’ calculations using SIPP (1984-1986); and SIPP-linked Administrative Tax Data. 11
Even in a mature system, young workers still are not contributing earlier in their career... Percentage of Workers Contributing Over Working Lives, By Age Group in 2014 100% 35-44 45-54 55-64 75% 50% 25% 0% 25 30 35 40 45 50 55 60 Note: Individuals must have worked at some point and contributed at least $1 to a 401(k) plan over their careers. Sources : Authors’ calculations using SIPP (1984-1986); and SIPP-linked Administrative Tax Data. 12
…and workers in lower quintiles may still fall short. Percentage of Workers Ages 55-64 Contributing, By Income Quintile, 2014 100% Highest Fourth Middle 75% Second Lowest 50% 25% 0% 25 30 35 40 45 50 55 60 Sources : Authors’ calculations using SIPP (1984-1986); and SIPP-linked Administrative Tax Data. 13
One could question whether all workers need to save aggressively. Sensitivity analysis, excluding workers with a DB and the very young, still shows a large gap. Impact of Various Factors on 401(k)/ IRA Balances for a Typical Worker Ages 55-64 in 2014 $400,000 $300,000 $270,100 Immature system Inconsistent $172,100 coverage/ $200,000 contributions Fees $120,500 Leakages $108,100 $90,000 $100,000 $0 Potential Actual Note: Assumes contributions start at age 30 and excludes workers with DB plans between ages 55-64. Sources : Authors’ calculations using SIPP (1984-1986); and SIPP-linked Administrative Tax Data. 14
Conclusion • 401(k)/IRA plans give households the potential to accumulate substantial retirement assets. • But, in reality, the typical worker has less than $100,000 in 401(k)/IRA assets, instead of the $364,000 from an excel spreadsheet. • The immaturity of the system and inconsistent contributions are the main culprits, followed by leakages and fees. • Today’s near-retirees typically spent only about one third of their working careers participating, and the portion of workers without coverage has stagnated and remains large. • The lack of universal coverage means that – even once the system matures – 401(k)/IRA plans will continue to fall substantially below their potential. 15
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