Vanguard is out with its latest annual report on the state of defined-contribution (DC) workplace retirement plans it manages, such as 401(k) plans. I have mixed feelings about this type of report. On the downside, there's a temptation to compare yourself against the averages in such reports, feeling good about how you're doing if you compare favorably and not so good if you don't. But that isn't very useful. A better benchmark is a plan you have developed that's tailored to your unique circumstances and goals.
On the positive side, reading reports like this can serve as a reminder of what to check on regarding your own retirement savings. So, let’s look at some of the report's main metrics through that lens.
Participation rate. Vanguard reports a record-high participation rate in the DC plans it managed in 2022. Of all employees eligible to participate, 83% did so. That’s up from 75% in 2013. While it's good to hear that participation rates are moving up, driven largely by widespread adoption of automatic plan enrollment for new employees, this figure lacks context. For example, the report doesn’t tell us how many employees also use an IRA.
For SMI members, we recommend considering the use of an IRA, and also a health savings account if you are eligible, to prepare for your later years. We put together a decision tree graphic to help you choose the best mix of accounts.
“Deferral” rate. The average employee contributed a historically high 7.4% of income to a workplace plan in 2022. When you factor in employer contributions, the rate goes up to 11.3% of income. While that latter figure sounds fairly good, once again, it lacks context.
For SMI members, our recommendation is to run some numbers to see how much you should be investing each month for your later years. Using a tool such as MoneyGuide can help, but even some of the freely available online calculators can give you a feel for how much you should be setting aside each month.
Employer match. An impressive 95% of employers with a Vanguard-managed DC plan offer some type of match on employee contributions. The report didn’t mention what percentage of employees are contributing at least enough to take full advantage of their employer’s match, but this is something everyone should be striving for.
In our household, our college-age son is signing up for the 401(k) plan offered by his employer this summer where there is a dollar-for-dollar match on his contributions up to 4% of his pay. Since he’ll only work eight or nine weeks before he has to head back to school, that won’t amount to much, but the match is free money and you never want to turn down free money!
Investment. Target-date funds are the default investment in 98% of Vanguard’s DC plans. This isn’t surprising since such funds make it easy for investors to get asset allocation decisions largely right (see Don’t Be Surprised if Target-Date Funds Miss the Mark).
Our main caution to SMI investors here is that the only downside protection offered by target-date funds is their allocation to bonds, and even that didn’t work out very well in 2022. That’s why the average participant in a Vanguard-managed DC plan lost nearly 16% last year. One alternative to consider is using SMI’s Personal Portfolio Tracker to implement a custom version of Fund Upgrading in your 401(k) plan.
Cashing out. In 2022, 14% of participants in Vanguard-run DC plans left their employer. Of those, 51% kept their money in their former employer’s plan, 16% rolled the money over into an IRA, and 32% cashed out. That latter group potentially subjected themselves to taxes, penalties, and the loss of future compounding.
When leaving a job, we recommend rolling workplace retirement savings into an IRA. By doing so, you will avoid taxes and penalties while availing yourself of all the investment choices needed in order to implement your preferred SMI strategy or strategies.
A couple of other findings from the Vanguard report that are worth highlighting:
Roth accounts. While the number of plans offering a Roth option has risen from 71% in 2018 to 80% in 2022, just 17% of Roth-eligible employees are using that option. Especially for younger employees, going the Roth route offers compelling benefits — lots of years for compounding to multiply account balances and then tax-free money in retirement. But there are potential benefits for older, higher-income employees as well. For those whose income makes them ineligible to contribute to a Roth IRA, there are no such restrictions on contributing to a Roth 401(k) plan. In both cases — younger employees and older, higher-paid workers — the low participation rates may be a matter of not knowing about the benefits of a Roth.
Catch-up contributions. In 2023, all plan participants are eligible to contribute up to $22,500, whereas those who are 50 years old or older are eligible to contribute an additional $7,500. However, just 16% of employees eligible to make catch-up contributions are doing so. For those who may be a bit behind on their retirement savings and can afford to take advantage of this provision, it’s a nice benefit.
What are your takeaways from this report? And more importantly, how do you stack up? Not in comparison to the average participant in a Vanguard-managed plan, but in comparison with where you really should be?
