Savings & Investing

A hybrid proposal to increase employee savings

Feb 28, 2017
By BlackRock

Currently 43% of Baby Boomer and Gen X households in the United States are estimated to have insufficient resources to retire at age 65.1 This arises from problems during both the accumulation phase and the retirement phase. This “one idea” will attempt to improve this situation by simultaneously: (1) increasing 401(k) plan accumulations via a stretch match provided through an alternative to the current safe harbor for automatic enrollment plans, and (2) providing for a longevity hedge through in-plan Qualifying Longevity Annuity Contracts (QLACs) provided via employer matches to a 401(k) plan.

The challenge

In addition to the problems of insufficient eligibility to a retirement plan2 and plan leakages,3 the retirement system in this country needs to deal with the problems of inadequate contributions to defined contribution plans and longevity risk at retirement.

The problem of longevity risk can be seen by looking at the probability of adequate retirement for Baby Boomer and Gen X households in the middle half when ranked by income.4 Chart 1 shows that 62% of these households are estimated to have adequate retirement income.5

Chart 1

However, for those in the longest relative longevity quartile,6 only 33% are simulated to have adequate retirement income. The problem of inadequate contributions to defined contribution plans among eligible employees is a combination of low participation rates for some (especially the young and low income) as well as a total contribution rate (i.e., employee and employer contributions combined) that are too low to provide adequate accumulations by the desired retirement age for many households.

In recent years the move from voluntary enrollment to automatic enrollment 401(k) plans has helped a great deal with respect to participation rates but there has been considerable concern that the default employee contribution rates are set too low for employees to accumulate sufficient retirement funds, especially in those cases where there is not an automatic escalation provision.

Proposed solution

This proposal would address these problems on two fronts.

First, provide employers willing to provide automatic enrollment 401(k) plans with an alternative to the current PPA safe harbor. This would be a type of stretch match similar to the alternative to the PPA safe harbor that was proposed in 2013. Specifically, the default contribution rate would be 6% of employee compensation with an auto increase of 2% per year until the employee contribution reached 10%. Most importantly the employer match would be “stretched” to provide incentives for the employees to contribute until 10% of compensation.7 Chart 2 shows the expected percentage increase in 401(k) accumulations at age 65 from FUTURE employee contributions by age and income quartile if the proposed stretch-match safe harbor was used instead of the PPA safe harbor.8 For every combination of age and income there would be at least a 14% simulated increase. 9

Chart 2

Second, encourage employers to use their matching contributions to 401(k) plans as premia for QLACs. These deferred annuities allow employees to use a portion of their account balances to purchase lifetime monthly income starting at some advanced age (typically 80 or 85). Chart 3 shows, in terms of the percentage change in the probability of having adequate retirement income, the impact of using 401(k) account balances attributable to employer contributions with the current employer at retirement age to purchase a QLAC at age 65.10

chart 3

Even at today’s annuity premia, households in the longest relative longevity quartile would have an increase between 6.7 and 8.7%. If discount rates start to approach historical norms, the annuity premia will decrease. If premia were to decrease by as much as 30%, the increase in the probability of success would range from 12.6 to 16.2%.

Conditions

I believe two conditions are imperative for the QLAC portion of this proposal to feasible:

  1. The QLAC financing will need to be made within the qualified retirement plans on some type of an automatic basis.
  2. For the previous condition to apply, there must be some type of fiduciary safe harbor to mitigate plan sponsors concerns.

Delivering consolidated lifetime savings accounts

Hear from Ben Franklin about the creation of consolidated lifetime savings accounts to facilitate cradle to grave financial planning.

Jack VanDerhei

About the author

Jack VanDerhei
Research Director
Employee Benefit Research Institute (EBRI)

Jack VanDerhei is the research director of the Employee Benefit Research Institute (EBRI), a private, nonprofit, nonpartisan organization committed to original public policy research and education on economic security and employee benefits. He is also the director of both the EBRI Defined Contribution and Participant Behavior Research Program and the EBRI Retirement Security Research Program and the director of the EBRI Center for Research on Retirement Income. He has been with EBRI since 1988.

VanDerhei has more than 200 publications devoted to employee benefits and insurance, but his major areas of research focus on the financial aspects of private defined benefit and defined contribution retirement plans. He is currently analyzing a database with annual observations since 1996 of over 24 million 401(k) participants from more than 60,000 plans.