For decades, employers have been steadily ridding themselves of the responsibility of funding and making payments to traditional defined benefit pensions in favor of 401(k)-type defined contribution plans. But are these individual account retirement savings plans providing sufficient retirement income for most Americans?
For millions of workers, that answer is “No.”
A survey of individuals in the 2020 U.S. Census showed just how deficient these plans are. Only a little more than one-third of workers (34.6%) participated in a defined contribution plan and the median account value of these retirement plans was a woefully inadequate $30,000. Only 13.5% of workers participated in a defined benefit plan that provides a guaranteed retirement income.
The data isn’t much better when total household savings are considered. In the Federal Reserve’s Survey of Consumer Finances for 2019-2022 (a measure of household savings), the median account balance was $87,000 for all households and $185,000 for households with workers nearing retirement (ages 55-64). In the household survey, only 54% of workers said they had a retirement account.
According to a recent report from the National Institute on Retirement Security (NIRS), the generation that will begin to retire in the coming decade is significantly unprepared for retirement. NIRS found that Generation X (generally those born between 1965 and 1980) has a median retirement savings account balance of a paltry $40,000.
Even when people save money in their plans, they often don’t keep it there. For example, a new Bank of America survey shows that of the 4 million participants who have accounts in the plans that BofA serves as recordkeeper, the number of participants taking a plan loan rose to about 75,000 (2.5%) participants in the second quarter of 2023, compared to about 56,000 (1.9%) participants in the previous quarter. The average plan loan balance was $8,550, BofA found.
Several other recent surveys have shown a similar trend of increasing hardship withdrawals. A survey by Fidelity revealed that the share of plan participants withdrawing money from their plan more than tripled between 2018 and 2023, rising from 2.1% to 6.9%. Another survey from Vanguard reported that hardship withdrawals doubled in a four-year span, climbing from a monthly rate of 2.1 transactions per 1,000 participants in 2018 to a rate of 4.3 transactions in 2022.
Participants who withdraw plan funds to cover non-retirement expenses, no matter how justified, are shortchanging their future. Every dollar withdrawn will no longer be in the account where it can grow tax deferred. That lost principle, combined with the loss of potential interest and investment gains over what could be years or decades, won’t be there for them when they need it in retirement. Some who withdraw assets could see their account balances reduced by thousands of dollars, tens of thousands or even more.
Even if a participant eventually repays plan loans to his or her account, the result is usually a significant reduction in their ultimate retirement account balance compared to what they would have had if the money had remained in the plan all along.
The American retirement nest-egg has been traditionally thought to rely on a three-legged stool, consisting of Social Security payments, personal savings and pension income. With employers increasingly terminating the defined benefit pension plans they have been offering their workers and replacing those vehicles with deficient and inadequate defined contribution savings plans, many workers, particularly those with inadequate incomes, will discover on reaching retirement that at least one leg of the stool has been partially, or even wholly, sawed off.