A Call for Changes in Retirement Policies and Solutions

A new report says that although the trend toward greater individual responsibility for retirement security will undoubtedly continue, there is much that employers, financial institutions, and the government can do to modernize their retirement policies and solutions in order to help Americans achieve a secure and dignified retirement.

The McKinsey & Co. study debuts a “Retirement Readiness Index” which finds that the average American family faces a 37% shortfall in the income they will need in retirement–a savings gap of $250,000 per household at the time of retirement–taking into account expected payouts of Social Security and pensions, as well as personal savings including 401(k) and other retirement plans. While middle and lower income households are least prepared, most Americans – even middle to higher income households–will fall well short of their retirement expectations, according to the study report.

McKinsey’s analysis indicates that a consistent focus on four policy principles could enable the average American family to reduce their retirement readiness gap by nearly half, injecting over $3.5 trillion in incremental assets into the retirement system over the next decade.

The four principles are:

  • Improving the accessibility of retirement plans,
  • Increasing plan participation and savings rates for all Americans, especially lower and middle income households,
  • Helping Americans to better manage their in-retirement risks in order to draw a stable “retirement paycheck,” and
  • Enabling Americans to work longer.

According to the report, 40 million American households do not have access to a workplace retirement savings plan – in most cases because the employer, often a small business, finds it too costly and administratively cumbersome to provide a plan to employees. These households could turn to IRAs to prepare for their retirement; however, fewer than 20% do.

The report says access to workplace retirement plans is an important driver of retirement preparedness. While the average American household with access to a DC plan will have about 70% of the income required for retirement, a similar household  without access will have to live on approximately 55% of the required income – and the gap only increases for lower income households.

The McKinsey study contends that with the right encouragement, the access problem could be solved. Although creating incentives for smaller businesses to provide broader access to retirement plans is important, universal coverage through a vehicle such as an auto-IRA would be most impactful, the report suggests. In addition, adding auto features that default individuals to contribute to their IRAs every year would have a tremendous impact, especially for lower income households.

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“Over one- third of households with access to a qualified retirement plan do not take advantage of it, and those who do participate – including the relatively affluent – do not contribute nearly enough,” the McKinsey report contends.

The Pension Protection Act was a first step toward increasing participation and savings rates in retirement savings plans by including auto-enrollment as a condition for fiduciary safe harbor. However, the report says further steps must be taken to ensure appropriate savings rates and reduce leakage, such as revising the default rate for automatic deferrals upward and implementing auto-escalation of deferral rates.

Managing In-Retirement Risks

The McKinsey report points out that the aging American population is facing more in-retirement risks - market and inflation risks, longevity, and health issues - than in the past, and most Americans do not adequately take these risks into account when planning for retirement. Appropriate asset allocation, taking into account each household's retirement risks, would go a long way toward hedging against these risks.

The report contends that most Americans lack the financial sophistication to fully understand the risks they face and to select financial products that can adequately protect them, so improving American household retirement preparedness will require education and advice regarding these risks as well as innovative solutions to hedge them.

Finally, the report notes that millions of American households nearing retirement are running out of time to fill their savings gap, and low-income households regardless of age realistically lack the disposable income to sufficiently raise their savings rate. Many will need to work longer and many of those already in retirement will need to return to work.

The study shows that postponing retirement by four years increases an individual's "Retirement Readiness Index" by 23 points.

Barriers to keeping or getting older Americans in the workforce that need to be eliminated include Social Security’s early eligibility age of 62, which the report says serves as a signal to stop working and start collecting benefits; incentives in DB plans and provisions restricting DB payments to active workers, which discourage retirees from continuing to work; and higher health care costs for older workers, which have discouraged employers from hiring and retaining these employees.

The report is being released by the Financial Services Roundtable, http://www.fsround.org.

Survey Finds Increasing Plan Sponsor Optimism

Forty percent of respondents to a new plan sponsor survey believe the worst of the current economic turmoil has come to an end.

The International Foundation of Employee Benefit Plans (IFEBP) said 27% of plan sponsors disagreed or strongly disagreed with that assessment during the September 2009 poll, while 33% were neutral. In either case, 87% agreed a recovery will come more slowly than in past recessions, according to a news release by the IFEBP.

Sally Natchek, IFEBP senior director of Research, said the group’s September survey was the final of three taken in the last year to assess employers’ and workers’ responses to the economic crisis. The other polls were in October 2008 and May 2009.

According to Natchek, the first survey found a cautious approach where employers were waiting to see how the events in the economy played out. By the following spring, employers were in a more active mode as layoffs increased, and findings of the latest survey show employers and employees have reduced risk exposure in their retirement plans.

Throughout the last year DC plan sponsors were more likely than DB plan sponsors to report their employees viewed the long-term impact of the crisis as severe. In September 2009, 25% of DC plan sponsors thought the majority of their employees perceived the long-term impact on their retirement as severe, half of the 47% that perceived the impact as severe in May 2009, and lower than the 31% who reported a severe impact in October 2008.

In September 2009, 43.8% of employers reported employees were decreasing their overall contributions to DC accounts, the announcement said. This number is relatively unchanged from the 44.1% of employers who reported decreased contributions in May 2009 and up from 28.2% who noted the trend in October 2008. Thirty-seven percent of employers in September 2009 also reported an increase in the number of participants stopping contributions, dropping slightly from the 40% who reported the trend in May 2009.

Forty-five percent of employers noted an increase in the number of employees making hardship withdrawals from their DC accounts in September 2009, up slightly from 42% in May. In October 2008, 29% of employers noted an increase in hardship withdrawals. The surveys reveal a similar pattern for employers reporting an increase in employees taking loans from their DC accounts (28% in October 2008, 40% in May 2009, and 39% in September 2009).


Risk Management

The September 2009 survey found that as a direct result of the financial crisis, 42% of DB plan sponsors revisited their asset allocation policies, 37% reviewed their actuarial assumption and plan design, and 27% increased their risk management focus. DC plan sponsors have reacted to the crisis by reviewing their fund lineup (28%), adding more low-risk investment choices (26%), and increasing diversification (24%), according to the news release.

As of September 2009, employers reported that their employees’ main concern was market losses in funds and underfunded retirement plans (47%), followed by less job security (31%) and delayed retirement (21%). This is a change from May, when decreased job security was cited as employees’ main concern (48%) and from October 2008 when delayed retirement was the main concern (46%).

"Pension Plans: Impact of the Financial Crisis—Survey Results, September 2009 Update," was conducted in September 2009. Responses were received from 850 individuals representing retirement plans in the United States.

The 17-page survey (Item #6597B) is free to foundation members. Nonmembers may purchase a copy for $50. To order visit www.ifebp.org/books.asp?6597B or contact the Foundation Bookstore at bookstore@ifebp.org or (888) 334-3327, option 4.

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