Data & Research August 2, 2017

Sound Advice Can Propel Retirement Savings Contributions

With less than generous government retirement income provisions, Americans can benefit from effective advice about managing finances in order to contribute more to retirement savings plans.
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Individuals in the United States face pressing challenges when it comes to saving for retirement, according to a study by the International Longevity Centre-UK (ILC), supported by UK-based Prudential plc.

The research found that in order to secure a comfortable retirement, Americans now must save between 11% and 18% of their annual income. If individuals today fail to save, they would face a projected intergenerational gap of $10,000 a year or 20% of earnings.

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However, the ILC says several changes can be made to reverse this trend. These include increasing private pension coverage and contributions. While the former would rely on a political victory, the latter may depend on how effective those in the retirement services industry are in helping participants manage their finances in order to save more for retirement. Another task would be encouraging participants, especially younger ones, to start saving as soon as possible.

The ILC notes that “With increasing emphasis on personal responsibility for retirement planning, people will need to be able to understand the benefits of deferring consumption for a later date, the value of investing in assets other than cash, the importance of asset diversification, and the virtues of buying some form of longevity insurance at the point of retirement.”

These efforts can be facilitated through sound financial wellness programs. Considering the national student loan debt is at a record high, participants young and old can benefit from student loan repayment assistance. And while products such as annuities are gaining considerable notice in the industry, they remain complex contracts for many Americans. Thus, robust and targeted education is also an essential piece to closing the intergenerational savings gap. 

These tasks are ever more important as the firm points out that public expenditures on Social Security in the U.S. is relatively low as a proportion to Global Domestic Product (GDP). Moreover, the pension system itself seems to be diminishing in the U.S. The report found that only 28% of those earning at least $75,000 a year are saving in a pension, and that figure drops to 3% when it comes to those making $25,000 a year or less.  

Getting people to save more in their pensions can also be assisted by plan design tweaks. Much research in the defined contribution space points to the benefits of automatic features like auto enrollment and auto escalation.

The ILC states “Two public policy options look to be particularly successful in this regard, one which compels people to save as per the Singaporean, Hong Kong and French systems and another which ‘nudges’ people to save as per the UK’s auto-enrolment system. Simply hoping that people will save is unlikely to be sufficient.” Furthermore, an opt-out option to automatic features can prevent significant backlash from employees not interested in saving. But with that regard, education and financial wellness can come into play in order to spread awareness of the importance of saving, while boosting participation.

The ILC concludes that “Raising capability does not just happen overnight. This must be supported by a financial advice market that works for the many and not the few, in conjunction with new advice models that utilize technological advancements such as robo advice to make advice more accessible, understandable and cost effective. Finally, there will always be people who are inert and do nothing in the face of complex decisions. Good product defaults that avoid the worst outcomes will be important in this regard.”

“The Global Savings Gap” by ILC- UK can be downloaded at ilcuk.org.  

Client Service August 2, 2017

Educating Participants About the Dangers of Taking Out a 401(k) Loan

Tell them about how they are putting their retirement at a disadvantage, one expert recommends.
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It is critical for plan sponsors and advisers to educate participants about the consequences of taking out a loan, Julie Stich, associate vice president of content at the International Foundation of Employee Benefit Plans tells PLANADVISER. “They need to keep the money in their plan to build up money over time through contributions and the compounding of investment returns,” Stich says.

Citing data from the National Bureau of Economic Research, Stich says more than one-fifth, 21%, of participants have an outstanding loan, and within a five-year period, that rises to 37%. The employer will charge participants interest on the loan, which is typically the prime rate plus 1%, she notes. Furthermore, 86% of borrowers leave their company with an outstanding loan, and most companies require participants to repay the loan before leaving, she says. If that is the case, the Internal Revenue Service (IRS) will consider that a distribution and subject the balance to taxes plus a 10% early distribution tax, Stich says. And these loans can be sizeable, since the IRS permits participants to borrow up to 50% of their balance or $50,000, whichever is less, she notes.

Stich recently authored a blog on the International Foundation of Employee Benefit Plan’s website about how sponsors can limit loans, titled, “Top Five Tips for 401(k) Loan Program Design.” In it, she says sponsors should explain the consequences of changing jobs with a loan outstanding. Sponsors should also only permit participants to take out one loan at a time. Stich also suggests that sponsors limit loan access to only employee contributions, not company matches, as well as the dollar amount or percent of vested balance available.

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“Sponsors can also limit the reasons why a participant would take out a loan, such as for debt reduction or to pay for the child’s education,” Stich says, although the IRS does allow participants to take out loans for the purchase of a primary residence. The IRS also permits participants to take out hardship withdrawals if they are for certain reasons, including medical expenses, to avoid being evicted from their home, to pay for funeral expenses or to repair damage to their primary residence, she says.

Most sponsors charge service fees, she notes. “The higher the loan origination fee, the lower the balance,” she says. “The most common service charge is $50, followed by $75.”

Finally, sponsors can permit participants to continue to contribute to their 401(k) while they are repaying the loan, and they can set up repayment from a personal bank account rather than payroll deductions so that when an employee changes jobs with an outstanding loan, they can continue to repay the loan and avoid defaulting on it and face steep taxes, she says.

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