Better support needed
for workers changing jobs
“Even when the new employer automatically enrolls the new employee,
the plan features of the old employer may not line up with the new one.”
—Kelly Hahn
Head, Retirement Research
Vanguard
By Thomas A. McCoy, CLU
If we take a macro-view of workers’ prospects for retirement security, there is reason for optimism. Today’s employees generally have watched their defined contribution (DC) plan balances swell, buoyed by a strong stock market. More important, many have taken the advice drummed into them by financial experts to save higher percentages of their income in their retirement plans.
A one-year-old study by Principal Financial Group found that among middle-income households (earning $50,000 to $100,000 per year) their average retirement savings rate was 7.8% before contributions from their employers.
Research from Vanguard projects that about 40% of workers are on track to achieve retirement security. Kelly Hahn, Vanguard’s head of retirement research, said that employers automatically enrolling workers into their retirement plan have played a key role in the progress toward retirement security.
She told a recent Harkin Institute Symposium audience, “About 60% of Vanguard’s employer clients are automatically enrolling their new hires in the plan, and when they do, almost everyone is saving toward their retirement. About one-third are defaulting their new hires at 6% or more of compensation.” With additional employer matches, the total savings rate can be as high as 12%, she noted.
Of course, many employers’ plans do not meet these contribution levels. Even if they do, one barrier to a secure retirement can be a job change, or more likely the several job changes employees will experience over their working life.
“Our data show that when people change jobs, their wages can go up by an average of 10%,” Hahn said.” At the same time, their savings rate tends to go down by one percent. Over 30 or 40 years, that one percent can have a really meaningful impact.
“Sometimes the savings rate drops because the new company doesn’t automatically enroll their new hires, so it’s up to the employee to decide whether to save and how much to save. We find that when this decision is left to the employee, one in four either forgets to save or chooses not to save, so their savings rate goes to zero.
“Even when the new employer automatically enrolls the new employee, the plan features of the old employer may not line up with the new one,” Hahn pointed out. “A common default rate is 3% with a one percent increase per year. So, an employee who spent five years at their former employer and built up their saving rate to 8% could be defaulted to 3% at the new employer.
“When we quantify the cumulative effect of this reduction, for a worker making $60,000 per year, this could amount to $300,000 in forgone wealth, which could be enough to fund an additional six years of retirement spending.
“Part of the solution could be auto-portability,” Hahn said, “so that a person moving to a new employer would automatically have their saving rate in the new plan defaulted to what it was in the old one.”
Michael Kreps, a principal in Groom Law Group, a leading employee benefits law firm, explained to the symposium audience how, without a system of auto-portability, an employee’s progress toward retirement security is being hindered.
“Often when an employee changes jobs, the money they have accumulated in the DC plan of their old employer will remain there. It seems like too much work for the employee to take the funds to the new employer’s plan. Also, not all plans take rollovers.”
If the DC account balance is between $1,000 and $7,000, an employer may deposit it automatically into an IRA for the departing worker. “The worker may or may not realize that IRA money is there. They lose track of it,” Kreps said.
The funds on these “involuntary transfers” to an IRA are required to be invested in safe, low-risk vehicles such as money market funds—potentially limiting long-run returns.
If the account is below $1,000, the old employer can close the account and mail the worker a check—a taxable event for the job-changing worker. “The distribution to workers of these under-$1,000 accounts results in billions of dollars of leakage from the retirement system,” Kreps said.
Other challenges to retirement readiness are more difficult to solve because they involve ongoing changes in longevity, morbidity and demographics. Sri Reddy, senior vice president, retirement and income solutions of Principal Financial Group, pointed out to the Harkin Institute audience, “In the last 120 years we’ve improved life expectancy by 12 years.
“With fewer births, more retirees and lengthening longevity, we’ve gone from eight workers per retiree in 1950 to three workers today. And that’s going to drop to about 2.2 sometime in the 2050s.”
As more cures for cancer and other diseases are developed, Reddy pointed out, dementia has increased, and life expectancies for those with dementia also are increasing. “So, with fewer births, fewer workers and more chronic diseases, the question becomes, ‘How do we pay for it?’”
Looking at overall prospects for retirement readiness, Reddy said there is reason for hope. One suggestion he offered is to increase the Social Security retirement age.
“While life expectancies have increased substantially, the number one age for claiming Social Security is 62. More than one-third of Americans take it early and pay taxes because they are still working, which is a bad outcome. If the Social security retirement age were raised to 73, a lot of Social Security shortfall issues would be solved.”
Creating retirement readiness in an era of longer life spans inevitably leads to the issue of guaranteed lifetime income products. Surveys suggest employees are strongly interested in having these solutions offered to them through their benefits plans, and some plans do offer them.
Reddy said that questions remain as to how far guaranteed income products can go toward solving retirement income shortfalls over the long term. With these annuity-based products, “Now you know what you’re going to receive in income, but what can you buy with that? Because that will change over the next 20, 30 or 40 years as well. And now you’ve traded one uncertainty for another uncertainty. It’s not an easy problem and it’s certainly not going away.”
Beyond the pure financial challenges of retirement, Reddy stressed the positive possibilities that today’s extra longevity offers. “Some people can phase into retirement, maybe working part-time.” Whatever their choices, “I think we need to think about retirement as a time when people still contribute meaningfully to society.”
The author
Thomas A. McCoy, CLU, is an Indiana-based freelance insurance writer.
