The majority of people today are not accumulating adequate funds for retirement. This article will discuss some of the causes, how well defined contributions plans are helping -- and will suggest solutions to this historic dilemma.
Financial independence = retirement security
Retirement security today has been redefined with the broader term of financial independence. Financial independence is obtained when someone has accumulated sufficient assets to provide for their living expenses without the need to earn income.
Preparation for financial independence requires individuals to regularly set aside funds for the future, foregoing current wants. A decline in defined benefit plans and the financial insecurity of government plans has pushed the major responsibility of funding to workers and their defined contribution plans.
Americans are not accumulating sufficient assets in defined contribution plans to provide for financial independence when they are in their 60s. Based on current statistics, many will need to work into their 70s. This later retirement age allows an increased period of time for fund accumulation and decreases the amount needed since the number of years in retirement will be reduced.
The average 401(k) participant with 11 years of tenure and 20 years until retirement (65) has accumulated only about $60,000, and the median total average plan balance is only roughly $27,000.
Not only are people not saving enough for retirement, but they are also carrying too much debt, and savings rates are at the lowest point since the Great Depression.
Causes of financial insecurity.
The reasons for current financial conditions are complex. In recent years, health care, utilities and gasoline have consumed a greater percentage of household budgets as wages in blue collar jobs have declined with the shift to international manufacturing. Current lifestyles may also be to blame, including poor health habits (re-sulting in higher health care costs), larger vehicles and bigger homes -- the average square footage of homes has increased from 1,500 to 2,500 (1970 versus 2005). Increased lifestyle changes raise the cost of utilities, maintenance and insurance. When people raise their lifestyle, every area of their finances become affected as they try to fit into the norms of the next level on the rung -- everything from clothing costs to vacation destinations affect the overall budget. The stress of trying to keep up also can affect health and job performance.
The decline in defined benefit plans could also be cited as a cause. The plans continue to cover fewer people each year. Defined benefit plans are expensive to fund and administer because of increased regulations and longer lifespans. Corporations struggling to compete internationally have shifted to defined contribution plans.
Many people believe that financial illiteracy is to blame as well. Many people have never been taught basic budgeting, bank account balancing, debt management, savings and investing skills.
Defined contribution challenges
Average employees arrive at their place of employment carrying the baggage of economic challenges, financial illiteracy, and possibly poor decisions or misfortune. It should not be a surprise when they do not use their defined contribution plans efficiently.
- Participation rates are only about 70 percent -- down about 5 percent from a few years ago.
- Only a fourth of employees are taking advantage of company matching funds, and 30 percent only contribute enough to get matching funds.
- Some employers are reporting increased defined contribution plan loans and withdrawals.
- Asset allocation averages indicate that participants are putting too much money into money market or fixed accounts, and using only four to five of the asset classes being offered.
Pension Protection Act to the rescue
Employers have already begun to adopt some of the requirements of the PPA that will take effect fully this year, all of which will help improve defined contribution plan utilization and efficiency:
- Automatic enrollment of new employees
- Automatic deferral of new employees
- Default investing
- Lowering of fees
- Offering advice
These measures are already showing a positive effect; however, they will not fully address the mounting challenges consumers face today.
The fundamentals and the big picture
Vince Lombardi, the great football coach, believed that focusing on fundamentals and having a big-picture mentality contributed to success. These principles can be applied to the crisis facing defined contribution plan members.
The bottom line is that individuals need to increase their education about finances and make better long-term financial decisions and savings habits. Since both the employee and the employer benefit from increased participation in retirement plans, employers should consider workplace financial education, with the use of technology and advisor assistance.
Workplace planning and education
The place of employment is where most people obtain the majority of their financial services.
Consider: Employer benefits programs provide more people with retirement benefits and with health, disability and life insurance than any other source. It is only natural employers can be the source of providing financial planning and education.
Employees will benefit by becoming better off financially as they better utilize employee benefits. They also might become less stressed as they better manage their finances. Employers will benefit because their workers are healthier, less stressed and more productive.
Financial planning delivery
Employers today have many options available to them to provide workplace financial education and planning. Many firms offer a full range of options:
- Internet-based training
- Educational workshops
- Expanded employee assistance programs
Lastly, some employers are beginning to offer a new wave of support through:
- Computerized financial planning designed for consumer use. Not only does this nicely complement educational programs, computerized planning and investment modeling designed under the guidelines of the Pension Protection Act can qualify as an exemption to the prohibited transaction rules.
- Individual advisor assistance, recognizing that it is important to help guide people through the implementation of their financial plans. An advisor serves as a coach or cheerleader to encourage them along the way. (A recent study shows that even electronic encouragement and reminders help people keep on track). Employers should not neglect individual advisor assistance since no plan will be helpful if it is not implemented.