The Role of 401(k)s in Resolving the Retirement Planning Crisis

The American College of Financial Services
October 19, 2020

While 401(k)s are today accepted as one of the three main pillars of retirement savings—the others being Social Security and private or personal retirement plans—they actually only entered the conversation in financial services in 1980. Up to that point, defined benefit or DB plans that provided retirement assets through pension funds had been the standard for decades, but the pension system was beginning to fall out of favor due to increasing life expectancy and the nomadic nature of the workforce. Not only could companies no longer afford to pay employees to support their lifestyle through non-working years, but a DB plan based on the idea of rewarding years of employee service was no longer applicable.

Because of this, 401(k) or defined contribution (DC) plans were created to collect contributions from participants and pay them out at a future date upon retirement, with additional growth usually based on a set investment portfolio that fueled savings with stock market gains. 401(k)s quickly became very popular, and have retained that popularity to this day: around 58 million Americans currently participate in 401(k) plans, 20% of total retirement savings.

However, the shift toward 401(k) plans has put many Americans in a tight spot that could jeopardize their retirement savings if they and advisors don't start planning ahead.


Understanding the Issues


The transfer from DB to DC accounts hasn't been without problems. While pension plans were traditionally handled by companies, 401(k) plans put the onus on individuals to manage their own financial security and make sure they are doing enough to prepare for retirement. This exposes individual savers to more risk and demands a high degree of savings discipline, forethought, and planning. Unlike financial professionals, most people are not so much focused on how they will survive years from now as how they will get by right now—one reason overall figures of retirement savings are dwindling across the country.

Total asset numbers vary dramatically in the United States: the average amount of retirement savings held by individuals and spouses between the ages of 56 and 61, on the border of retirement, was only $21,000. While higher-income earners are often able to use their expanded resources to pursue skilled advisers and put aside hundreds of thousands, perhaps millions of dollars, at least some everyday Americans may have no savings at all—especially those facing financial struggles stemming from the COVID-19 crisis. Even one in three Baby Boomers reported saving less than $25,000 as their generation approaches retirement in ever-increasing numbers.


An Expanding Retirement Savings Gap


So why is this retirement savings gap developing? The exact reasons may depend upon individual and family choices, beliefs, and practices, but three main reasons rise to the top. Firstly, with the freelance and gig economy increasingly dictating the work environment and small businesses struggling to make ends meet in a hostile landscape dominated by big competitors, many people may simply not have access to any kind of 401(k) plans whatsoever. Recent legislation like the SECURE Act has sought to address this issue, but still up to 35% of private-sector workers don’t have access to a 401(k) plan even if they wanted to.

Secondly, in most workplaces, retirement savings plans like 401(k)s or 403(b)s are not mandatory: they’re optional, and as such, not everyone chooses to take advantage of them. Studies show that while 65% of private-sector employees have access to retirement plans and resources, only 48% participate. Reasons can vary: some may feel they can't afford to put money away for some nebulous future date when they're already living paycheck to paycheck. Others may not be comfortable with putting their money in the hands of their employer and the stock market when the potential for portfolio losses exist, and still others may simply need more education about the system to see the need to start planning ahead.

And thirdly, many workers may have financial reasons or feel the need to make early withdrawals from their retirement plans, even when such a move comes with significant tax penalties. Rather than leave money sitting with a previous employer's fund, around 40% of people who leave their jobs simply choose to cash out any 401(k) contributions they might have accumulated, taking serious losses in the process. Other workers may have emergency financial situations that require taking money out of a safe place. Either way, when combined with the failure to participate above, financial experts say trillions of dollars are being left on the table by those not properly leveraging retirement savings strategies.


Providing Guidance on Finance's Toughest Questions


Any potential fix to the retirement savings problem in America today faces political debate and the potential for social and cultural shock—but it's far from out of reach. With proper advice and education, more people can be altered to the benefits of planning ahead for retirement and using their 401(k) options to the greatest extent possible.

Our article, 401(k) Reform: Can Improvements to America’s Flagship Savings Vehicle Rescue Retirement?, provides these and other insights into the crisis facing this crucial pillar of Americans' retirement planning. Download now to get a glimpse of what that future could look like and how you can work with clients to address the issues at hand.

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