401(k)s to Overtake Pensions as Primary Retirement Vehicle in 2012: State Street

‘Leakage’ from DC plans threatens employee savings during job switches

For the first time, in 2012, more people will be saving for retirement in 401(k)-type plans than in traditional pensions, and that means employees need better guidance from plan sponsors, State Street Global Advisors reported Wednesday.

“In 2012, defined contribution will surpass defined benefit as the predominant retirement vehicle globally, which is a real shift,” said Kristi Mitchem, senior managing director and head of global defined contribution at State Street Global Advisors, at a media briefing in New York.

But the DC system falls short because some employers don’t offer a savings plan while others offer low matches, and some employees choose not to participate in a DC plan even if it is available, Mitchem said.

DC Leakage Leads to Regret

“Leakage,” or money coming out of the retirement savings system, is one of the greatest threats to retirement savings, yet it often goes unaddressed, said Brigitte Madrian, a public policy and corporate management professor at Harvard University's Kennedy School of Government, who also spoke at the briefing.

Leakage occurs when employees cash out of their DC plans when leaving a job, or when they make hardship withdrawals or take out loans. The Government Accountability Office reported in 2006 that cash-outs at a job change caused $74 billion of the $84 billion in total leakage.

Though representing only 3% of total retirement savings assets, leakage from job changes has “a nontrivial impact” because employees usually come to regret letting their retirement savings run through their hands, Madrian said.

According to a Fidelity retirement survey in 2011, regret is correlated with the amount of leakage. A majority, 55%, of employees who responded said they

regretted taking a cash distribution when changing jobs, while only 29% regretted taking out a loan against a 401(k).

“The regret is exactly where the problem is the biggest,” Madrian noted.

Warning on Savings Risk of High-Turnover Job Market

Dallas Salisbury, president and CEO of the Employee Benefit Research Institute said at the briefing that job leakage occurs during job turnover, and job turnover has dramatically changed in the last half century along with the increasing use of DC plans.

“We have always been a high turnover society, and in the retirement planning world that makes a huge difference,” Salisbury said, adding that American employees need to save now more than ever. He pointed to Warren Buffett’s prediction that the next 20 to 30 years will be a low-yield environment, with fixed income yielding an average of 3% and equities 5%.

U.S. retirement assets totaled $17.4 trillion in 2010, according to the 2011 Investment Company Fact Book, with $4.5 trillion in private DC plans and $4.7 trillion in IRAs.

With these two vehicles–DC plans and IRAs–comprising the lion’s share of retirement savings, companies that sponsor DC plans such as 401(k)s face growing pressure to improve savings outcomes, Mitchem advocated greater awareness of plan features such as automatic enrollment and escalation of automatic payroll deductions at an additional 1% per year.

In addition, a new State Street survey of participants found that 75% of savers said they would participate in a “savings boot camp” that forced them to save 10% of their paychecks in an automated 401(k) plan, Mitchem said.

Read Top 10 Worst States for Workers in Retirement Plans at AdvisorOne.com

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