A sporadic saver’s dilemma

Three senators have proposed a law that would require employers to tell their 401(k) participants how much money they are projected to earn each month based on the current balance of their account. Since most Americans don’t have much money in their 401(k) accounts, the disclosure would quickly highlight how much more they need to save. For instance, the average 401(k) account produces just $225 a month in income. From there, one of two things could happen.

Best case, they increase the amount they contribute to their 401(k), which presently averages 7%. Or, worst case, they increase the amount they invest in stocks, thus increasing their exposure to market risk. At the moment, the evidence seems to suggest that many workers don’t have a clue about how to invest the money in their 401(k)s.

For older workers who need their retirement nest eggs soon, the worst case scenario is potentially devastating. Full story at Marketwatch.

A new financial what if to dream about: One-click IRA consolidation?

Automatic enrollment has gained a following. What about one-click IRA/401(k) consolidation?

The scattered-accounts problem is actually a risk with the auto-I.R.A., too. Its architects envision a strict limit on the number of investment choices. That makes it different from normal I.R.A.’s, where you can often invest in whatever you’d like. Even if all auto-I.R.A.’s offered the same limited menu, no matter which bank or brokerage was administering it, account owners could still end up with a bunch of different I.R.A.’s years from now.

Mark Iwry, nonresident senior fellow at the Brookings Institution, said that he and David John, a senior fellow at the Heritage Foundation, who together came up with the auto-I.R.A. idea, were well aware of this potential problem. “Our direction is to facilitate the potential consolidation,” Mr. Iwry said…“You’re told that you have two I.R.A.’s, here’s where they are, and if you want to combine them you could just click here.”

If that sounds a bit messy, well, that’s the paradox of simplification. “Simplifying is a lot of work. It’s a complex undertaking,” said Pamela F. Olson, a partner at Skadden Arps in Washington, who was assistant secretary for tax policy at the Treasury Department during George W. Bush’s first term as president…In fact, it’s hard to get people riled up about the topic in the first place.

Or as another tax lawyer in the story notes, “There’s no real constituency for simplification.” Actually, there is a constituency. It’s just large and diffuse, and therefore, unlikely to organize.

Hat tip: Amelia Kaye

Automatic enrollment is in the new Obama budget proposal

On page 37:

Making Saving for Retirement Easier as the Economy Recovers.
Over the long-term families need personal savings, in addition to Social Security, to prepare for retirement and to fall back on during tough economic times like these. However, 75 million working Americans—roughly half the workforce—currently lack access to employer-based retirement plans. In addition, the existing incentives to save for retirement are weak or non-existent for the majority of middle and low-income households. The President’s 2010 Budget lays the groundwork for the future establishment of a system of automatic workplace pensions, on top of and clearly outside Social Security, that is expected to dramatically increase both the number of Americans who save for retirement and the overall amount of personal savings for individuals. Research has shown that the key to saving is to make it automatic and simple. Under this proposal, employees will be automatically enrolled in workplace pension plans—and will be allowed to opt out if they choose. Employers who do not currently offer a retirement plan will be required to enroll their employees in a direct-deposit IRA account that is compatible with existing direct-deposit payroll systems. The result will be that workers will be automatically enrolled in some form of savings vehicle when they go to work—making it easy for them to save while also allowing them to opt out if their family or individual circumstances make it particularly difficult or unwise to save. Experts estimate that this program will dramatically increase the savings participation rate for low and middle-income workers to around 80 percent.

The idea draws praise from bloggers at both Heritage and the Nation. The trend of companies offering automatic enrollment is slowing. Strangely, more than half of them say they aren’t adding automatic enrollment because of the increased costs of an employer match. Strange, since the two can be uncoupled easily.

You really want to read about pension funds, don’t you?

Pension fund talk really gets the blood flowing, doesn’t it? Well, we’re going to try our wonky best.

India’s Pension Fund Regulatory and Development Authority (PFRDA) is the government body responsible for regulating the country’s pension sector. In response to a proposal for new pension system that features defined contribution plans and professional financial funds, the PFRDA recently published a report on recommendations for this new plan. (The paper is no longer online, so special thanks to Amol Agrawal for sending it our way. We’ll post it if it comes back online.)

The paper’s discussion of the default rule is an interesting window into how thinking about default rules for investments has changed over the past decade, and how policymakers in different countries may end up addressing this issue.

Continue reading the post here.

Some good news on overinvestment in an employer’s stock

From former CBO director and soon to be Office of Management and Budget director Peter Orszag.

The overall share of 401(k) participants with 90 percent or more of their assets invested in company stock is more like .47*7.3=3.4 percent. It’s still too high…The good news is that the trend is towards less investment in company stock. For example, in 1999 EBRI estimated that 19.1 percent of all 401(k) assets were held in company stock…By 2006, that share had fallen to 11.1 percent.

The figure below, which shows this decline, comes from the Employee Benefit Research Institute. The company stock figures are the second batch of bars from the left.

Trends in automatic 401(k) enrollment

Large companies are doing better than small ones. And more than 10 percent of the total rise has come since the passage of the Pension Protection Act. See the below side from recent presentation by CBO director Peter Orszag.

New estimates on the benefits of automatic enrollment for 401(k) plans

The Pension Protection Act of 2006 gave companies some carrots for adopting auto-enrollment 401(k) plans, a favorite nudge of ours. A paper out earlier this summer by the Employee Benefit Research Institute draws some preliminary conclusions about its effect – chiefly that there is a “very significant positive impact in generating additional retirement savings for many workers, especially for low-income workers.” (Go here for the full summary)

For example, under one set of assumptions used in the Issue Brief, the median 401(k) accumulations for the lowest-income quartile of workers currently age 25–29 (assuming all 401(k) plans were voluntary enrollment) would only be 0.1 times final earnings at age 65 (this is largely due to the fact that 41 percent of workers—as opposed to participants—were assumed to have zero balances at age 65). However, if all 401(k) plans are assumed to be using the safe harbor automatic enrollment provisions under PPA, the median 401(k) accumulations for the lowest-income quartile jumps to 2.5 times final earnings under the most conservative assumptions and 4.5 times final earnings under the set of assumptions most beneficial to participants.

Even among higher paid workers the increases are considerable. The multiple jumps from 1.8 times final earnings under a voluntary enrollment scenario to between 6.5 to 10.4 times final earnings under an automatic enrollment scenario, depending on one’s assumptions about automatic escalation of contributions.

While individual company adoption of auto-enrollment is good for that company’s workers, a bigger lesson of the paper is the need for universal adoption. In an age when workers switch jobs more frequently than ever, the risks to saving among many, especially those predisposed not to enroll, are large. Based on projections by the authors (with some assumptions for average savings rates and salaries), individuals who are automatically enrolled in a 401k at their work and remain there for life end up with median replacement rates at retirement ranging from 51–69 percent. The replacement rate is the percentage of a worker’s final salary that is replaced in retirement by a nominal annuity purchased with 401(k) assets. If a worker switches jobs, however, and only has an average chance of being automatically enrolled, the replacement rate range drops to 21-26 percent. That’s serious money.

Hat tip: Mostly Economics