Data & Research March 10, 2014

Readiness of Older Employees Is Improving

Retirement readiness improved for Baby Boomers and Generation X households during 2013, says a new report.
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A new analysis released by the Employee Benefit Research Institute (EBRI), “What Causes EBRI Retirement Readiness Ratings to Vary: Results from the 2014 Retirement Security Projection Model,” reveals that overall retirement income adequacy has improved in recent years and fewer households are likely to run short of money during retirement. However, factors such as age, income and access to an employer-sponsored 401(k)-type retirement plan can still produce substantial individual differences in readiness.

Findings from the report show that eligibility for participation in an employer-sponsored 401(k)-type plan remains one of the most important factors for achieving retirement income adequacy. Gen Xers in the lowest-income quartile with 20 or more years of future eligibility in a defined contribution plan are half as likely to run short of money as those with no years of future eligibility, the report shows. The impact of access to a 401(k)-type plan is also positive, but less pronounced, for those in the middle-income quartiles. EBRI’s research shows investors in the middle income range experience increases in retirement readiness ratings (a proprietary readiness measure from EBRI) of about 3% when given similar access to a defined contribution plan, increasing from 27.1% to 30.3%.

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With regard to longevity and the high cost of health care, the report shows these two factors in particular can drive huge variations in retirement income adequacy. For both of these factors, a comparison between the most risky quartile—i.e. those most likely to experience high health care costs—with the least risky quartile shows a spread of approximately 30 percentage points in readiness for the lowest income range, approximately 25 to 40 percentage points for the highest income range, and even larger spreads for those in the middle income ranges.

The report also finds that annuities and long-term care insurance could mitigate much of the variability in retirement income adequacy experienced at or near retirement age. For example, the annuitization of a portion of a worker’s defined contribution and individual retirement account (IRA) balances may substantially increase the probability of not running short of money in retirement. In addition, the report notes that a well-functioning market in long-term care insurance could provide an extremely useful way to help control the volatility from the stochastic, long-term care risk, especially for those in the middle-income quartiles.

Future Social Security benefits make a huge difference for the retirement income adequacy of some households, notes the report, especially Gen Xers in the lowest-income quartile. If Social Security benefits are subject to proportionate decreases beginning in 2033 (when the Social Security Trust Fund is projected to run short of money), the retirement readiness values for those households are projected by EBRI to decreases from 20.9% to 10.3%.

“It would appear that while retirement income adequacy depends to a large degree on the household’s relative wage level and future years of eligibility in a defined contribution plan, a great deal of the variability in these values could be mitigated by appropriate risk-management techniques at or near retirement age,” concludes Jack VanDerhei, EBRI research director and author of the report.

The full report is published in the February EBRI Issue Brief at www.ebri.org.

Data & Research March 10, 2014

For IRAs, It’s All About the Rollover

A new analysis from the Investment Company Institute (ICI) shows a vast majority of traditional individual retirement accounts (IRAs) are opened with rollovers from employer-sponsored retirement plans.
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Nearly nine out of 10 traditional IRAs opened in 2012 were launched with assets transferred from an employer-sponsored retirement plan, according to the ICI’s recent report, “The IRA Investor Profile: Traditional IRA Investors’ Activity, 2007–2012.” The research finds younger IRA investors were the most likely to have rollover contributions in 2012, but all age groups surveyed showed relatively strong rollover action. In fact, a little more than half (51.5%) the rollovers observed in 2012 were made by investors over age 50.

Investors age 25 to 29 showed the highest rate of rollovers, with 26.9% of traditional IRA investors in the category having a rollover in 2012. As expected, the oldest age groups survey were the least likely to see IRA account balances grow due to rollovers, with just 4.9% in the age 70 to 74 reporting a rollover in 2012.

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The only exception to the general pattern of declining rollover incidence as age increases is among investors aged 60 to 64, the report shows. While 8.0% of traditional IRA investors aged 55 to 59 had rollovers in 2012, 9.6% of investors aged 60 to 64 had rollovers in the same year. Researchers say the modest uptick is likely due to investors in this age group retiring and rolling their retirement accounts into IRAs.

Another striking result in the nearly 80-page report shows that in tax year 2012, just 8.5% of traditional IRA investors between ages 25 and 69 made a contribution to their account. But for the minority of IRA investors that make regulator contributions, commitment to regular deferrals appears to be strong, as more than two-thirds of IRA investors who contributed at the limit in 2011 did so again in 2012.

Even with weak overall contribution rates, the strong pace of rollovers has pushed the IRA market beyond $6 trillion in assets under management as of September 2013, explains Sarah Holden, a senior director of retirement and investor research at the ICI. She says IRAs are an especially important retirement savings vehicle for those without access to retirement plans through their employers.  

For retirement plan advisers, the importance of rollovers to IRA balances is made more significant by increased scrutiny from multiple federal agencies—including the Department of Labor, the Securities and Exchange Commission and the Financial Industry Regulatory Authority. These agencies are reconsidering how participants deal with 401(k) assets when they leave a company (see “Some Advisers May Want to Pause on Rollovers”), with a focus on identifying potential conflicts of interest in the marketing and recommendation of IRA products, and on the possibility of expanding fiduciary rules to cover certain types of rollovers and related advice.

The ICI report finds traditional IRA savers showed little reaction to the 2008 financial crisis beyond a slight movement away from equity allocations. Although account balances fell considerably following the stock market decline in 2008, the average traditional IRA balance for investors that maintained account balances in all years between 2007 and 2012 was higher at year-end 2012 than at year-end 2007. The change in traditional IRA balances reflects contributions, rollovers, conversions, withdrawals, and investment returns, the report explains.

In examining asset allocations of traditional IRAs, the report finds equity holdings fell from about 75% of the average portfolio to about 66% between 2007 and 2012. For the significant minority of IRA investors that had all of their traditional IRA balances invested in equity holdings, very few changed this position during the same time period.

The movement of traditional IRA balances mainly reflected the impact of investment returns, the report finds, as well as investors’ rollover and withdrawal activity. Contributions, relatively, had little effect, the report says.

Traditional IRA investors in all age groups, except for those 75 or older, saw their account balances increase on average between 2007 and 2012. Beginning at age 70.5, individuals are no longer eligible to make contributions to traditional IRAs and typically must begin to take withdrawals, putting downward pressure on account balances among older traditional IRA investors. Increased Roth conversion activity in 2010 also may have put downward pressure on average traditional IRA balances, the report finds.

One positive sign in the data shows withdrawal activity is rare among younger IRA investors and overall, only about one in five traditional IRA investors took withdrawals in a given year. Of these, nearly three-quarters were taken by traditional IRA investors aged 60 or older who can take penalty-free distributions, and more than half were taken by investors aged 70 or older for whom annual distributions generally are required. Withdrawal activity responds to rule changes, and it predictably dipped in 2009 when required minimum distributions (RMDs) were suspended by law.

 A full copy of the report is available here.

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