Posted on 18 June 2009
By Mark Miller
Retirement investors under the age of 30 participating in defined contribution plans are seeing their accounts bounce back at a much faster rate than over-55 investors who are near retirement, according to Mercer, the benefits consulting firm.
Mercer analyzed its defined contribution data for participants under 30, and those over 55 from the end of 2007 through April 30, 2009. It found that participants under age 30 have seen their accounts gain 24 percent, while those 55 and over have lost an average of 16 percent. “This generally can be attributed to the fact that younger participants with smaller balances can more quickly recover their losses through new contributions and potentially a more aggressive investment strategy,” Mercer stated. “In contrast, near retirees face a huge challenge in accumulating adequate savings for retirement in the midst of recent economic volatility.”
Mercer’s data also shows that older investors pulled back on their pre-tax contribution rates from 9.2 percent in September 2008 to 8.8 percent in April 2009. That contributed to lagging performance as the market bounced back somewhat this year. Mercer also calculated the amount of additional contributions older investors would need to make in order to recoup their losses over a range of years; for example, a 6.6 percent annual contribution rate over five years would recoup the losses.
The bigger picture here–acknowledged by Mercer and many others–is that decimated retirement portfolios will be a major factor driving people to consider working longer in the years ahead. The threads of the retirement safety net–savings, pensions, health benefits, housing–are fraying badly just at the time when we need it to support a population experiencing growing longevity.
In theory, there’s no reason defined contribution plans shouldn’t have worked well for retirement savers; they include the generous tax advantage of allowing employees to contribute pre-tax dollars and allowing those contributions to accumulate tax free until withdrawal at retirement age; many employers also make matching contributions.
But in the real world, the performance of DC plans has been disappointing. There’s the stock market collapse, of course, which erased 30 to 40 percent of most savers’ portfolios. But employee participation is just as big a problem. One survey by the Employee Benefits Retirement Institute (EBRI) showed that just 51 percent of employees at large and medium-sized companies were contributing to DC plans as of 2003. Even more important, about one in every two American workers doesn’t have access to a 401(k) plan at work.
As a result, 401(k) accounts simply aren’t getting the job done for too many Americans. EBRI data shows that 53 percent of Americans have saved less than $25,000 for retirement, excluding the value of their primary home; and 20 percent have saved less than $1,000.
How big a boost can you get from working longer? Financial planners at T. Rowe Price have used Monte Carlo simulations to project some answers. These are simulations that can be used to model future uncertainty, and the analysis produces outcomes based on hypothetical probability. But the illustrations make the point—convincingly—that you can improve your chances for long-term retirement security by remaining in the workforce longer.
First, let’s consider the impact of working and saving longer on your retirement income. Consider the example of a woman who working full time, with an annual salary of $100,000 and tax-deferred savings of $500,000 (well done!). Let’s say she decides to stay on the job for four additional years past 62, and that annual inflation runs at a 3 percent rate. Let’s also assume she saves 15 percent of her salary for each of those additional working years. Those decisions will boost her annual retirement income by 7 percent; at the end of those additional working years, her annual retirement income would be 22 percent higher than it would have been had she retired at age 62. If she could sock away even more of her income—25 percent—the gain would be 28 percent.
Factoring in the benefit of delayed Social Security benefits really adds rocket fuel to the projections. The Social Security Administration’s formulas give our hypothetical worker a significant increase in income; every year she waits to file for benefits will yield about 8 percent more in payments. That really starts to add up in the out years. “Delaying three years, from age 62 to 65, results in a 27 percent increase in the purchasing power of a retiree’s Social Security benefits,” says Christine Fahlund, a senior financial planner at T. Rowe Price. “At age 70, it would almost double that purchasing power.”
The chart below illustrates the long-term effect.