As you know, traditional pensions have largely gone the way of eight-track tapes (or cassettes, or CDs, for that matter). Since the introduction of 401(k) plans in 1981, so-called “defined-contribution” plans have become the main vehicle workers use to save for their later years.
Automation has done a lot to increase participation rates and even take care of some of the more challenging aspects of self-directed investing, such as getting asset allocation decisions mostly right. Still, there are signs that the DIY retirement preparation “experiment” has room for improvement. A new study from J.P. Morgan Asset Management (JPM) tells the tale.
Key findings
According to the company’s “Retirement by the Numbers” study of 12 million participants in 16,000 defined-contribution plans:
Too many are saving too little. When people begin contributing to their workplace plan, the average contribution rate is less than 5% and it eventually peaks at just 8%. In fact, 85% of participants never achieve the generally recommended 10% contribution rate. Not surprisingly, the youngest workers (Gen Z) contribute the smallest percentage of their salaries, ranging from 4.1% to 4.5%, depending on salary. Still, even the oldest workers (Baby Boomers) contribute less than 10%, with averages ranging from 6.5% to 8.6%.
Despite the growing popularity of automatic contribution rate escalation programs, the JPM study found that more than half of 401(k) plan participants do not raise their contribution rate from one year to the next.Debt is a roadblock. Nearly half of plan participants have high credit card utilization rates (use over 50% of their credit limits), which “often coincides with lower 401(k) plan contributions and smaller account balances, reducing retirement readiness by up to 40%, on average, for older participants.” Participants with high credit card utilization are also more likely to borrow from their retirement savings. Nearly 20% of participants have outstanding plan loans, which average 17% of their retirement account balance. The study also found that low emergency fund savings tends to suppress retirement plan contribution rates.
Some savers are their own worst enemies. In addition to borrowing from retirement savings, many plan participants cash out early. The study found that 15% of participants who leave their company between ages 20-29, take a cash withdrawal. On the other end of the age spectrum, 5% of participants in their 50s who are still working withdraw an average of 76% of their balances in cash, despite potential tax penalties. And the percentage of workers withdrawing large percentages of their retirement savings increases with age.
Key take-aways
While many aspects of investing are outside of a person’s control, many of the issues cited in the JPM study are largely controllable. As we’ve written in the past, before investing, it’s important to pay off non-mortgage debt and build a sufficient emergency fund. From there, it’s generally best to invest at least 10% of income for later-life needs and to not tap retirement savings until retirement.
A lesson from the real world
In all the years I have spent thinking about, writing about, and actually managing money, I have become convinced of two things: First, a budget is the single most powerful tool anyone can use to manage money well. And second, how you design your budget — how you allocate money to various purposes — will make all the difference in your financial success and satisfaction.
Once you have some money, you have five choices. You can spend it, use it to make debt payments, save it, invest it, or give it away. That’s the order our consumer culture encourages. Lifestyle spending comes first, which is usually followed by debt payments. Then, if any money is left over, some might be saved, some invested, and some given away. But there isn’t usually much left over.
A far better, far more biblical approach, is to give a portion first, then save and invest portions, and then see how much can be spent. Along the way, have no debt other than a reasonable mortgage.
As with so many things in life, it’s simple but not easy.
When I learned that approach, I was 29 years old, had just committed my life to Christ, and had $20,000 of credit card debt and a car payment. It took four and a half years to right the ship.
Your next steps
Of course, 401(k) plans are not an experiment; they are real life — the main option, along with IRAs, for building retirement savings.
If debt or the lack of an emergency fund are holding you back from saving sufficiently for your later years, you may want to pause your retirement plan contributions temporarily as you focus on getting out of debt and building savings. (Or, if your employer matches contributions, temporarily limit your contributions to the amount that would qualify for the matching money.)
Trying to make progress with retirement savings while carrying consumer debt or living without a sufficient emergency fund is likely to lead to a one-step-forward, two-steps-back experience. It would be better to clear the roadblocks and then focus your efforts on building savings for later life.
Thoughts? Counterpoints? Meet me in the comments section.
