Data & Research March 14, 2017

Shift from DB to DC Resulted in Decline in Income Replacement

Retirement income as a percentage of wealth has declined as the employer-sponsored retirement plan landscape has been moved to mostly DC plans, a study finds.
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Researchers from the Center for Retirement Research at Boston College note the shift from a defined benefit (DB) employer-sponsored retirement plan landscape to a defined contribution (DC) plan landscape and question whether this shift has made households better or worse off.

Using data from the 1992, 1998, 2004, and 2010 waves of the Health and Retirement Study (HRS), a nationally representative survey of older Americans, and a sample including both single individuals ages 51 to 56 and couples in which at least one spouse was 51 to 56, the researchers found DB wealth in all years is higher than DC wealth. DB wealth is roughly constant over time, while DC wealth nearly doubled between 1992 and 2010. “Combine these patterns with the shift in coverage from DB to DC between 1992 and 2010, and the result is relatively level retirement wealth over time,” the researchers wrote in an Issue Brief.

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However, they note that stable aggregate retirement wealth does not necessarily imply that households today are as well prepared for retirement as those in 1992. “Preparedness depends on how retirement wealth is distributed, how much income that wealth produces, and how that income relates to pre-retirement wages,” the paper says. The research found that DC plan wealth is skewed more toward those with more education and higher earnings, with the top quartile holding 52% of total DC wealth in 2010 compared to 35% of DB wealth. 

The researchers explain that the yield on DB wealth in recent years has been higher than that on DC wealth, because DC plan participants face two disadvantages when turning wealth into income: while DB participants face actuarially fair annuities, DC participants have to buy annuities on the open market where marketing and other costs reduce annuity factors by about 15% to 20%; and the interest rate used to calculate commercial annuity rates has declined sharply since 1992, while the interest rate assumption for DB annuities is a steady 5.8%. 

NEXT: Lower retirement income as a percentage of wealth

The research found retirement income at projected retirement ages as a percentage of wealth for those ages 51 to 56 in households with a plan was 12.5% in 1992 and 11.7% in 2010.

Given the growth of DC wealth and the disadvantages of annuitizing that wealth, one might have expected an even greater decline in the ratio of retirement income to current retirement wealth, the researchers note. They explain that the main reason the ratio did not decline more is that overall retirement ages have been increasing, and the difference in the retirement age between those in DC and DB plans has been getting larger. “Later retirement ages, all else equal, produce more annuity income per dollar of retirement savings because payout periods are shorter for people who work longer. Indeed, if the analysis had instead assumed that everyone retired at 62 over the entire period, the ratio of income to wealth would have declined much more sharply,” the paper says.

The researchers concluded that employer-sponsored plans are providing less income today than in the past. They suggest this outcome could be improved by making 401(k) plans work better through auto-enrollment, auto-escalation of default contribution rates, and reduced leakages; and expanding coverage to workers whose employers do not offer a plan.

The full issue brief may be downloaded from here.

Client Service March 14, 2017

Americans Need More Info About IRAs

Many simply do not know enough about them.
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There are several reasons why many Americans are not investing in individual retirement accounts (IRAs), TIAA found in its 2017 IRA Survey. First of all, 28% do not know enough about them, and 17% think they are too complicated. Additionally, 46% of Americans do not think they could possibly save any more than they currently are saving. In fact, nearly 20% of those who have an IRA contribute less than $250 a year, and only 5% contribute more than $5,000.

Forty-four percent of those surveyed did not know about the tax breaks that IRAs offer.

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Those who own an IRA express far more confidence about retirement savings—94% of these folks have this perception, compared to 64% who are not contributing to an IRA.

“With so many competing financial priorities, it’s not surprising to find that Americans focus on their current needs,” says Kathie Andrade, chief executive officer of TIAA’s retail financial services business. “By learning about the tax benefits of contributing to an IRA, they may find they can take the sting out of saving for their long-term goals.”

Those who have an IRA say the three biggest factors that prompted them to open one were help from a financial adviser (40%), education about IRAs (25%), and a simple process to open one (10%).

However, some IRA owners are not using them efficiently, as 37% own more than one IRA and 53% hold IRAs at different financial institutions to balance risk.

NEXT: Gen Y and IRAs

While only 27% of Gen X and 17% of Baby Boomers say they do not know enough about IRAs, this jumps to 37% for Gen Y. In addition, only 43% of Gen Y are aware of the tax benefits. However, once the tax benefits are explained to them, 50% of Gen Y say they are more likely to contribute to one. Nearly one-third of Gen Y say they would rely on the advice of friends and family when selecting an IRA provider, whereas this is the case for 24% of all Americans.

“Our younger customers have a long way until retirement, and that’s exactly why they may benefit the most from an IRA,” Andrade says. “However, we’ve heard that some of them are nervous about ‘locking up’ their money in retirement savings when other life milestones are on the horizon. That’s why we remind them that an IRA can actually provide more options, not less. It can help pay for things like a first-home purchase or higher education. That peace of mind often helps younger adults make the decision to contribute.”

Half of those who own an IRA are looking ahead to when they retire, and are planning to use that account once their taxable accounts are exhausted.

When it comes to rolling over money from a plan at a former employer, 33% have left the money behind. That rises to 43% of Gen X, 35% of Gen Y and 23% of Boomers.

Asked why they didn’t roll the money over to their new plan or an IRA, 17% said they didn’t know what to do, 17% didn’t know that this was permissible, 13% said they didn’t have the time, and 9% said it was too complicated.

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