The United States of Pension Poverty?

Ted Kedmey of TIME reports, This Is the Scariest Number Facing the Middle Class (h/t, @HOOPPDB):

The average middle class American has only $20,000 in retirement savings, according to a new survey that shows large swathes of the public are aware of those shortfalls and feeling anxious about their golden years.

Wells Fargo surveyed more than 1,000 middle class Americans about the state of their savings plans. Roughly two-thirds of respondents said saving for retirement was “harder” than they had anticipated. A full one-third of Americans said they won’t have sufficient funds to “survive,” a glum assessment that flared out among the older respondents. Nearly half of Americans in their 50s shared that concern.

But perhaps the most startling response came from the 22% of Americans who said they would prefer to suffer an “early death” than retire without enough funds to support a comfortable standard of living.

Let's take a closer look at the Wells Fargo survey which finds saving for retirement is not happening for a third of the middle class:

Saving for retirement is a formidable challenge for middle-class Americans, with 34% not currently contributing anything to a 401(k), an IRA or other retirement savings vehicle, according to the fifth annual Wells Fargo Middle-Class Retirement study. Forty-one percent of middle-class Americans between the ages of 50 and 59 are not currently saving for retirement. Nearly a third (31%) of all respondents say they will not have enough money to “survive” on in retirement, and this increases to nearly half (48%) of middle-class Americans in their 50s. Nineteen percent of all respondents have no retirement savings. On behalf of Wells Fargo, Harris Poll conducted 1,001 telephone interviews from July 20 to August 25, 2014 of middle-class Americans between the ages of 25 and 75 with a median household income of $63,000.

Sixty-eight percent of all respondents affirm that saving for retirement is “harder than I anticipated.” Perhaps the difficulty has caused more than half (55%) to say they plan to save “later” for retirement in order to “make up for not saving enough now.” For those between the ages of 30 and 49, 59% say they plan to save later to make up retirement savings, and 27% are not currently contributing savings to a retirement plan or account.

Sixty-one percent of all middle-class Americans, across all income levels included in the survey, admit they are not sacrificing “a lot” to save for retirement, whereas 38% say that they are sacrificing to save money for retirement.

“Saving for retirement isn’t easy. It requires sacrifice, and it’s not something people can push off and hope to achieve later in life. If people in their 20s, 30s or 40s aren’t saving today, they are losing the benefit of time compounding the value of their money. That growth can’t be made up later, so people have to commit early in life to make savings a regular discipline year after year – it is the only way most people will achieve their financial goals to carry them through retirement,” said Joe Ready, director of Institutional Retirement and Trust.

While a majority of middle-class Americans say that they are not sacrificing a lot to save for retirement, 72% of all middle-class Americans say they should have started saving earlier for retirement, up from 65% in 2013. When respondents were asked if they would cut spending “tomorrow” in certain areas in order to save for retirement, half said they would: 56% say they would give up treating themselves to indulgences like spa treatments, jewelry, or impulse purchases; 55% say they’d cut eating out at restaurants “as often”; and 51% say they would give up a major purchase like a car, a computer or a home renovation. Notably, fewer people (38%) report that they would forgo a vacation to save for retirement.

What Have They Saved?

According to the survey, middle-class Americans have saved a median of $20,000, which is down from $25,000 in 2013. Middle-class Americans across all age groups in the study expect to need a median savings of $250,000 for retirement, but they are currently saving only a median amount of $125 each month. Excluding younger middle-class Americans who may be earning less money, respondents between the ages of 30 and 49 are putting away a median amount of $200 each month for retirement, whereas those between the ages of 50 and 59 are putting away a median of $78 each month for retirement.

Twenty-eight percent of all age groups included in the survey report that they have a written financial plan for retirement. That number is slightly higher, 34%, for those between the ages of 30 and 39. People with a written plan for retirement are saving a median of $250 per month, far greater than the median $100 per month that is being saved by those without a written plan.

“People who have a written plan for retirement are helping themselves create a future on their own terms, with a foundation built on saving, and hopefully, investing.As evidenced by the difference in monthly savings amounts for those with a written plan and those without, it is clear that a plan makes a sizeable difference,” added Ready.

The Power of the 401(k)

Middle-class Americans value the 401(k) as a way to create a retirement nest egg. Seventy percent of respondents have a 401(k) or equivalent plan available to them through their employer, and a majority of them (93%) are currently contributing to their plans. Approximately 67% of those in a plan contribute enough to maximize their company’s 401(k) match, and the median contribution rate for those between the ages of 30 and 59 is 7%.

Eighty-five percent of those with access to a 401(k) or equivalent plan from their employer affirm they “wouldn’t have saved as much for retirement” if they did not have a 401(k). Moreover, 90% say the 401(k) or equivalent plan “makes it easy to save for retirement.”

“The 401(k) makes a significant difference for people in that it gives them the ability to save in a regular, systematic way. It conditions people to think that saving money is paying themselves first and is just as important as paying day-to-day bills,” said Ready.

Examining retirement savings by age, the median amount saved by those in their 40s is $40,000, for those in their 50s is $20,000, and those in the age range of 60 to 75 is $25,000. The median amount saved by those who have access to a 401(k) plan is much higher than that saved by those without access to a plan, particularly for those who are younger. Middle-class Americans between the ages of 25 and 29 with access to a 401(k) plan have saved a median of $10,000 versus a median of zero savings for those without access. Respondents between the ages of 30 and 39 with access to a 401(k) have saved a median of $35,000 versus those without access who have saved a median of less than $1,000, and those between the ages of 40 and 49 with access to a 401(k) have saved a median of $50,000 versus the $10,000 saved by those without access.

Having access to a 401(k) also seems to positively impact a sense for what is possible. More than half (58%) of non-retirees without access to a 401(k) plan say “it is not possible” to pay bills and “still” save for retirement, compared to a third (32%) of those who have access to a plan, but say they can’t save and pay bills at the same time.

Those who have access to a 401(k) are more likely to say they would give up certain expenses, big purchases or expenditures like eating out in order to save for retirement, at a rate approximately 10 percentage points higher than those without access to a 401(k).

The Retirement Picture

Across all age groups, almost half (48%) of non-retirees are not confident that they will have saved enough “to live the lifestyle they want” in retirement. This lack of confidence jumps to 71% for non-retirees between the age of 50 and 59.

A quarter of all middle-class Americans say they “get depressed” when thinking about their financial life in retirement. However, the rate of those who feel down about retirement increases to one in three for those in their 40s and 50s. In a new survey question, 22% of the middle class say they would rather “die early” than not have enough money to live comfortably in retirement.

Working longer or into traditional retirement years appears to be a predicted reality for a third of middle-class Americans who say they will need to work until they are “at least 80 years old” because they will not have enough retirement savings, holding steady from a year ago. Half of those in their 50s say they will need to work until age 80. In another new question asked this year, a quarter (26%) of middle-class Americans say working into their 80s is something they plan to do even if it’s not a financial necessity.

The majority (70%) of middle-class Americans do not think Social Security will be their primary funding source for retirement, but the perception varies greatly for those based on age. Almost half (46%) of non-retirees in their 50s think Social Security will be their primary source of income, as do 56% of non-retirees between the ages of 60-75.

I guarantee you Social Security will be the primary source for retirement funding for the majority of middle class Americans. America's new retirement reality is grim and unfortunately the retirement crisis isn't sparking new thinking.

Instead, Americans are offered more of the same. If you read the Wells Fargo survey, it extolls the virtues of 401(k)s as a savings plan but neglects to mention America's 401(k) nightmare which is actually still going on even if the stock market bounced back since the crisis.

For example, during the summer, Bloomberg reported on how retirees suffer as $300 billion rollover boom enriches brokers. And Ron Lieber of the New York Times recently reported on combating a flood of early 401(k) withdrawals (h/t, Suzanne Bishopric):

This week, the Internal Revenue Service announced that people under age 50 in 401(k) and similar workplace retirement plans will be able to deposit up to $18,000 in 2015, an increase of $500 from this year. Those 50 and over can toss in as much as $24,000, a $1,000 increase.

Which is all fine and dandy for the well-heeled and the frugal. But one of the biggest problems with these accounts has nothing to do with how much we can put in. Instead, it’s the amount that so many people take out long before they retire.

Over a quarter of households that use one of these plans take out money for purposes other than retirement expenses at some point. In 2010, 9.3 percent of households who save in this way paid a penalty to take money out. They pulled out $60 billion in the process; a significant chunk of the $294 billion in employee contributions and employer matches that went into the accounts.

These staggering numbers come from an examination of federal and other data by Matt Fellowes, a former Georgetown public policy professor who now runs a software company called HelloWallet, which aims to help employers help their workers manage their money better.

In a paper he wrote with a colleague, he noted that industry veterans tend to refer to these retirement withdrawals as “leakage.” But as the two of them wrote, it’s really more like a breach. And while that term has grown more loaded since their treatise appeared last year and people’s debit card information started showing up on hacker websites, it’s still appropriate. Millions of people are clearly not using 401(k) plans as retirement accounts at all, and it’s a threat to their financial health.

“It’s not a system of retirement accounts,” said Stephen P. Utkus, the director of retirement research at Vanguard. “In effect, they have become dual-purpose systems for retirement and short-term consumption needs.”

How did this happen? Early on in the history of these accounts, there was concern that if there wasn’t some way for people to get the money out, they wouldn’t deposit any in the first place. Now, account holders may be able to take what are known as hardship withdrawals if they’re in financial trouble. Moreover, job changers often choose to pull out some or all of the money and pay income tax on it plus a 10 percent penalty.

The breach tends to be especially big when people are between jobs. Earlier this year, Fidelity revealed that 35 percent of its participants took out part or all of the money in their workplace retirement plans when leaving a job in 2013. Among those from ages 20 to 39, 41 percent took the money.

The big question is why, and the answer is that leading plan administrators like Fidelity and Vanguard don’t know for sure. They don’t do formal polls when people withdraw the money. In fact, it was obvious talking to people in the industry this week and reading the complaints from academics in the field that the lack of good data on these breaches is a real problem.

Fidelity does pick up some intelligence via its phone representatives and their conversations with customers. “Some people see a withdrawal as an opportunity to pay off debt,” said Jeanne Thompson, a Fidelity vice president. “They don’t see the balance as being big enough to matter.”

Or their long-term retirement savings matter less when the 401(k) balance is dwarfed by their current loans. Andrea Sease, who lives in Somerville, Mass., is about to start a new job as an analytical scientist for a pharmaceutical company. She was tempted to pull money from her old 401(k) to pay down her student loan debt, which is more than twice the size of her balance in the retirement account. “It almost seems like they encourage you,” she said, noting that the materials she received from her last retirement account administrator made it plain that pulling out the money was an option. “It’s an emotional thing when you look at your loan balance and ask yourself whether you really want to commit to 15 more years of paying it, and a large sum of 401(k) cash is just sitting there.” So far, she’s keeping her savings intact.

Another big reason that people pull their money: Their former employer makes them. The employers have the right to kick out former employees with small 401(k) balances, given the hassle of tracking small balances and the whereabouts of the people who leave them behind. According to Fidelity, among the plans that don’t have the kick-them-out rule, 35 percent of the people with less than $1,000 cashed out when they left a job. But at employers that do eject the low-balance account holders, 72 percent took the cash instead of rolling the money over into an individual retirement account.

This is unconscionable. Employers may meekly complain about the difficulty of finding the owners of orphan accounts, but it just isn’t that hard to track people down these days. Whatever the expense, they should bear it, given its contribution to the greater good. Let people leave their retirement money in their retirement accounts, for crying out loud.

Account holder ignorance may also contribute to the decision to withdraw money. “There is a complete lack of understanding of the tax implications,” said Shlomo Benartzi, a professor at the University of California, Los Angeles, and chief behavioral economist at Allianz Global Investors, who has done pioneering research on getting people to save more. “And given that we’re generally myopic, I don’t think people understand the long-term implications in terms of what it would cost in terms of retirement.”

In fact, young adults who spend their balance today will lose part of it to taxes and penalties and would have seen that balance increase many times over, as the chart accompanying this column shows.

But Mr. Fellowes of HelloWallet, interpreting the limited federal survey data that exists, says he believes that people raid their workplace retirement accounts most often because they have to. They are facing piles of unpaid bills or basic failures of day-to-day money management. Only 8 percent grab the money because of job loss and less than 6 percent do so for frivolous pursuits like vacations.

What can be done to change all of this? Mr. Benartzi thinks a personalized video might be even more effective than a boldly worded infographic showing people the money they stand to lose. He advises a company called Idomoo that has a clever one on its website aimed at people with pensions. If you want to see the damage that an early withdrawal could do, Wells Fargo has a tool on its site.

Fidelity has recently begun calling account holders to talk to them about cashing out, and it has found that people who get on the phone are a third as likely to remove some of their money as they are if they receive written communication. Here’s hoping more people will get such calls when they leave for another job.

Mr. Fellowes has a bigger idea. Given that so many people are pulling money from retirement savings accounts for non-retirement purposes, perhaps employers should make people put away money in an emergency savings account before letting them save in a retirement account. It’s a paternalistic solution, but some of the large employers he works with are considering it.

It’s surprising that regulators haven’t taken more notice of the breaches here. The numbers aren’t improving, but more and more people are relying on accounts like this as their primary source of retirement savings. “This is a problem that industry should solve,” said Mr. Benartzi, pointing to the unsustainability of tens of billions of dollars each year leaving retirement accounts for non-retirement purposes.

He says he thinks that there’s a chance that a company from outside the financial services industry could come in and solve the problem in an unexpected way before regulators take action. “If we don’t solve it, someone is going to eat our lunch, breakfast and dinner and drink our wine too.”

Forget a company from outside the financial services industry coming in to solve the problem. My solution is to bolster defined-benefit plans for all Americans, not just public sector workers, and have the money managed by well-governed public pension funds at a state level.

I emphasize well-governed because a big part of America's looming pension disaster is the mediocre governance which has contributed to poor performance at state pension funds. I edited my last comment on the Pyramis survey of global investors to include this comment:

The other subject I broached with  Pam is how the governance at the large Canadian public pension funds explains why they make most of their decisions internally. Public pension fund managers in Canada are better compensated than their global counterparts and they are supervised by independent investment boards that operate at arms-length from the government.

Of course, good governance isn't enough. States need to introduce sensible reforms which reflect the fact that people are living longer and they need to introduce some form of risk-sharing in these state pension plans.

As far as 401(k)s, RRSPs, and other forms of defined-contribution plans, you know my thoughts. They might help people save but the brutal truth is they're not pension plans with guaranteed benefits to help people retire in dignity and security. This is why despite their existence, America's new pension poverty keeps growing.

It's high time U.S. policymakers start tackling the domestic retirement (and jobs) crisis. It's time to move beyond public sector pension envy and go Dutch on pensions, introducing a major overhaul of the retirement system which will provide adequate retirement income for all Americans. There will be major resistance but the benefits of defined-benefit plans far outweigh the costs.

Moreover, the real cancer of pensions is that the status quo is a surefire path to destruction. As more and more companies exit defined-benefit pensions, they leave millions of workers fending for themselves in these crazy markets. It's a looming disaster which will severely impact the United States of Pension Poverty and unless policymakers address this issue, it will come back to haunt the country (in the form of increased social welfare costs and lower government revenues).

Below, Ray Martin of CBS News discusses why you shouldn't use your 401(k) as a piggy bank. And Robert Shiller, Case-Shiller Index co-founder and Yale University professor of economics, discusses the recent trend of slow home price gains and the surplus in housing.