Month: September 2020

Shift to 401(k) like letting a toddler drive a car?

Background

In 1978 legislation was passed that enabled 401(k) plans.  Since then they have become popular with private companies as a way to shift the retirement savings burden away from the employers and onto their employees.  This means a shift to 401(k) defined contribution plans from defined benefit plans (pensions).  How dramatic is this shift, and how are the employees behaving?

Findings

  • Half of private sector employees aren’t participating in any retirement plan:   They don’t yet have money in a pension or a 401(k) plan, either because they choose not to participate or because they haven’t worked at a company that offers one.
  • Huge shift from pension to 401(k):  Today, only 11% of employees participate in a pension plan. Most of these employees also have a 401(k).  This suggests that the pension is a legacy from a less recent employer and probably won’t pay a significant retirement benefit.
  • Participants are investing too conservatively:  A Wells Fargo study showed that almost 60% of participants are investing to minimize loss, vs. seeking enough growth to retire successfully.  Pension managers follow analytic investment strategies to grow the portfolio, but 401(k) participants — who often know little about investing – are likely to take too little risk.  This then puts their retirement at risk.
  • Job changers cash out their 401(k):   A Hewitt study showed that over 40% of the time, someone leaving an employer takes a cash distribution from their 401(k), instead of leaving it in or rolling it over into an IRA.  While companies often force this for those with very low balances, ¼ of those with a balance of $30-50k are cashing out too.  

Implications

This sounds like an SOS for plan participants.  For 40 years the burden of preparing for retirement has shifted to the employee, and they’re not behaving well.  Changes in the 401(k) system have encouraged more participation, but can’t force people to invest intelligently or to keep their money invested in a tax-advantaged plan – vs. pulling it out to buy a car.  Platitudes about investor education seem meaningless when that education has been going on for decades and clearly failing.  The options seem to be:

  • Force investors to invest more responsibly – which is really a return in the direction of pensions and Social Security
  • Accept people will make mistakes and let them, or…
  • Seek a third path of culture change, perhaps tied to behavioral finance.  More to come on this.

And – let’s not forget that nearly half of private sector employees have no retirement plan, neither 401(k) nor pension.  You can’t shift to a 401(k) if you never had a retirement plan. This post isn’t focused on how to get people to participate – or more employers to offer plans.  However, if almost 50 million workers aren’t saving for retirement, the long-term implications for them, and for the government safety net, are huge.  More to come on this in subsequent posts.

Sign up for the weekly insights email!

The small print

The percent participation data comes from EBRI, and the most recent data available is 2017.  However, more recent data is highly unlikely to change the trend or the conclusions.  The data on percent of investors cashing out is from Hewitt.  The most recent releases in 2009 and 2010 were the data I used here; however in 2017 their research director confirmedthat the overall statistic of the percent of departing employees cashing out was the same as in 2009.    

Incomes rise with COVID: Do you feel richer than in February?

Background

We’re in the midst of the COVID pandemic and a much-publicized economic downturn.  At the same time, personal income is up since February.  We’ve already seen that personal spending is down.   But how can it be that incomes rise with COVID and recession sweeping the country?

Findings

  • Disposable personal income was up 6% in July vs. February.  This includes wages, proprietors’ (business) income, rental income, investment income, and government transfer payments.  It subtracts taxes.
  • Earned income dropped – but increased government transfer payments far more than compensated for the decline:  Absent the increased government payments, income would be down 4% in July.
  • The government stimulus was both unemployment benefits and the broadly distributed stimulus money :  In April around 85-90% of all US households got the federal $1200/adult stimulus checks.  Ongoing, incremental unemployment benefits have been distributed as states’ compensation programs gear up.
  • Spending is down – so savings is up:  With spending down 5% July vs. February, and income up 6%, the savings rate is still much higher than the historical trend.  The current 18% rate is the highest it’s been since WW II.

Implications

The summary statistic is that incomes rise with COVID.  Of course, every household has a different situation with what they make, if they’re hurting, and how much stimulus or unemployment compensation payments they are receiving.  It’s important to remember, though, that the initial stimulus was a blanket infusion of money to households with the expectation they’d spend it either on necessities, or to buy things that would juice the economy.  The reality is…not.  It appears that most of the money is just sitting in savings.  This shouldn’t be surprising, given that a 10% unemployment rate also means a 90% employment rate.  Most households seem to be hanging on to the extra money as a buffer.

From the US economy and federal policy perspective, this isn’t a good thing. From the personal financial management perspective, this is a good thing.  For once households aren’t spending a windfall money infusion, probably out of fear.  This compares to many people treating income tax refunds as fun money to immediately buy something for themselves.  If you are counseling clients on their finances, a great average outcome for their long-term success would be to keep spending down, stash the surplus income, and if possible keep working.

Sign up for the weekly insights email!

The small print

The data is from the monthly Bureau of Economic Analysis’ Personal Income and Outlays report.  Because it comes out about a month after the end of a period, we don’t know what happened in the past 30 days.  The data shows that the only significant changes in government transfer payments are in the unemployment insurance line and the “other” (e.g. COVID stimulus) line, so I’ve simplified my estimate of the government impact by using February transfer payments as a baseline and then assuming any change is due to these two categories.