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.
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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.