Data Show That Automatic Enrollment in 401(k) Plans Has Led to Higher Match Rates from Large Plan Sponsors

New research from the nonpartisan Employee Benefit Research Institute (EBRI) finds that employers adopting automatic enrollment in their 401(k) plans have also generally increased the “employer match” to participant’s accounts—in some cases, by a significant amount.

The EBRI research is the first using actual plan information on both actual auto enrollment and actual match rate information both before and after adoption of auto enrollment. The new EBRI analysis uses plan-specific data for large employers from Hewitt Associates, and finds that employers instituted more generous contribution rates after adopting automatic enrollment, and did so when measured by several different standards.

This release provides preliminary results from the research. Full results of the simulated impact of the changes on worker’s retirement wealth will be available next month in the February 2010 EBRI Issue Brief, and will be posted online at www.ebri.org

“Our recent analysis of plan-specific data shows that, at least among large 401(k) plans, plan sponsors actually increased the generosity of their contribution rates,” said Jack VanDerhei, EBRI research director and author of the analysis. He noted that EBRI has published three separate simulation studies since 2005 showing the potential importance of automatic enrollment for future retirement account accumulation, even under the assumption that employer contribution rates would not change when the 401(k) plan was modified.

“The modifications to 401(k) plans made by sponsors in response to the Pension Protection Act of 2006 will be very important for retirement income adequacy in this country. Adding these more realistic assumptions to our simulation model will allow us to more accurately demonstrate the relative improvements in retirement accounts, especially for young and low-income workers,” he added.

The EBRI results contradict an earlier publication of the Center for Retirement Research (CRR) at Boston College and by the Urban Institute, which concluded that among a sample of large 401(k) plans, match rates are lower among firms with automatic enrollment than among those without automatic enrollment after controlling for firm characteristics.

However, there were two major limitations with the CRR/Urban published analysis:

• The study was based on U.S. Department of Labor Form 5500 data that does not include specific information on 401(k) match rates. Instead, the authors constructed an estimate for the match rate as the ratio of employer-to-employee contributions for each 401(k) plan.

• They merged the Form 5500 data with information on automatic enrollment from the Pensions &Investments database of the top 1,000 pension funds, which includes a flag indicating whether plan administrators reported offering automatic enrollment in their defined contribution (401(k)-type) plans.

However, this database does not report the year that the automatic enrollment provision was adopted, so there is no way to tell from this data source how long auto-enrollment had been implemented in a planThe authors of the CRR/Urban published study present a regression analysis on this database and produced a finding that: suggests a negative relationship between automatic enrollment and match rates and is statistically significant at the firm-level. In particular, match rates are about 7 percentage points lower among firms with automatic enrollment than among those without automatic enrollment, after controlling for firm characteristics.

While the authors correctly point out that although the regressions suggest a relationship between automatic enrollment and match rates, they do not necessarily imply that auto enrollment causes lower match rates; however, this crucial qualification has been generally ignored in recent press accounts of the study.

Earlier EBRI Research

The CRR/Urban published study conflicts with previous EBRI research published in 2007,2 which surveyed Mercer Human Resource Consulting defined benefit sponsors to gauge their recent activity and planned modifications to their defined benefit (pension) and defined contribution (401(k)-type) plans. The EBRI survey also was able to determine what, if any, increases in employer contributions to defined contribution plans were provided in conjunction with reductions to their defined benefit plans.

Although the association between the adoption of automatic enrollment and employer contributions to 401(k) plans was not the focus of the EBRI study, one-third of the defined benefit sponsors surveyed indicated that they had already increased or planned to increase their employer match to a defined contribution plan, and 20.9 percent indicated that that they had already increased or planned to increase their nonmatching employer contributions to a defined contribution plan. There was some overlap between the two groups, but overall, 42.5 percent of the defined benefit sponsors surveyed indicated that they had already increased or planned to increase their employer match and/or nonmatching employer contribution to a defined contribution plan. This was particularly true of defined benefit sponsors that had either closed a defined benefit plan to new hires or frozen the plan to all members in the last two years or planned to do so in the next two years.

Moreover, the 2007 EBRI study found an extremely large correlation between the adoption of automatic enrollment for a 401(k) plan and the freezing or closing of the defined benefit plan.4 Of those defined benefit sponsors that had closed their defined benefit plans in the last two years, 80.5 percent had either already adopted or were currently considering adopting automatic enrollment features for their 401(k) plans. Of those defined benefit sponsors that had closed their defined benefit plans in the last two years, 76.1 percent had either already adopted or were currently considering adopting automatic enrollment features for their 401(k) plans.

EBRI’s New Research and Methodology

The new EBRI study analyzes in detail 225 large defined contribution plans6 that had adopted automatic enrollment 401(k) plans by 2009, but did not have them in 2005 (the last observation that was not influenced by PPA). The following information was coded for each plan:

• The default contribution rate for the automatic enrollment (AE) plan in 2009.

• The entire match rate contribution formulae for both years.

• All nonelective contributions paid to the defined contribution participants by the employer.

Whether plan sponsors were more or less generous after adopting AE was measured with three different metrics:

1. The average 2009 first-tier match rate was 87.78 percent, while the average 2005 first-tier match rate was 81.26 percent. The difference of 6.52 percentage points suggests that, to the extent that this sample is representative of the universe of large 401(k) sponsors, those sponsors adopting AE were more generous to the 401(k) participants when measured by this variable after automatic enrollment was implemented than they were before.

2. The average effective match rate8 for 2009 was 4.32 percent of compensation, but only 4.00 percent of compensation in 2005. The increase of 0.32 percentage points again suggests that large 401(k) sponsors adopting AE were more generous to the 401(k) participants when measured by this variable after the adoption of automatic enrollment than they were before3. The average total employer contribution rate9 for 2009 was 6.35 percent of compensation and 5.46 percent of compensation in 2005. The increase of 0.89 percentage points once more suggests that those large 401(k) sponsors adopting AE were more generous to the 401(k) participants when measured by this variable than before.

Influence of Defined Benefit Plan Activity

This information was then combined with the defined benefit information for the same sponsor in an attempt to analyze whether EBRI’s 2007 findings of the association between defined benefit freezing/closing and enhanced 401(k) contributions were corroborated. The average improvements for all three metrics were much higher for sponsors that had frozen/closed their defined benefit plans than for the overall average. For example, the change in the total employer contribution rate for all frozen plans was 1.64 percent of compensation versus 0.89 percent for the overall average. Employers that had closed their defined benefit plans to new employees had an even larger average improvement: 2.82 percent of compensation.

The defined benefit sponsors that had frozen or closed their plans were then split into those that had done so prior to adopting AE and those that had changed their defined benefit plans between 2005 and 2009. If the hypothesis that the 401(k) improvements were a result, at least partially, of a simultaneous quid pro quo for the decreased accruals in the defined benefit plan, one would expect that the earlier improvement would be smaller than those that took place approximately at the time of the conversion to AE. In fact, this is exactly what is found for all six comparisons. For example, the average total employer contribution improvement for firms that had frozen their plans prior to 2005 was 0.69 percent of compensation, compared with 2.45 percent for those that froze between 2005 and 2009. Similar evidence is found for those that closed their pension plans to new employees: The average improvement in total employer 401(k) contribution was only 0.56 percent of compensation for those that closed prior to 2005, but 3.34 percent for those that closed the plan between 2005 and 2009.

-Employee Benefit Research Institute

The Combo Annuity/LTC Driver

Americans have just survived a devastating period of asset depletion and shrinkage. For many retirees and near-retirees, the ability to pay for the costs of long term care and other retirement costs has been severely compromised.

What options are available for them? Are the costs affordable?

For many retirees and near-retirees, annuities have been the investments of choice when the decision to park investment dollars not needed for current expenses has been made. No taxes to pay now--that is a great feature. With variable insurance products, they can reallocate funds among attractive funds without a tax consequence. That is attractive too.

Those are just two of several factors accounting for the annuity’s popularity.

Yet, except for the very wealthy, investment dollars during the retirement years, including dollars inside of annuities, do need to be viewed as a source of funds when expenses are incurred, and especially when expenses increase significantly over what had been normal levels. Market researchers confirm that one of the major concerns people have is how to cover expenses if a family member, such as a spouse, needs to receive LTC services.

The insurance industry has largely focused its attempts to address such LTC needs via the stand-alone LTC policy; this generally attempts to cover all or most of the LTC costs an individual will incur.

Let’s be clear on what that means. It means that, in event of chronic illness, the insured will not have to pay any out-of-pocket expenses, except possibly to cover costs for an initial care period of typically 90 days. Said another way, the insured would only modestly need to cover LTC expenses with funds from sources other than the LTC policy.

There is much to like to like about stand-alone LTC policies. Since they in effect prepay one’s LTC costs through coverage paid for by premiums, the insured doesn’t have to draw on personal assets should care for chronic illness be needed.

This benefit comes at a significant premium cost, however. What does the target market of retirees and near retirees say about this kind of policy? They have clearly spoken over recent years with their wallets, so to speak. That is, sales of individual stand-alone LTC policies have plummeted over the past several years, according to sales figures from research organizations such as LIMRA, Windsor, Conn.

Given that assets for many have fallen greatly in the past two years, one finds it hard to imagine that such products will satisfactorily address the LTC need in the future.

Now 2010 has arrived, however. With it comes a change to federal tax law that allows extremely favorable treatment of so-called combination annuities. These annuities combine a LTC rider (that is tax-qualified under prescribed standards of federal law) with an annuity.

Under most of these designs, the insured’s annuity account value is paid out first, to be followed by a stream of LTC payments guaranteed by the insurer. Just as with stand-alone LTC designs, payments are subject to a maximum monthly amount and payable for similar benefit periods.

Under the combination annuity, the insured covers a material percentage, varying from 20% to 33%, of the LTC benefit via the annuity values. Under the new tax law, however, such payments are exempt from income tax.

In other words, the combination annuity provides a mechanism for the accumulated earnings of an annuity to be paid out income tax free. That of course is not otherwise possible with an annuity.

A significant cost reduction results from this design, somewhere on the order of 70% compared to stand-alone products. For example, at age 65, for a comparable set of benefits provided by a typical insurance company, a stand-alone LTC policy might cost $2,500 a year while the combination annuity’s LTC coverage would probably cost $700 a year.

Furthermore, should the insured die without becoming chronically ill, the heirs will receive the valuable and sizable annuity contract’s proceeds. Contrast this to the standalone policy where, if the insured dies, no benefits are payable. The stand-alone LTC creates a use-it-or-lose-it situation. If there’s no claim, there’s no payment.

The combination annuity thus provides an eminently affordable tax-favored solution to covering costly later-in-life LTC costs. Consequently, it can provide major demand-driven sales to an insurer’s and advisor’s annuity portfolio.

-National Underwriter Company

Keeping Your 401(k) on Track

Setting up a reasonable and workable investment plan for your retirement is one of the most important decisions you can make.

But once that decision is made, your work is only half done. An equally important task is to monitor your selections and the portfolio as a whole to make sure your original plan is still on track.

What does monitoring consist of?

Most 401(k) plans are composed of mutual funds, where daily scrutiny isn't necessary or even desirable. Quarterly check-ups—a review every three months or so—is more in order.

First, you should review the performance of your individual fund holdings to determine how well the professional expertise you have hired is doing. This includes examining the performance of each fund against its peers (other funds with similar objectives) and an appropriate index. For example, if you are invested in large-company stocks, a good comparison index would be the Standard & Poor's 500.

If your funds' performance figures are good relative to the benchmarks, no problem.

However, if the figures are unsatisfactory, you need to take a closer look at the fund's manager to try to determine why the performance is off. If the unsatisfactory performance is likely to be short-term—for instance, perhaps the manager's investment style is temporarily out of favor—you should hold on to the fund and give the manager a chance to improve over time. However, if the underperformance is long-term in nature—for instance, you have been monitoring the fund for a year and the poor performance relative to similar funds is persistent—you may want to sell the fund and find a better replacement.

Second, you should take a look at the quarterly and annual reports that funds send to all shareholders. These periodic reports detail the fund holdings, and they often discuss fund performance as well as any changes that fund management may be making in light of their investment outlook. These reports should be examined to make sure that the fund continues to follow the approach that you hired it to do.

In addition to monitoring the individual components of your portfolio, you need to step back and take a look at your portfolio as a whole. Once a year, you should compare your current asset allocation with your desired asset allocation and rebalance if things are out of whack. Determining your current asset allocation is relatively easy—you simply total up your investments in any particular asset category and divide by your total investment portfolio.

If your allocation starts to stray significantly—by five percentage points or more—from your desired plan, you need to rebalance to bring your holdings back in line with your original plan.

Monitoring your portfolio of mutual funds requires only a little bit of time and a small amount of effort to ensure that your plan is on track. Ignore your portfolio—and it may just go away.

© 2010 AAII Journal

Older Americans Staying Longer in the Work Force

The labor-force participation rate is increasing for older Americans (those age 55 and older) as older workers are faced with higher health costs and economic losses, according to a study published today by the nonpartisan Employee Benefit Research Institute (EBRI).

For those ages 55-64 (the "near elderly"), the increase is being driven almost exclusively by the increase of women in the work force; the male participation rate is flat to declining. However, among those age 65 and older (the elderly), labor-force participation is increasing for both male and females, says the study in the February 2010 available at www.ebri.org

As the study suggests, workers increasingly are facing more responsibility in paying for their retirement expenses:

Private-sector workers who have access to an employment-based retirement plan most commonly have a defined contribution plan (typically a 401(k) plan, financed at least partially with workers' own contributions), and retiree health insurance is becoming increasingly scarce. Even for those who do have retiree health insurance, caps on what the employer will pay annually for the coverage are being reached and/or surpassed.

Consequently, the study says, workers today have greater incentives to stay in the work force, such as the ability (and in some cases the need) to continue to accumulate assets in defined contribution plans and to have access to employment-based health insurance coverage, instead of having to tap into their savings to pay for their expenses.

The study, based on U.S. Census Bureau data, includes these additional points:

• The percentage of civilian noninstitutionalized Americans age 55 or older who were in the labor force declined from 34.6 percent 1975 to 29.4 percent in 1993. However, since 1993, the labor-force participation rate has steadily increased, reaching 39.4 percent in 2008-the highest level over the 1975-2008 period.

• Education is a strong factor in an individual's participation in the labor force at older ages: Individuals with higher levels of education are significantly more likely to be in the labor force than those with the lower levels of education.

• The upward trend among the working near elderly and elderly is not surprising and is likely to continue because of workers' need for access to employment-based health insurance and for more earning years to accumulate assets in defined contribution (401(k)-type) plans-especially after the 2008 downturn in the stock market and economy.

• While some older Americans have a greater need to work to help make their retirement assets last longer or to continue to build up assets, monetary incentives are not the only motivating factor. There also is an increased desire among Americans to work longer, particularly among those with more education, for whom more meaningful jobs may be available that can be done well into older ages.

EBRI is a private, nonprofit research institute based in Washington, DC, that focuses on health, savings, retirement, and economic security issues. EBRI does not lobby and does not take policy positions. www.ebri.org

-Employee Benefit Research Institute

The 2010 Retirement Confidence Survey: Confidence Stabilizing, But Preparations Continue to Erode

The 2010 Retirement Confidence Survey-the 20th annual wave of this survey-finds that the record-low confidence levels measured during the past two years of economic decline appear to have bottomed out. The percentage of workers very confident about having enough money for a comfortable retirement has stabilized at 16 percent, which is statistically equivalent to the 20-year low of 13 percent measured in 2009 (Fig. 1, pg. 7). Retiree confidence about having a financially secure retirement has also stabilized, with 19 percent saying now they are very confident (statistically equivalent to the 20 percent measured in 2009) (Fig. 2, pg. 8).

Worker confidence about paying for basic expenses in retirement has rebounded slightly, with 29 percent now saying they are very confident about having enough money to pay for basic expenses during retirement (up from 25 percent in 2009, but still down from 34 percent in 2008) (Fig. 3, pg. 9).

PREPARATIONS STILL ERODING: Fewer workers report that they and/or their spouse have saved for retirement (69 percent, down from 75 percent in 2009 but statistically equivalent to 72 percent in 2008) (Fig. 11, page 14). Moreover, fewer workers say that they and/or their spouse are currently saving for retirement (60 percent, down from 65 percent in 2009 but statistically equivalent to percentages measured in other years) (Fig. 13, pg. 15).

MORE PEOPLE HAVE NO SAVINGS AT ALL: An increased percentage of workers report they have virtually no savings and investments. Among RCS workers providing this type of information, 27 percent say they have less than $1,000 in savings (up from 20 percent in 2009). In total, more than half of workers (54 percent) report that the total value of their household's savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000 (Fig. 14, pg. 16).

CLUELESS ABOUT SAVINGS GOALS: Many workers continue to be unaware of how much they need to save for retirement. Less than half of workers (46 percent) report they and/or their spouse have tried to calculate how much money they will need to have saved for a comfortable retirement by the time they retire (Fig. 23, pg. 22).

AMERICANS EXPECTING TO WORK LONGER: Although the age at which workers report they expect to retire shows little change from 2009, a longer-term look finds significant change. In particular, the percentage of workers who expect to retire after age 65 has increased over time, from 11 percent in 1991 to 14 percent in 1995, 19 percent in 2000, 24 percent in 2005, and 33 percent in 2010 (Fig. 29, pg. 28).

INSTITUTIONAL CONFIDENCE LAGGING: Americans continue to lack confidence in institutions. Just 19 percent of workers and 22 percent of retirees report they are very confident about banks, while 12 percent of workers and 13 per-cent of retirees say they are very confident about insurance companies (Fig. 19, pg. 19). They are most likely to express confidence in private employers (23 percent of workers and 27 percent of retirees very confident) and least likely to feel confidence in the federal government (11 percent of workers and 8 percent of retirees) (Fig. 20, pg. 20).

Download Issue Brief PDF

-Employee Benefit Research Institute

401(k) Plan Pluses and Minuses: How Does It Add Up?

Retirement is a long way down the road for many employees-an event that is barely visible on the distant financial horizon. For these individuals, retirement plans may not seem particularly important.

However, the decision over whether you should contribute to a 401(k) plan can have a big impact on your long-term financial future.

These types of retirement plans offer significant advantages to those who choose to participate in them. On the other hand, there are certain disadvantages to these types of savings plans. Your contribution decision should be based on adding up the pluses and minuses, and seeing which comes out on top.

The Positives

Contributions to a 401(k) plan by the employee are made on a pretax basis (although some plans allow for additional contributions on an aftertax basis). Pretax contributions are those that are taken from your salary before income taxes for the year are determined. The result is a lower tax bill in the year that contributions are made.

This doesn't mean that the contributions are tax-free. Instead, you pay taxes when the money is withdrawn from the plan, usually at retirement. In other words, taxes on your contributions and on the earnings (interest, dividends and capital gains) are deferred. However, the money builds up more quickly than would be the case if you invested aftertax money and paid taxes each year on the earnings.

The tax-deferral aspect also gives you flexibility to determine the best time to pay the tax, with the possibility that when you eventually do pay taxes, it will be at a lower rate.

The other major advantage of many 401(k) plans is employer-matched contributions. For instance, an employer may contribute $0.50 for every $1 that you contribute to the plan. This is an obvious advantage-you are earning 50% on your contribution before you have even invested it anywhere.

This advantage depends in part on any cap the employer may have on the match. And the advantage depends on the employer's vesting requirements. Vesting is the right an employee gradually acquires to receive employer-contributed benefits, and is based on the length of time employed. The faster vesting requirements can be met, the more advantageous the employer match, unless you plan to stay with the company (or have been with the company) for the full vesting time period.

There are several other important advantages offered by 401(k) plans:

• Flexibility: You can determine the amount you are able to contribute, and you make the decisions as to where your money is invested among the available investment choices.
• Portability: If you should leave your employer, any contributions you have made to your plan, as well as their earnings, are yours; vested contributions made to your plan by your employer are also yours.
• Periodic investing made easy: An automatic deduction from your paycheck each month allows you to gradually build up your investment without having to make big financial sacrifices.

The Negatives

These advantages are strong arguments in favor of participating in your company's 401(k) plan. But you do need to be aware of the disadvantages.

Limited Access

If you contribute to a 401(k) plan, you will have limited access to your money without costly penalties for a long period of time-until you leave your employer or reach the age of 59½.

If you remain with your employer, access to your 401(k) money isn't entirely restricted, just limited: Some plans allow participants to borrow funds from their 401(k) plan assets, usually at an intermediate-term market rate. However, loans that are not repaid within the restricted time period are considered distributions, with taxes and a 10% early withdrawal penalty due. In addition, some companies will permit withdrawals from a 401(k) plan due to severe financial hardships. However, anyone requesting part or all of their dollars under this clause must show their employers that they have exhausted all other non-retirement financial resources, and the withdrawals are also subject to the 10% early withdrawal penalty and, of course, income taxes.

These features are comforting for short-term emergencies, but you will have lost the primary advantage of the plan. To take full advantage of your employer's 401(k) plan, you should consider money invested in the plan to be long-term savings.

If you leave the company and you have not reached 59½, you can take a lump-sum distribution of your 401(k) plan money to spend as you wish, but only by paying a 10% early withdrawal penalty and, of course, taxes. You can avoid the penalty only by rolling your money over into an IRA or a new employer's qualified plan.

Limited Choices

A second possible drawback is that you are limited to the investment choices provided by the employer. This may or may not be a negative. Most employers provide at least one form of investment in three broad asset categories-cash, bonds, and stocks. And many employers provide a number of choices within those categories. But if you are uncomfortable with or strongly dislike your employer's selection(s), you may want to consider an alternative savings vehicle.

The Decision = Adding It All Up

For most individuals, the positives of contributing to your employer's 401(k) plan will outweigh the negatives. But make sure you do the math to make sure it all adds up.

© 2010 AAII Journal

 

Don’t Let an Underground Storage Tank Destroy Your Savings Account

Does your home have an underground oil storage tank? Perhaps it holds your heating oil. Maybe you don't even use it any more. Whether you use it now or not, a tank that leaks oil into the environment can cost you big time, particularly if it affects the water table. If you have an underground tank, check with us to see what coverage your homeowners policy provides for leaks. You need coverage for both cleanup costs and liability to other parties. Without a special endorsement, your policy probably doesn't cover the cleanup costs. In addition, the following are some important ways to reduce the chance of loss arising from fuel leaks, a loss that could cost tens of thousands of dollars without proper insurance coverage.

• If you are not sure whether you have an underground storage tank on your property, check with your realtor or your local environmental government agency. These agencies often have information on registered oil tanks. Also, if your neighbors have underground storage tanks, chances are that your home has one, too.
• If your heating oil tank is still in use, watch for signs that it may be leaking, such as your furnace using more fuel than normal based on the weather and temperature.
• If your heating oil tank is over 10 years old, you should have it periodically inspected for leakage. Soil sampling can often be performed for this task rather than extensive digging. Above ground oil tanks should be visually inspected on a regular basis by a licensed contractor.
• If you suspect a leak, know that you are responsible for the cleanup as well as the disposal and replacement of this tank. The longer you wait, the more contaminants will be released and the more the cleanup will cost. Hire a licensed contractor or environmental consultant concerning the best way to proceed. The typical recommendation involves the removal of the tank. Also, get certificates of insurance verifying the contractor's workers compensation and general liability insurance coverage before any major work begins.
• If soil or groundwater contamination is found during excavation, remember that you are responsible for reporting this to the local environmental government agency.

Get more personal lines insurance and risk management tips and ideas from IRMI.

Copyright, 2008. International Risk Management Institute, Inc.

International Risk Management Institute

Longevity Risk Invites Annuity Solutions

"Nothing is certain but death and taxes," Benjamin Franklin once said. That was in the 18th century. The 21st century adaptation might be, "nothing is certain but longevity and taxes."

Longevity is a known financial risk and its importance will grow year after year, right along with consumer need for income annuities.

But longevity is not well understood. Too often retirement planning ends with addressing income needs only through average life expectancy, which is about age 85 for male annuitants and age 87 for females who currently are age 65.

Planning only through life expectancy is like pretending that longevity risk does not exist. In fact, longevity risk begins at life expectancy-the risk that someone will live longer than average. There is significant and growing probability of living to age 90, 95, 100 or more.

This means that, when planning for the future, individuals need to recognize the possibility of a very long life and the uncertainty of how long that might be.

Life expectancy for annuitants is actually higher than the ages commonly cited. Two important factors contribute to this. First, annuitants are healthier than the general population because annuities are generally purchased by individuals with above-average health who figure they will gain the most advantage from an annuity purchase. Also, mortality improves each year, adding approximately 1.5 years of life expectancy; this is usually overlooked.

Furthermore, longevity improvement will be magnified if significant life-extending medical breakthroughs occur.

Annuities can address longevity risks in all markets, but high income retirees should not be overlooked. Annuity purchasers with high annual payouts show mortality as much as one-third lower than purchasers of small annuities, according to research published by the Society of Actuaries. At age 65, each 10% reduction in mortality indicates an approximately one-year increase in life expectancy. This suggests that the planning horizon should be approximately three years longer for higher income individuals, who are above-average candidates for annuity solutions because they are positioned to benefit the most.

By comparison, an individual of upper-middle to high net worth who has planned for retirement based on current population data has likely underestimated life expectancy by 4 to 5 years-an underestimate of 20% to 25%.

Retirees often respond to longevity risk in one of two ways. The first is to live frugally in retirement, spending only income and gains and not touching principal. The second is to live the desired lifestyle in the early years of retirement with the expectation of slowing down as they get older so they won't need as much income. Both are forms of self-insurance.

But, just as it is difficult for an individual to self-insure one's own mortality risk (hence the need for life insurance), it also is difficult for a retiree to self-insure his or her retirement.

What is the best way to manage longevity risk for clients? Of course, Social Security is a start. Beyond that, the traditional approach has been an annuity with a portion of the benefits payable only while the annuitant lives, such as 10 years certain and life; this is still a good solution.

A more recent solution is a deferred start income annuity. For example, a small single premium paid at age 65 provides an income beginning at age 85, with no death benefits or surrender benefits. This provides a very efficient and low cost income guarantee for the later years, when income management can be very challenging due to advanced age or depleted assets. Such an annuity must be viewed in context with the balance of a retirement portfolio that it is protecting and making possible greater freedom of investment choices.

Another approach to longevity risk protection is through guaranteed lifetime withdrawal benefits on accumulation annuities and some mutual funds. These can provide investment protection denominated in longevity benefits, while providing well-rounded longevity protection if the account value is annuitized when investment returns are favorable.

The most difficult problems to solve are those that people do not see. The financial risk of increasing longevity is hidden inside the good news of increasing longevity. Now is the time to fully educate retirees and draw upon the solutions that already exist.

Noel Abkemeier, F.S.A., is a consulting actuary with Milliman, Inc., in the Williamsburg, Va. office. His e-mail address is noel.abkemeier@milliman.com.

National Underwriter Company

Loans from 401(k) Plans: How Many, How Large?

WASHINGTON-How many participants have taken loans from their 401(k) plan? How large are those loans?

The latest update of the EBRI/ICI database shows that, at year-end 2008, less than one-fifth of participants had loans from their 401(k) plan. The average loan balance was down at the end of 2008 compared with year-end 2007.

The details:

• Among participants with outstanding 401(k) loans at the end of 2008, the average unpaid balance was $7,191, compared with $7,495 in the year-end 2007 database. The median (mid-point, half above and half below) loan balance outstanding was $3,889 at year-end 2008, compared with $4,167 in the year-end 2007 database.
• With account balances generally pulled down by the stock market in 2008, the ratio of the loan outstanding to the remaining account balance edged up in 2008, although within ranges seen in other years of analysis. Similar to year-end 2002, loan balances as a percentage of account balances (net of the unpaid loan balance) for participants with loans was 16 percent at year-end 2008.
• Fifty-nine percent of the 401(k) plans for which loan data were available in the 2008 EBRI/ICI 401(k) database offered a plan loan provision to participants. The loan feature was more commonly associated with large plans (as measured by the number of participants in the plan). Ninety-three percent of plans with more than 10,000 participants included a loan provision, compared with 33 percent of plans with 10 or fewer participants.

Note: Average and median 401(k) loan amounts are calculated among participants with 401(k) loans. The EBRI/ICI 401(k) database, the largest of its kind, is a joint project of the nonpartisan Employee Benefit Research Institute (EBRI) and the Investment Company Institute. Additional information about 401(k) loan activity, asset allocation, and account balances appears in the October 2009 EBRI Issue Brief, available at www.ebri.org

Employee Benefit Research Institute
© 2010 Employee Benefit Research Institute
http://www.ebri.org

401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2008

Because 401(k) balances can fluctuate with market returns from year to year, meaningful analysis of 401(k) plans must examine how participants' accounts have performed over the long term. Looking at consistent participants in the EBRI/ICI 401(k) database over the five-year period from 2003 to 2008 (which included one of the worst bear markets for stocks since the Great Depression), the study found:

• After rising in 2003 and for the next four consecutive years, the average 401(k) retirement account fell 24.3 percent in 2008.

• The average 401(k) account balance moved up and down with stock market performance, but over the entire five-year time period increased at an average annual growth rate of 7.2 percent, attaining $86,513 at year-end 2008.

• The median (mid-point) 401(k) account balance increased at an average annual growth rate of 11.4 percent over the 2003-2008 period to $43,700 at year-end 2008.

THE BULK OF 401(K) ASSETS CONTINUED TO BE INVESTED IN STOCKS. On average, at year-end 2008, 56 percent of 401(k) participants' assets were invested in equity securities through equity funds, the equity portion of balanced funds, and company stock. Forty-one percent was in fixed-income securities such as stable-value investments and bond and money market funds.

THREE-QUARTERS OF 401(K) PLANS INCLUDED LIFECYCLE FUNDS IN THEIR INVESTMENT LINEUP AT YEAR-END 2008. At year-end 2008, nearly 7 percent of the assets in the EBRI/ICI 401(k) database were invested in lifecycle funds and 31 percent of 401(k) participants held lifecycle funds. Also known as "target-date" funds, they are designed to simplify investing and automate account rebalancing.

NEW EMPLOYEES CONTINUED TO USE BALANCED FUNDS, INCLUDING LIFECYCLE FUNDS. Across all age groups, more new or recent hires invested their 401(k) assets in balanced funds, including lifecycle funds. At year-end 2008, 36 percent of the account balances of recently hired participants in their 20s were invested in balanced funds, compared with 28 percent in 2007, and about 7 percent in 1998. At year-end 2008, almost 23 percent of the account balances of recently hired participants in their 20s were invested in lifecycle funds, compared with almost 19 percent at year-end 2007.

401(K) PARTICIPANTS CONTINUED TO SEEK DIVERSIFICATION OF THEIR INVESTMENTS. The share of 401(k) accounts invested in company stock continued to shrink, falling by nearly 1 percentage point (to 9.7 percent) in 2008. That continued a steady decline that started in 1999. Recently hired 401(k) participants contributed to this trend: they were less likely to hold employer stock.

PARTICIPANTS' 401(K) LOAN ACTIVITY WAS STABLE. In 2008, 18 percent of all 401(k) participants eligible for loans had a loan outstanding against their 401(k) account, the same percentage as at year-end 2007 and year-end 2006. Loans outstanding amounted to 16 percent of the remaining account balance, on average, at year-end 2008; this is similar to the year-end 2002 level.

Download Issue Brief PDF

Employee Benefit Research Institute