From the March 2012 issue of Investment Advisor • Subscribe!

March 1, 2012

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

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

Illustration by Ellen Weinstein Illustration by Ellen Weinstein

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 in late January.

“In 2012, defined-contribution will surpass defined-benefit as the predominant retirement vehicle globally,” 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; others offer low matches; and some employees choose not to participate in a DC plan at all, 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 their DC plans when leaving a job or when they make hardship withdrawals. 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 of employees who responded said they regretted taking a cash distribution when changing jobs, while only 29% regretted taking 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 making up 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.

“Plan participants communicated loud and clear about what they need: simple steps and automated features,” Mitchem said in a statement. “The ongoing volatility in the financial markets has increased anxiety amongst plan participants and a significant percentage want simplified and prescriptive guidance in order to make progress toward their retirement goals.”

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