The government and retirement industry have wrestled with how best to move the needle on retirement readiness, from President Barack Obama’s auto IRA proposal, myRA, to Rep. Richard Neal’s Automatic Retirement Plan Act of 2017.
The Employee Benefit Research Institute has studied the defined contribution system for years and has developed a Retirement Security Project Model with the goal of helping policymakers come up with a plan to help workers do a better job of replacing their income in retirement.
Jack VanDerhei, research director of the Employee Benefit Research Institute, says that the biggest reasons Congress continues to float proposals to help retirement readiness is that if people become financially indigent in retirement, states are on the hook for their health care and nursing home costs.
The fact that is abundantly clear from the EBRI research is that people who have access to a defined contribution plan through their workplace and start saving for retirement early on are in the best position when they finally hit retirement. In EBRI’s model, retirement is set at age 65.
EBRI has revamped its model numerous times over the years to take into account changes in the system, like more plans adopting automatic enrollment and the Pension Protection Act of 2006.
What it finds in all of its modeling is that younger workers, those ages 35 to 39, who have at least 30 more years of defined contribution plan eligibility, are the ones most likely to retire with enough money, even taking into account long-term care costs.
The EBRI model take into account how much the average person spends in retirement to determine which groups are better prepared financially for retirement. It found that those who spent 90% or 80% of average in retirement were on a much more stable footing in retirement.
If a household spends 100% of average and long-term care costs are included in the calculation, 57.4% of households, headed by individuals ages 35-64, will not run short of money in retirement. If long-term care costs aren’t included in the calculation, then 75.5% of households would be prepared for retirement.
VanDerhei says that many people, if they realize they have limited financial resources, will cut back immediately on the things they can control. Those who spend only 90% of average would have a success rate in retirement of 68.1%, if long-term care costs are included in the calculation. If they are excluded, the probability of success in retirement rises to 91.1%.
“Not surprisingly, what is the right number for the probability of success is going to depend on the assumptions,” he says.
The millennial challenge
In looking at Generation X, EBRI found that 48% of those with no access to a workplace retirement plan will probably still have enough money in retirement, but the percentage goes up to 72% for those who have had access to and participated in a workplace plan for 20 or more years.
“Assuming retirement expenditures are a full 100% of the average costs for retirees in their age-, income- and family-status cohorts, the aggregate retirement deficit for households in this age cohort is $4.13 trillion in 2014 dollars,” according to EBRI.
For those who spend 90% of the average cost for retirees, the aggregate deficit for households drops to $2.09 trillion. For those in the 80% expenditure bracket, that amount drops to $0.70 trillion.
“The average retirement deficit for households with no future years of eligibility for a defined contribution retirement plan is approximately $88,000 per individual. In other words, this is the anticipated average shortfall for young workers who have no access to the defined contribution system,” EBRI found.
For those with one to four years of eligibility, the average retirement deficit dropped to $63,000. With those with 15-19 years of future eligibility, it declines to approximately $33,000. For those with 20 or more years of future eligibility, the deficit drops to about $20,000.
“In other words, for workers who will spend much of their working life in the defined contribution system, the projected deficit is less than a quarter of that for those who are simulated to have no access to participate in the defined contribution system,” the report said.
When EBRI looked at the different retirement legislation that has been proposed in recent years and their impact on retirement deficits, it found that all options had an impact. In the federal auto-IRA approach, if nobody opts out, the aggregate retirement deficit would decrease by $268 billion or 6.5% from the $4.13 trillion deficit mentioned earlier. With an opt-out rate of 10%, the deficit reduction would be $244 billion, or 5.9%. With a 25% opt-out rate, the deficit reduction would be $202 billion, or 4.9%.
Under the Automatic Retirement Plan Act of 2017 proposal, all but the smallest employers would be required to offer plans. Under the bill, the plans would have to offer automatic enrollment at 6% with automatic escalation of 1% a year up to 10%. If plan participants opted out of the plan, they would be re-enrolled in it three years later at the 6% contribution level. If nobody opts out under this proposal, the deficit would drop by $645 billion or 15.6%.
A blue sky scenario
EBRI also came up with its own best-case-scenario plan called the Universal Defined Contribution System. VanDerhei admits that nobody would probably ever implement this scenario, but if they did they would find that the deficit would drop by $802 billion, or 19.4%. The plan, rather than “presuming a single stylized defined contribution plan for employers regardless of size, this analysis assumes employers will choose a type of plan and a set of generosity parameters similar to employers in their size range. Unlike the auto-IRA and ARPA analyses, the universal defined contribution scenario is based on observed contribution rates and demonstrated opt-out behavior when simulating employee behavior,” the report stated.
None of the policy proposals would have much of an impact on those individuals who are already close to retirement, however, EBRI says. They would have a greater impact on the younger cohort groups.
Plan leakage also plays a major role in retirement deficits, VanDerhei says. Through its modeling, EBRI finds that plan loans, hardship withdrawals and plan cash-outs all have a negative impact on the amount of money individuals have access to in retirement.
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