By Cyril Tuohy
Consumers' 401(k)s and Individual Retirement Accounts (IRAs) are being eroded by fees, “leakage” and low participation rates, according to a new analysis of the Federal Reserve’s latest triennial Survey of Consumer Finances.
In a research note, Alicia H. Munnell, director of the Center for Retirement Research at Boston College, breaks down the impact of erosion over time on 401(k)/IRA balances.
Using data supplied by the Vanguard Group, Munnell analyzes a hypothetical 401(k)/IRA balance of $373,000 for a 29-year-old in 1982 who reached the age of 60 last year.
Assuming the 29-year-old, who earned a median income in 1982, contributed 6 percent of his salary with a 50 percent match from his employer and placed the contributions in a 50-50 stock and bond allocation, the 401(k)/IRA balance would have grown to $373,000.
However, after subtracting fees, the hypothetical account balance would be worth only $314,000. Subtract the “leakage,” or the penalties associated with hardship withdrawals, and the account drops to $236,000. Then, account for intermittent contributions due to job changes, and the asset value shrinks even further to $165,000, before finally dropping to $100,000 because of low contribution rates in the early years as the program was beginning to spread and the young employee wasn’t “maxing out” the contribution.
“Surely, this system could function more efficiently,” Munnell wrote in her 15-page research update.
Dipping into retirement assets prematurely before reaching age 59.5 will, in most cases, result in expensive federal tax penalties. Many financial advisors consider withdrawing funds from a retirement account before reaching the minimum age to be a cardinal sin.
Leakage is estimated to be as high as 1.5 percent of 401(k) and IRA assets that are not rolled over or otherwise kept in a retirement plan, Munnell found.
Measuring a household’s combined 401(k)/IRA holdings is useful because people typically roll over their 401(k) balances into IRAs when they leave their jobs.
An accurate picture of household retirement assets emerges only when 401(k) and IRA balances are measured together as part of the same household, not when measured in separate buckets.
Americans have amassed $6.5 trillion in IRA accounts and $4.9 trillion in defined-contribution accounts, but the median 401(k)/IRA account balance for households approaching retirement is only $111,000, Munnell wrote.
The financial crisis for the first time exposed the vulnerability of the defined-contribution system. As a result, many academics have begun to look more carefully at the advantages and shortcomings offered through workplace and individual retirement programs.
Critics of the defined-contribution system, designed as it was to supplement defined-benefit plans, say it was never meant as a primary support pillar.
The do-it-yourself system that absolved the corporation of pension responsibilities, as future liabilities disappeared from the balance sheets, only served to mortgage the long-term retirement future of workers, critics say.
Workers by default were ill-equipped and unprepared to enter the retirement business without the professional advice available under a defined-benefit system. The financial crisis underscored just how vulnerable many people were under a defined-contribution model.
Surveys indicate workers find many features of the defined-contribution system convenient and that many employees like the portability, the convenience and the choices offered by defined-contribution retirement plans.
If $111,000 in the average household 401(k)/IRA account balance doesn’t sound like much, it isn’t.
This has led lawmakers from both parties to introduce retirement reform bills in an attempt to fix the “crisis,” even if some experts say such fears are overblown. A household with a 401(k)/IRA account balance of $111,000, but living in a $400,000 home with plans to downsize and move to a state with a lower cost of living, isn’t staring at a crisis, even if a couple has to forego a cruise or two, they argue.
Munnell’s research also found that many defined-contribution plans offer target date funds, which rebalance automatically to match an investor’s time horizon. Retirement plans began adopting these funds after the Pension Protection Act of 2006.
The share of retirement plans automatically enrolling employees increased after the pension reforms were signed into law, but has stabilized at around 50 percent, Munnell found.
The nonparticipation rate among eligible workers has also remained at about 21 percent for the past decade, she found.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at email@example.com.
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