There is no denying that recent 401(k) plan innovations of automatic enrollment, auto-escalation features and qualified default investment alternatives have gone a long way to improve retirement plan participation and savings rates.
Using “nudge economics,” auto-401(k) features turned the two main weaknesses of plan participants' behavior — inertia and procrastination — into virtues by automatically enrolling workers, automatically defaulting them into target date funds and, in some cases, automatically bumping up their salary deferral rate each year.
Workers always have the right to opt out of the 401(k) plan, but thanks to inertia and procrastination, few do.
But much more needs to be done, and nudge economics alone can't deliver better retirement outcomes. People have to be prepared to make key financial decisions throughout their lives.
To improve their chances of success, innovations in 401(k) plan designs and product solutions that help workers shift from the accumulation to distributions will be essential in the next phase of the retirement system evolution. Several forward-looking recommendations are detailed in an insightful new report, “A 360-Degree Approach to Preparing for Retirement.”
The report, a collaborative effort by the Principal Financial Group and Create-Research, also stresses how financial advisers can play a critical role at both the plan and participant level by guiding employers to select more-effective plan features and helping workers develop and stick to a retirement savings plan. The entire report is available at principal.com/create/retirement360/.
PRODUCT INNOVATIONS
As a result of auto-enrollment and qualified-default-investment options, target date funds have emerged as one of the top investment options of the past decade, holding $500 billion in assets last year. That figure is expected to grow by 15% a year.
Based on a survey of 148 asset managers, plan sponsors and advisers actively involved in the 401(k) market, the “360-Degree Approach” report predicts that a number of new features will likely be incorporated into life cycle funds in the near future.
These include a clear retirement income benchmark for participants at the outset, dynamic asset allocation, broad diversification and embedded advice. In particular, target date funds are expected to morph into target income funds over time.
As a result, the “to” and “through” retirement phases will blend, potentially creating a better framework for managing four key retirement risks: investment, inflation, interest rate and longevity.
A DEBT PROBLEM
Although 401(k) plan innovations are welcomed, we all need to recognize that the nation's looming retirement crisis isn't just a savings problem; it is also a debt problem.
Three recent reports document how ballooning consumer debt is crowding out retirement savings.
Nearly 60% of middle-class Americans said that paying the monthly bills is their top financial concern. Saving for retirement comes in as a distant second.
Just 13% of respondents to the latest annual Wells Fargo Middle Class Retirement survey listed retirement savings as a top priority.
More than 40% of the 1,000 middle-class adults between 25 and 75 who participated in the Wells Fargo telephone survey said that it isn't possible for them to pay their bills and save at the same time.
In a separate report, HelloWallet found that more than 20% of households that have a 401(k) or other defined-contribution plan added more credit card debt to their family balance sheet than they contributed to their retirement savings between 2010 and 2011.
Using Census Bureau and Federal Reserve data, HelloWallet founder and former Brookings Institution scholar Matt Fellowes calculated that monthly debt payments for households near retirement age increased by 69% between 1992 and 2010.
Debt payments in those older households now total 22 cents of every dollar earned.
Mr. Fellowes also deduced that most retirement plan participants who accumulate debt faster than retirement savings are older than 40, college-educated, earn more than $50,000 a year and have insufficient emergency funds.
Speaking of college grads, a third study by NerdWallet warns that student loan debt could sink the retirement prospects of the country's youngest workers.
The average student loan debt load of $23,300 will cost college students more than $115,000 in today's dollars — money that they won't have available to save for retirement.
As a result, the average Millennial college graduate won't be able to retire until 73 — 12 years later than the average retirement age, the report predicts.
Bottom line: The current 401(k) system needs an extreme makeover to provide a secure retirement for future generations. There are some great ideas to make saving easier, but first, you need enough money to save.
The key is improved financial literacy.
“In the industrial age, it was hard to get by without basic literacy: the ability to read and write,” the “360-Degree Approach” report said. “In this age of personal responsibility, it is just as hard to get by without financial literacy: the ability to plan and prioritize.”
Perhaps teaching 5-year-olds that two cookies later is better than one cookie now is a good place to start.
