Views: Mitigating COVID-19’s catastrophic impact on retirement readiness
As the coronavirus has placed many financial worries onto families, it has also placed a sense of worries for those that are planning for their retirement. Read this blog post to learn more.
It’s bad enough that more than 50 million Americans have filed claims for unemployment benefits since the start of the COVID-19 pandemic and lockdown. But in addition to the disruption, financial hardship, and uncertainty that unemployed Americans (and their families) are experiencing right now, this crisis also threatens their financial security during retirement.
As I have written many times before in this column, defined contribution plan participants will seriously diminish their retirement savings if they prematurely cash out all or part of their 401(k) savings account balances. According to our research, a hypothetical 30-year-old who cashes out a 401(k) account with $5,000 today would forfeit up to $52,000 in earnings they would have accrued by age 65, if we assume the account would have grown by 7% per year. In addition, the Employee Benefit Research Institute (EBRI) estimates that the average American worker will change employers 9.9 times over a 45-year period. With at least 33% and as many as 47% of plan participants cashing out their retirement savings following a job change, according to the Savings Preservation Working Group, that means workers switching jobs could cash out as many as four times over a working career, devastating their ability to fund a secure retirement.
Even before COVID-19 and “social distancing” became part of the national lexicon, cash-outs posed a huge problemto Americans’ retirement prospects. At the beginning of this year, EBRI estimated that the U.S. retirement system loses $92 billion in savings annually due to 401(k) cash-outs by plan participants after they change jobs.
These alarming trends were uncovered long prior to the pandemic and lockdown. Since the start of the COVID-19 outbreak, theCoronavirus Aid, Relief, and Economic Security (CARES) Act stimulus has temporarily eased limits, penalties, and taxes on early withdrawals from retirement savings accounts made by December 31, 2020. While the CARES Act measures are clearly well-intentioned, participants who take advantage of these provisions risk creating a long-term problem while resolving short-term liquidity needs.
Heightening the temptation to make 401(k) withdrawals is the recent expiration of another CARES Act provision—the extra $600 weekly payments to Americans who lost their jobs due to the COVID-19 pandemic. These additional federal unemployment benefits expired at the end of July, and as of this writing no deal to extend them has been reached in Congress. For Americans who had been relying on this benefit, or continue to experience financial hardship and stress about paying expenses, it is understandable that 401(k) savings could look like an attractive source of emergency liquidity.
However, given the long-term damage that cash-outs inflict on retirement outcomes, plan sponsors and recordkeepers should take this opportunity, as fiduciaries, to educate their current and terminated participants about the importance of tapping into their 401(k) savings only as an absolute last resort.
Institutionalizing portability can help
The lack of a seamless process for transporting 401(k) assets from job to job causes many participants to view cashing out as the most convenient option. And without an easy way to locate the mailing addresses of lost and missing terminated participants, sponsors and recordkeepers are unable to ensure holders of small accounts receive notifications about the status of their plan benefits.
Fortunately for participants, sponsors, and recordkeepers, technology solutions enabling the institutionalization of plan-to-plan asset portability have been live for three years. These innovations include auto portability, the routine, standardized, and automated movement of a retirement plan participant’s 401(k) savings account from their former employer’s plan to an active account in their current employer’s plan.
Auto portability is powered by “locate” technology and a “match” algorithm, which work together to find lost and missing participants, and initiate the process of moving assets into active accounts in their current-employer plans.
By adopting auto portability, sponsors and recordkeepers can not only discourage participants from cashing out, but also eliminate the need for automatic cash-outs. And these advantages come at a time when the hard-earned savings of tens of millions of Americans are at risk of being removed from the U.S. retirement system.
Before the COVID-19 pandemic, EBRI estimated that if all plan participants had access to auto portability, up to $1.5 trillion in savings, measured in today’s dollars, would be preserved in our country’s retirement system over a 40-year period. Now more than ever, the institutionalization of portability by sponsors and recordkeepers is essential for helping Americans achieve financial security in retirement.
SOURCE: Williams, S. (31 August 2020) "Mitigating COVID-19’s catastrophic impact on retirement readiness" (Web Blog Post). Retrieved from https://www.employeebenefitadviser.com/opinion/how-to-mitigate-covid-19s-potentially-catastrophic-impact-on-retirement-readiness
Older workers are staying in the job market. Here’s why
According to the Bureau of Labor Statistics, the amount of employees over the age of 65 has risen by 697,000. With over two million jobs being created over the past 12 months with the help of the economy, the older generations are still wanting to be employed. Read this blog post to learn more as to why.
Older workers are sticking around the job market. This is why
The number of workers aged 65 and above increased by 697,000 as the economy created more than 2 million new jobs over the past 12 months, according to data from the Bureau of Labor Statistics in this CNBC article. The spike in the number of older workers represents about 36% of the overall increase, reflecting a trend over the past 10 years. “The norms about working at older ages have changed quite a bit, and I think in a way that really is to the advantage of older workers who want to keep working,” says an expert.
What ‘Rothifying’ 401(k)s would mean for retirees
Clients will not benefit from a switch to a retirement system where contributions would be made on an after-tax basis even if it could result in bigger tax revenue in the near term, experts write in The Wall Street Journal. "Over their lifetimes, workers would accumulate one-third less in their 401(k)s under a Roth system. This is because, with no tax advantage from contributing to a 401(k), workers would save less and those lower contributions would earn less over the years," they write. Moreover, "lifetime tax revenue generated by the average worker under a Roth regime would fall 6% to 10%, compared with the current regime."
Stop 'dollar-cost ravaging' your clients’ portfolio in retirement
Retirees who stick to a 4% withdrawal rule during a market downturn are putting their financial security at risk, as their portfolio would not recover even if the market eventually improves, writes an expert in Kiplinger. Instead, seniors should focus on how much income they can generate from their portfolio, he writes. "[I]t means choosing investments — high dividend-paying stocks, fixed income instruments, annuities, etc. — that will produce the dollar amount you need ($2,000, $3,000, $5,000 or more) month after month and year after year."
Will clients owe state taxes on their Social Security?
Retirees may face federal taxation on a portion of their Social Security benefits — but they could avoid the tax bite at the state level, as 37 states impose no taxes on them, writes a Forbes contributor. "While probably not a big enough issue to warrant moving in retirement, it is something to consider when choosing where you want to spend your retirement," writes the expert. "At the very least, you need to know about Social Security taxation when figuring out how much additional income you will need to have in order to maintain your standard of living during retirement."
8 ways clients can start saving for college now
There are a few savings vehicles that clients can use to prepare for college expenses, but they need to consider the pros and cons, according to this article in Bankrate. For example, clients who save in a 529 savings plan can get tax benefits — such as tax deferral on investment gains and tax-free withdrawal for qualified expenses — but will face penalties for unqualified withdrawals aside from taxes. Parents may also use a Roth IRA to save for their child's college expenses, but these accounts are subject to contribution limits and future distributions will be treated as an income, which can reduce their child's eligibility for scholarships or assistance.
SOURCE: Peralta, P. (18 February 2020) "Older workers are staying in the job market. Here’s why" (Web Blog Post). Retrieved from https://www.employeebenefitadviser.com/news/why-older-workers-are-staying-in-the-job-market
Sidecar accounts can help plug 401(k) leakage — to an extent
Many 401(k) participants often dip into their retirement savings to help fund emergency expenses. In fact, the number 1 financial concern for Millennials and Generation X members is not having enough emergency savings for unexpected expenses. Read on to learn more.
Not having enough emergency savings for unexpected expenses is the No. 1 financial concern for millennials and members of Generation X, and the No. 2 financial concern among baby boomers, after retirement security. These findings from a PwC Employee Financial Wellness Survey released last year shouldn’t surprise members of the retirement services industry, since too many defined contribution plan participants dip into their 401(k) savings —through loans, hardship withdrawals or cash-outs upon changing jobs — to fund emergency expenses.
While 48% of households faced at least one expense related to an unexpected emergency over the past year, according to CIT Bank, a recent GoBankingRates survey has found that a staggering 62% of Americans have less than $1,000 in a savings account. The frequency of unexpected emergency expenses, and the lack of savings to fund them, work in tandem to create a situation where many Americans are forced to withdraw hard-earned retirement savings from 401(k) accounts in defined contribution plans, where they are safely incubated in the U.S. retirement system for future enjoyment. In fact, according to a Boston Research Technologies survey of 5,000 401(k) plan participants, slightly more than one-third of all 401(k) cash-outs upon job change are for emergencies, while the rest end up being used for discretionary spending.
The development of “sidecar” accounts, also known as “rainy day” funds, is a positive trend because these instruments can help plan participants avoid tapping into their retirement savings to pay emergency expenses. Sidecar accounts are set up alongside 401(k) savings accounts in defined contribution plans, and if an employee chooses to set one up, they can allocate after-tax contributions to the fund in order to reach a targeted amount of savings. When a sidecar fund reaches the desired amount, future contributions can be directed to the plan participant’s pre-tax retirement savings. If a participant dips into a sidecar fund, the targeted balance can be automatically replenished over time with future after-tax contributions.
Sidecar accounts can serve as a valuable tool for preserving retirement savings, and fortunately, our elected officials are attempting to make it easier for plan sponsors to offer them for participants. The Strengthening Financial Security Through Short-Term Savings Accounts Act of 2018, a bipartisan Senate bill sponsored by Senators Cory Booker (D-N.J.), Tom Cotton (R-Ark.), Heidi Heitkamp (D-N.D.), and Todd Young (R-Ind.), would allow sponsors to automatically enroll participants in sidecar or standalone accounts for emergency expenses. The bill would also enable the U.S. Department of the Treasury to create a pilot program giving employers incentives to set up these accounts. The bill hasn’t yet become law, but the fact that it’s been proposed is positive for the U.S. retirement system as a whole.
Vast majority of leakage is from cash-outs
Although a sidecar account could be a useful tool in the ongoing struggle to curtail leakage of savings from defined contribution plans, they won’t plug the biggest hole in the retirement system’s proverbial bucket. According to the U.S. Government Accountability Office, 89% of leakage is the result of premature cash-outs of 401(k) accounts. Loans, hardship withdrawals and other factors contribute to the remaining 11%. As mentioned above, with an estimated one-third of cash-outs taken to cover emergencies, two-thirds of cash-outs are for non-emergency expenses.
Unfortunately, the lack of widespread, seamless plan-to-plan portability causes too many participants to cash out, or simply leave their savings behind in a former employer’s plan, because doing so is easier than consolidating their 401(k) accounts in their current-employer plans.
Thankfully, there is a solution to address the 89% of leakage caused by cash-outs — auto-portability, which has been live for more than a year. Auto-portability is the routine, standardized and automated movement of a retirement plan participant’s 401(k) savings from their former employer’s plan to an active account in their current employer’s plan, and is specifically designed for accounts with less than $5,000. Key components of the auto-portability solution are the paired “locate” and “match” technologies for tracking down and identifying participants who have stranded 401(k) accounts in former-employer plans, which in turn enable the process of consolidating a participant’s savings in their current-employer plans.
Plugging the biggest hole in the U.S. retirement system bucket would help millions of Americans improve their retirement outcomes. The Employee Benefit Research Institute forecasts that, if auto-portability were implemented across the country, up to $1.5 trillion, measured in today’s dollars, would be preserved in the retirement system.
Fortunately for plan participants and sponsors alike, the White House and government agencies also realize the benefits of widespread auto-portability. The U.S. Department of Labor recently issued guidance on auto-portability through an advisory opinion as well as a prohibited transaction exemption clarifying fiduciary liability for sponsors who adopt auto-portability as a new feature of their automatic rollover service.
This crucial DOL guidance helps to clear the way for the nationwide implementation of auto-portability — helping all Americans, and especially women and minorities, save more for retirement. In his remarks at the White House in December (during the signing ceremony for the executive order establishing the White House Opportunity and Revitalization Council), Robert L. Johnson noted that 60% of African-Americans and Hispanic-Americans cash out their 401(k) accounts — and the nationwide adoption of auto portability “will put close to $800 billion back in the retirement pockets of minority Americans.”
Now that an innovative solution has been created to address the root cause of the majority of leakage (cash-outs), it’s good to see that a creative tool like the sidecar account has also been developed to help participants avoid making choices (i.e. dipping into their retirement savings to pay emergency expenses) that cause the remaining asset leakage.
SOURCE: Williams, S. (23 January 2019) "Sidecar accounts can help plug 401(k) leakage — to an extent" (Web Blog Post). Retrieved from https://www.benefitnews.com/opinion/sidecar-accounts-can-help-plug-401k-retirement-leakage?brief=00000152-14a7-d1cc-a5fa-7cffccf00000
