Employer-sponsored retirement plans are providing less retirement income today than in the past, according to a new analysis from the Center for Retirement Research.
If this doesn't change, “future retirees will be much more dependent on Social Security than those in the past, which is problematic given the reduced support due to the rising full retirement age and the need to close the program's long-term funding gap,” according to the report, written by Alicia Munnell, Wenliang Hou, Anthony Webb and Yinji Li.
Employer-sponsored retirement plans have shifted dramatically in recent decades from defined benefit to defined contribution plans. CRR's report, “How Has the Shift to 401(k) Plans Affected Retirement Income?,” addresses how that shift has affected retirement wealth and income between 1992 and 2010.
The data for this analysis come from the 1992, 1998, 2004 and 2010 waves of the Health and Retirement Study (HRS), a nationally representative survey of older Americans. The sample includes both single individuals and couples ages 51 to 56. A household is classified as having a retirement plan if one or both spouses is currently receiving DB benefits, is covered by a DB pension or participating in a DC plan on a current job, or has DB or DC assets from a past job.
The findings from the Health and Retirement Study show that overall participation in employer plans has declined — from 68% in 1992 to 63% in 2010.
In addition, total wealth from retirement plans can at best be characterized as “flat,” according to CRR.
In 2010, the total median projected retirement income was $20,800, and the mean was nearly $37,000. This is just slightly higher than in 1992, where the median income was $19,542 and the mean was $33,415.
Comparing DB, DC Plans
Although DB income was consistently higher than DC income over the study period, DC income did increase substantially, while DB income remained relatively flat, according to the analysis.
In 1992, the median income with a DC plan was $6,465 and the mean was $16,186, compared with $20,531 median income and a $29,414 mean income with a DB plan. In 2010, the median income with a DC plan was $10,698 and the mean was $24,369, compared with a $19,201 median income and a $29,533 mean income with a DB plan.
The shift from DB to DC has also reduced the amount of retirement income per dollar of wealth because DC participants have to pay more for annuities, and annuity rates fell as interest rates dropped, according to the report.
“While DB participants face actuarially fair annuities, DC participants have to buy annuities on the open market where marketing and other costs reduce annuity factors [which determine payment amounts] by about 15 to 20%,” the report states. “In addition, the interest rate used to calculate commercial annuity rates has declined sharply since 1992, while the interest rate assumption for DB annuities is a steady 5.8%.”
Replacement Rates Declining
A more important indicator for assessing retirement security is the ratio of benefits to pre-retirement earnings, aka the “replacement rate.”
To determine the “replacement rate,” the CRR analysis uses the already-calculated income at the projected retirement ages divided by the highest five years of earnings between ages 51 and 56. (The earnings data come from W-2 forms linked to the HRS records. Approximately 75% of the HRS sample has given permission to link this information, which was determined to be reasonably representative of the larger sample.)
The results for this subsample show that, at least between 1998 and 2010, the replacement rate has declined because earnings at ages 51 to 56 have increased. In 1998, the replacement rate was 37.4% versus 33.8% in 2004 and 31.8% in 2010.
“Even with later retirement ages, steady retirement income combined with rising wages has produced declining replacement rates,” the report states.
This is troublesome because households will require ever-larger replacement rates from employer plans to maintain their standard of living in retirement, given increases in Social Security's full retirement age, growing out-of-pocket health costs and rising longevity.
“The bottom line is that employer-sponsored plans are providing less income today than in the past,” the report states.
CRR suggests two solutions that could improve this outcome: “1) making 401(k) plans work better through auto-enrollment, auto-escalation of default contribution rates and reduced leakages; and 2) expanding coverage to workers whose employers do not offer a plan.”