Financial Fragility of Retirees May Be Increasing

Financial Fragility of Retirees May Be Increasing

Observing that retired people have long been seen as financially fragile because they have little ability to increase their income, a study recently published by the Center for Retirement Research at Boston College found that most current retirees appear able to absorb a financial shock without a substantial reduction in their standard of living, but that future retirees might turn out to be more financially fragile as they derive less of their income from Social Security and traditional pensions and more from financial savings in 401(k)s.

Published in February 2018, the brief, “Will the Financial Fragility of Retirees Increase?” was written by research fellow Steven A. Sass. The analysis was based on reviews of studies by the Social Security Administration’s Retirement Research Consortium and others that examine how the growing dependence on household savings affects the financial fragility of the elderly.

The shocks most likely to hit the elderly were identified in the study as a spike in medical expenses and losing a spouse. The brief cited research showing that in 2013-2015, more than 20% of families aged 65 or older had to make a medical payment of at least $400, more than 1% of their annual income, and more than two standard deviations above the family’s normal monthly mean expense on health care. In addition, the brief reported the results of a study showing that women widowed between 2002 and 2004 typically got 62% of the couple’s Social Security benefit and only half the couple’s employer pension benefit.

However, the analysis found that despite being exposed to such shocks, most retirees appear to be absorbing them without incurring much hardship. For example, the brief noted, a recent study found that only 10% of households aged 65 or older reported cutting back on needed food or medication over the previous two years. “Public and private health insurance, family contributions, and the savings of the elderly seem sufficient to allow most to avoid a significant reduction in living standards,” Sass said.

At the same time, Sass acknowledged that future retirees may be less able to absorb such shocks because of their high degree of reliance on savings from 401(k) and similar defined contribution plans. For future retirees, he observed, retirement income replacement rates are projected to decline due to inadequate savings and the limited income that safe withdrawal rates provide, thereby reducing the cushion between their incomes and fixed expenses.

Overall, he concluded, the increased dependence on financial assets is likely to increase the fragility of the nation’s retirement income system given inadequate retirement savings, the limited income households are likely to get from their savings, and their greater exposure to market downturns if they hold a significant portion of their savings in equities. Among the strategies households approaching retirement can use to increase their retirement income and reduce their fixed expenses, Sass observed, are to work longer, annuitize wealth, take out a reverse mortgage, and downsize. “Whether the prospect of increased financial fragility leads them to change their behavior remains to be seen,” he said.

From Benefit Trends Newsletter, Volume 61, Issue 5

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. This newsletter is written and published by Liberty Publishing, Inc., Beverly, MA. Copyright © 2018 Liberty Publishing, Inc. All rights reserved.

Americans Continue To Show Inadequate Levels of Financial Literacy

Americans Continue To Show Inadequate Levels of Financial Literacy

A large share of Americans lack the knowledge associated with making sound financial decisions, and financial literacy levels are especially low in the area of comprehending risk, according to the findings of an annual survey conducted by the TIAA Institute and the Global Financial Literacy Excellence Center (GFLEC) at the George Washington University School of Business.

This second wave of the “P-Fin Index” survey was conducted online in January 2018 with a nationally representative sample of 1,012 U.S. adults aged 18 or older. The results of the survey were presented in a report released on April 4. To compile the index, the researchers asked respondents 28 core questions, with three or four questions devoted to each of the eight areas of functional financial knowledge covered in the survey: earning, consuming, saving, investing, borrowing/managing debt, insuring, comprehending risk, and go-to information sources.

On average, the respondents answered only 50% of the 28 survey questions correctly. While 16% of the respondents demonstrated a relatively high level of personal finance knowledge and understanding by answering more than 75% of the index questions correctly, 21% showed a relatively low level of knowledge by answering 25% or fewer of the questions correctly.

The results further showed that financial literacy is the lowest in the area of comprehending risk, as, on average, just 35% of the questions on risk were answered correctly. According to the report’s authors, this finding is in line with other research identifying risk-related concepts as the most difficult for individuals to grasp, and is consistent with the findings from the 2017 P-Fin Index.

However, the survey also revealed that personal finance knowledge levels were relatively high on the topics of borrowing and debt management: on average, 60% of the questions on those subjects were answered correctly. Researchers speculated that for many individuals, knowledge and understanding of debt-related topics may emerge from confronting accumulated debt across the life cycle, often starting with student loans.

Moreover, the survey showed that financial literacy levels varied across demographic groups. Financial literacy was found to be significantly higher among men than women, as 21% of the male respondents, but just 12% of the female respondents, answered 75% of the survey questions correctly. Older respondents were also shown to have more financial knowledge than younger respondents: 7% of the respondents aged 18-28, but 22% of the respondents aged 60+, answered 75% of the survey questions correctly. Financial knowledge was also found to increase with income, as 30% of the respondents with an annual income of $100,000+, compared with 15% of respondents with an annual income of $50,000-$99,999, answered 75% of the survey questions correctly.

Not surprisingly, financial knowledge was shown to increase with education, with 33% of respondents with a college degree answering 75% of the survey questions correctly, compared to 6% with a high school degree only. However, the results indicated that respondents who reported that they have participated in a financial education class or program answered more of the questions correctly on average than those who had not: 24% of those who had received financial education answered 75% of the survey questions correctly, versus 13% of those who had not.

The survey also looked at how the financial knowledge levels of the respondents correlated with their financial outcomes. The findings indicated that of those respondents who said they certainly or probably could not come up with $2,000 if an unexpected need arose within the next month, 49% answered less than 26% of the survey questions correctly, while just 8% answered 75% of the survey questions correctly. Moreover, of the non-retirees who reported that they have tried to figure out how much they need to save for retirement, only 22% answered less than 26% of the survey questions correctly, while 65% answered 75% of the survey questions correctly.

From Benefit Trends Newsletter, Volume 61, Issue 6

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. This newsletter is written and published by Liberty Publishing, Inc., Beverly, MA. Copyright © 2018 Liberty Publishing, Inc. All rights reserved.

Monitoring Retirement Fund Menus Can Improve Performance

Monitoring Retirement Fund Menus Can Improve Performance

A

The monitoring of defined contribution (DC) retirement plan menus by plan sponsors in order to identify underperforming funds and replace them with more attractive funds can provide value to plan participants, according to new research published by Morningstar Investment Management.

In a white paper entitled “Change Is Good,” released on April 15, researchers observed that when retirement plan sponsors evaluate the quality of mutual fund investments offered to plan participants, they may occasionally decide to replace one fund with another. The authors noted that previous studies of plan sponsor replacement decisions have suggested that the decision to replace funds is frequently motivated by historical performance data relative to a benchmark that does not predict future performance. They pointed out, however, that even though this monitoring activity is an important function of investment fiduciaries, little is currently known about whether adding and removing mutual funds from a plan menu is valuable for participants.

To investigate the monitoring value provided by plan sponsors, researchers analyzed a unique longitudinal dataset of plan menus from January 2010 to November 2018 that includes 3,478 fund replacements across 678 DC plans. For each plan, the analysis compared the menus for two different periods, employing a matching criterion to determine when a fund was replaced. A fund was deemed to have been replaced if it did not exist in the later menu, and a new fund was added in that later menu that was of the same investment style, such as bond or equity.

The results indicated that, on average, the replacement funds had better historical performance and lower expense ratios, as well as more favorable comprehensive metrics based on star and quantitative ratings, than the funds they replaced. The analysis also showed that the largest performance difference between the replacement and replaced funds was for the five-year historical returns. According to researchers, this finding suggests that the five-year historical reference period is the one that carries the most weight among plan sponsors.

In addition, the analysis revealed that the future performance of the replacement fund was better than the fund being replaced at both the future one-year and three-year time periods. The authors emphasized that this outperformance persisted even after controlling for expense ratios, momentum, style exposures, and other metrics commonly used by plan sponsors to evaluate funds, such as the star rating and the quantitative rating. “Our findings suggest that monitoring plan menus can have a positive impact on performance,” the authors concluded.

Researchers cautioned, however, that while they were able to analyze certain factors related to the outperformance of replacement funds—such as the type of fund, lower expense ratios, higher recent historical performance, and various ratings—the primary drivers of the outperformance remain unclear, because the dataset provided no information about the decision-making process plan sponsors use to determine whether a fund should be replaced, or about other salient factors, like the relative importance of the fund being replaced or how long the fund has been in the plan. Thus, the study’s authors added, although the analysis suggests that monitoring fund menus can improve performance, “more research on why this effect occurs is warranted.”

From Benefit Trends Newsletter, Volume 62, Issue 6

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. This newsletter is written and published by Liberty Publishing, Inc., Beverly, MA. Copyright © 2019 Liberty Publishing, Inc. All rights reserved.

New Retirement Savings Plans Are Needed To Ensure Financial Security

New Retirement Savings Plans Are Needed To Ensure Financial Security

While the vast majority of Americans who save for retirement do so through a 401(k) or similar plan provided by their employer, additional types of saving plans may be needed to help the millions of workers who are not adequately saving in workplace plans build a financially secure retirement, according to an article published on March 14 by The Pew Charitable Trusts.

The article, “3 Ways People May Save for Retirement in the Future,” was written by John Scott, director of Pew’s retirement savings project. Scott observed that “we may have reached the limit of what our employer-sponsored system can do to support a secure retirement,” as currently only about half of private sector businesses offer retirement benefits, and even though around 140 million people participate in retirement plans, the proportion of the employed workforce covered by these plans has never exceeded 70%.

Scott argued that while Congress could increase incentives to encourage more employers to sponsor plans, he noted that previous research has shown that small employers are often reluctant to offer retirement benefits because of the plan startup costs and administrative burdens, and that it is not clear that offering them a new tax break would overcome these concerns.

Given that is unlikely that many more employers will start voluntarily offering retirement benefits or that many more employees will start saving on their own, Scott said, new approaches that build on the elements that are known to work in the current system should be considered. Specifically, he recommended the development of a low-cost, portable, individual-based system, managed by a third party, that allows workers to automatically contribute to their own retirement account with each paycheck, and that gives employers the option to add to those accounts through a matching contribution.

While acknowledging that no current initiative fully captures these ideas, Scott noted that recent actions at the state and Federal levels point to the outlines of a system that could cover more workers, without relying solely on individual employers to sponsor their own retirement plan.

Among these initiatives, Scott said, are state-level retirement savings programs for employees without a workplace plan. He reported that California, Connecticut, Illinois, Maryland, and Oregon are implementing programs in which workers are automatically enrolled at a default rate of contribution, typically around 5% of pay, and with the ability to opt out at any time. In these programs, employers facilitate worker contributions through their payroll systems, but otherwise are not involved.

Scott also mentioned that a new approach may come from Congress, as the Retirement Security Act, which would allow any group of employers to share plan costs in group plans known as multiple employer plans, or MEPs, was recently introduced in the Senate. He observed that these plans could be especially helpful to smaller employers wary of the administrative costs of offering a stand-alone plan.

Finally, Scott pointed out that there are more than 10 million independent or contingent workers in the U.S. who have very low rates of retirement benefit coverage. To help these workers save in a changing economy, he recommended the development of retirement savings models that expand coverage options, possibly using new entities affiliated with associations, unions, or industry sectors

From Benefit Trends Newsletter, Volume 62, Issue 4

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. This newsletter is written and published by Liberty Publishing, Inc., Beverly, MA. Copyright © 2019 Liberty Publishing, Inc. All rights reserved.

Personalized Guidance for Retirement Plan Participants

Personalized Guidance for Retirement Plan Participants

Many Americans remain cautious about their investment decisions in the wake of the financial crisis, and members of the millennial generation in particular may need personalized guidance from employers in making retirement planning decisions, according to a study on retirement plan participation recently released by Broadridge Financial Solutions.

The findings of the report, “Retirement 2020: Capitalizing on trends to maximize participation, boost efficiency and accelerate outcomes,” are based in part on a survey of 1,003 U.S. respondents aged 22-59 that was conducted July 10-16, 2018. The survey findings indicated that whereas 72% of baby boomer respondents have confidence in a workplace retirement plan, only 58% of millennial respondents feel the same way.

The report emphasized that the millennials surveyed expressed investment preferences that run counter to conventional financial advice. For example, researchers noted, the millennial respondents said they are equally confident investing in a private business as they are in the global stock market, and many prefer traditional low-yield savings accounts to employer-sponsored plans. The survey results showed that among all respondents, just 24% reported seeking financial advice from a professional advisor, while 27% said they seek financial advice from family and friends.

The report cited a previous study showing that the main reasons why workers of all ages decrease their retirement plan contributions are needing to pay down debt/bills (27%), needing money for day-to-day expenses (25%), facing a major life event (18%), and having less income (16%). The report noted that debt is a big problem for millennials in particular, as one-half of millennials with a bachelor’s degree, and one-quarter of all millennials, hold student debt; and the median loan balance for millennials with a bachelor’s degree is $25,000.

Researchers observed that the financial crash in 2008 hit investors hard, both psychologically and financially, as the survey showed that a significant number of investors now distrust Wall Street and have an inflated view of market risk: nearly 25% of all respondents said they think it is likely that they will face another market crash like the one that occurred in 2008, and 20% said they believe the stock market is a rigged game they cannot win.

The report also noted that because workers often fail to seek professional advice, many are not aware of, and are thus are unable to evaluate, the available investment options. For example, researchers observed, a recent survey showed that more than 40% of investors have no familiarity with health savings accounts (HSAs) and their triple-tax advantage, and only 30% make regular contributions to a HSA. This survey also found that of those respondents, 65% said they use their HSA funds to cover current health care needs, while only 8% indicated that they use their HSA to save for the future.

Given these challenges, the report recommended that retirement plan sponsors take advantage of technology tools that will allow them to engage plan participants by creating personalized experiences, while streamlining operations and lowering costs. Researchers advised plan sponsors to consider using data-driven content creation platforms to facilitate workflow automation, and cloud-based tools to enable multiple compositors to collaborate from any location.

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. This newsletter is written and published by Liberty Publishing, Inc., Beverly, MA. Copyright © 2019 Liberty Publishing, Inc. All rights reserved.