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02.08

Low Defined Contribution Plan Savings May Pose Challenges to Retirement Security

By IEEE-USA Staff

This article has been adapted from the GAO Report, Private Pensions: Low Defined Contribution Plan Savings May Pose Challenges to Retirement Security, Especially for Many Low-Income Workers, 29 Nov. 2007 [www.gao.gov/docsearch/abstract.php?rptno=GAO-08-8].

Over the past 25 years, pension coverage has shifted primarily from “traditional” defined benefit plans, in which workers accrue benefits based on years of service and earnings, toward defined contribution (DC) plans, such as 401(k) plans and IRAs, in which participants accumulate retirement balances in individual accounts. Defined contribution plans provide greater portability of benefits, but shift the responsibility of saving for retirement from employers to employees. Whether employees are saving enough to secure their retirements is a question of some concern.

Prompted by a request from Representative George Miller, D-Calif., who chairs the Committee on Education and Labor in the U.S. House of Representatives, the U.S. Government Accountability Office (GAO) completed a study, released in November 2007, which addresses the following issues: (1) What percentage of workers participate in DC plans, and how much have they saved in them? (2) How much are workers likely to have saved in DC plans over their careers, and to what degree do key individual decisions and plan features affect plan saving? (3) What options have been recently proposed to increase DC plan coverage, participation, and savings? GAO analyzed data from the Federal Reserve Board’s 2004 Survey of Consumer Finances (SCF), the latest available, utilized a computer simulation model to project DC plan balances at retirement, reviewed academic studies, and interviewed experts.

The GAO concluded that regardless of the age of the individual, and at most income levels, DC account participation is low, and the account balances of workers participating in DC plans are modest. Based on the 2004 SCF survey, only 36 percent of workers were participating in a DC plan with their current employer. For all workers with a current or former DC plan, including funds rolled over into a new plan or an IRA, the median account balances measured $22,800.

Among workers aged 55 to 64 with a current or former DC plan, including rolled over retirement funds, the median account balance was $50,000, which if converted into an annuity at age 65 would represent about $4,400 per year for life.

Leakage, or the cashing out of lump-sum distributions for non-retirement purposes, could adversely affect account accumulation for some plan participants. 21 percent of households reported that they had previously received lump-sum distributions from previous jobs’ retirement plans, about 47 percent cashed out all the funds, 4 percent cashed out some of the funds, and 50 percent rolled over all the funds into another retirement account. Low-income workers had the opportunity to participate in DC plans less frequently than the average worker, and when they were offered a plan, they were less likely to do so. As a result, only 8 percent of workers in the lowest-income quartile participated in DC plans with their current employer.

Simulations of future workers’ DC plan savings over an entire working career indicate that DC plans could replace, on average, about 22 percent of annualized career earnings at retirement, but with projected replacement rates varying widely across income groups and with changes in certain assumptions. These projections show that individuals in this cohort would accumulate enough DC plan savings over their careers to produce average annuitized retirement income of $18,784 (in 2007 dollars) per year, but also that about 37 percent of the sample population would have zero savings from DC plans when they retire.

Workers in the lowest-income quartile have projected replacement rates of 10.3 percent on average, but 63 percent of these workers are projected to have no DC savings at retirement. Highest-income workers, in contrast, have average projected replacement rates of almost 34 percent from DC plans. Workers who are eligible to participate in a plan for at least 15 years have an average projected replacement rate of 33.5 percent, but about 16 percent of these workers still have no projected savings at retirement.

The GAO report makes no policy recommendations, but notes that recent regulatory and legislative changes and proposals could have positive effects on DC plan coverage, participation and savings. Some of these have facilitated plan sponsors’ adoption of automatic enrollment and automatic escalation of contributions, which some studies indicate may increase DC participation and savings among workers who already have access to a plan.

Other proposals focus on encouraging more employers to sponsor plans in order to increase plan participation and savings. In one, the “State-K” proposal, states would collaborate with private financial institutions to offer employers the option of adopting a state-designed, low-cost plan.

Broader options, such as the automatic individual retirement account (IRA) or universal accounts proposals, would seek to extend retirement account coverage by facilitating savings in IRAs or creating retirement savings vehicles for people not covered by a voluntary employer-based retirement plan. Another would expand the saver’s credit by making it refundable to workers who pay little or no federal income tax.

However, in evaluating the data, GAO concluded that current and projected plan balances suggest that while some workers save significant amounts toward their retirement in DC plans, a large proportion of workers will likely not save enough in DC plans for a secure retirement.

Commenting on the report, Rep. Miller noted, "Today's workers will more likely struggle to make ends meet during retirement than previous generations." He added, "While Social Security faces long-term challenges that must be addressed, this GAO report makes it clear that the real retirement security crisis is the lack of savings in private retirement plans."

Read the full GAO Report online at: http://www.gao.gov/docsearch/abstract.php?rptno=GAO-08-8

See also, Rep. Miller's related press release at: http://www.house.gov/apps/list/speech/edlabor_dem/RelDec11.html

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