“Defined contribution plans, such as 401(k)s, and the IRA rollovers they produce, are the component of retirement security that seems to be generating the most non-Social Security retirement wealth for Baby Boomers and Gen Xers,” says Jack VanDerhei, research director for the Employee Benefit Research Institute. “The potential increase of at-risk percentages resulting from (1) employer modifications to existing plans, and (2) a substantial portion of low-income households decreasing or eliminating future contributions to savings plans as a reaction to the exclusion of employee contributions for retirement savings plans from taxable income, needs to be analyzed carefully when considering the overall impact of such proposals.”

 

In September, the Senate Finance Committee held a little-noticed hearing that explored changes to retirement plans — principally employer-sponsored 401(k)s — that would in one way or another cut their tax deductions.

Jack VanDerhei, research director at the Employee Benefits Research Institute and a leading pension expert, says they could severely cut how much money that workers and employers set aside. He says the $20,000 cap would even hit lower-income workers, causing “a significant reduction” in their retirement savings.

The price of pay discrimination stalks retirement, too, since less pay means less in old age. Among Baby Boomers, the youngest of whom are now 47, single women have a retirement savings shortfall nearly twice that of single men, the Employee Benefits Research Institute estimated

In testimony before the Senate Finance Committee, Jack VanDerhei, EBRI research director, noted that such a change would cause individual employees to reduce the contributions they make to their 401(k) plans and, therefore, lead to lower overall retirement savings. He backed up this assertion with modeling results that show the impact this change would have on individuals at different income levels. For example, the model show that individuals age 26-35 in the highest income groups would see their 401(k) accounts reduced by 11.2 percent when they retire, while individuals in the lowest income groups would see their accounts drop by 24.2 percent.

This model found a similar across-the-income-spectrum reduction in overall retirement savings under another proposal included in the deficit reduction report by the National Commission on Fiscal Responsibility and Reform, the so-called Simpson-Bowles Commission. That proposal would cap annual employer plus employee tax-deferred retirement plan contributions at $20,000 or 20 percent of income. when it comes to the average percentage decline in 401(k) plan assets at retirement, the EBRI model showed that the highest-income group and lowest-income group were the most adversely affected In every age group except the oldest employees.

As always, the devil is in the details—and perhaps in the definitions underlying those details.  As the Employee Benefit Research Institute’s (EBRI) Dr. Jack VanDerhei pointed out in testimony submitted for the hearing, “Unfortunately, the ‘success’ of these plans is sometimes measured by metrics that are not at all relevant to the potential for defined contribution plans to provide a significant portion of a worker’s pre ‐ retirement income.”  Among those metrics, VanDerhei cited such things as the “average” 401(k) balance and what it would provide in retirement income (with no adjustment for the reality that many, if not most, of the participants in the denominator of that calculation are years, if not decades, away from retirement age), and even the focus on what the average balance is for workers nearing retirement age—but only applying that calculation to the 401(k) balance with the employee’s current employer.

 

However, Jack VanDerhei, research director of the Washington-based Employee Benefit Research Institute, testified that the Brookings proposal would hurt lowest-income workers most. Based on new modeling results of 401(k) plan surveys, “the surprising result we found” was that lowest-income workers said they would reduce or stop contributing to work-based plans if the current exclusion ended, Mr. VanDerhei said.

The potential negative effect on retirement savings in the Brookings proposal and similar ones advocating lower tax-deductible contribution limits prompted plenty of criticism from groups representing employers and retirement plan sponsors, who warned that savings rates would plummet as employers were discouraged from offering plans and employees were left to make retirement savings decisions on their own.

Witnesses before the Senate Finance Committee offered arguments against changing tax advantages for workers’ retirement plan savings.

Dr. Jack VanDerhei, Research Director of the Employee Benefit Research Institute (EBRI), was one of the speakers at the hearing. VanDerhei said that if the existing level of allowable tax-deferred savings in private-sector 401(k)-type defined contribution retirement plans is changed, as some advocates have proposed, “highest-income workers generally would be the most affected if federal tax limits in 401(k) type plans were lowered. But the surprising result we found is that the lowest-income workers would also be very negatively affected, and many report that they would reduce contributions or stop saving in their work-based retirement plan entirely, if the current exclusion of worker contributions for retirement savings plans were ended.”

VanDerhei also laid out detailed arguments against a proposal put forth by Brookings Institution Fellow William Gale, who also spoke at the hearing. According to EBRI, Gale’s proposal would replace existing 401(k) tax deductions with a flat-rate refundable credit that would serve as a matching contribution in a retirement savings account, using either an 18% credit or a 30% credit.

EBRI believes that Gale’s analysis assumes that workers will keep their aggregate retirement contributions constant and that employers will not make changes in their employer match in 401(k) plans. Under any cost-benefit analysis, VanDerhei said, it is very difficult to determine how workers not currently covered and/or participating in a defined contribution plan will react to the incentives under the Gale plan.

However, EBRI research director Jack VanDerhei argues that the lifecycle model falls short. “It’s just saying you have managed to make virtually nothing in your working years and you have nothing in retirement, so you have therefore smoothed your income,” he says. “If that’s the definition of success, there are a lot of people on the (lower) income scale who will be considered successful in that model that wouldn’t be in my model. I go back and factor in minimum expenditures that would be desired.”

The heaviest of those desired expenditures is health care. “The No. 1 cause of failure for people who get to retirement age with what appears to be an adequate amount of money is to get hit with nursing-home costs,” says VanDerhei, who argues that his retirement-security projection model does a better job accounting for potential health shocks.

To prove it, SmartMoney asked the nonprofit Employee Benefit Research Institute to estimate what would happen to future retirees if bonds were to stay at their current, low yields, while equities rose at 6% a year, a more modest rate than historical averages. They found that 56% of late boomers, those approaching retirement age today, would be at risk of running short of money in retirement.

A few weeks ago, the folks at the Employee Benefit Research Institute put out a new report that caught my attention. What they found, essentially, is that putting off retirement for a few years so we can amass more money may not be the Band-Aid we think it is.

I — and many others — have long said that if you’re behind in your savings efforts, one of the best ways to catch up is to work longer. When you do that, not only are you bringing in additional income, you’re allowing the money you have saved to stay in the bank and continue to grow.

What EBRI’s research showed is that this may not do the trick on its own, and we may have to work much longer — even into our 70s and 80s — for it to have the desired impact. That’s not to say a few more years of income won’t help, but you have to look at other solutions, too:

• Keep your job. What I’m telling you here isn’t just to continue working — it’s to continue working at your current job, if you can. I’ve always been a proponent of working somewhere, anywhere, that allows you to bring in some additional income and leave your retirement savings intact. But one major takeaway from the research, says Jack VanDerhei, the institute’s research director, is that working longer, combined with continuing to save in a defined contribution plan — ideally, a 401(k) — is the real winning strategy.

Unfortunately, you may not get that opportunity if you take retirement when your company deems you eligible, then pick up a job elsewhere. For starters, that new employer may not have a retirement plan. If it does, it may not provide the same matching incentives as your current employer. And it may not allow for immediate vesting (only about 40 percent of employers do), which means if you finally do retire in three, four or even five years, you’ll very likely leave money on the table.

“Without a doubt, if you think of it as two groups –those lucky enough to work (at age 65) for an employer who sponsors a retirement plan and those who aren’t — it makes such an incredible difference as to whether or not you’ll be at a particular probability of success when it comes to having enough saved,” says VanDerhei.

 

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