Don't HR Alone #45 - Retirement Plan Participation by Generation
Wells Fargo: Millennials Make Greatest Gains In 401(K) Plan Participation
Rates of saving for retirement and investing habits differ from one generation to the next, according to a recent analysis of four million people who participate in 401(k) plans provided by Wells Fargo. Retirement plan data for Boomers, Generation X, and millennials reveal ways each generation can learn from the others when it comes to saving for retirement. The full analysis can be found in the Wells Fargo 2017 Driving Plan Health report.
Millennials show 13% gain in participation in past five years
Millennials have demonstrated the biggest gains in the percentage of those participating in their 401(k) plans over the last five years, with an increase of 13.3%. They’re also the most-diversified generation, with 83% meeting Wells Fargo’s minimum diversification goal*. This diversification number drops to 80% for Gen X and 77% for Boomers. In addition, 30% of millennials contribute enough to maximize their full employer match when one is offered. This number falls to 27% for Gen X and 25% for Boomers.
“This engagement among millennials is encouraging because the sooner they get started, the more prepared they will be for retirement — they have the power of time to help grow their nest egg,” said Mel Hooker, director of relationship management for Wells Fargo Institutional Retirement and Trust. “This generation is benefitting from legislation that made it easier for employers to automatically enroll employees into their 401(k) plan, and from the use of default investments that help them meet a minimum level of diversification.”
Millennials are also the greatest users of Roth 401(k) plans, which allow participants to contribute after-tax income. Millennials use this option, when offered by their employer, at a rate of 16% compared to 11% of Gen X and 8% of Boomers.
“It’s important to note that the use of Roth 401(k) plans is an intentional choice on their part, perhaps as a tax diversification strategy,” added Hooker.
*Minimum diversification goal in 401(k) plans is defined by Wells Fargo as when a participant is either (1) invested in a diversified investment option such as a target-date fund, managed account product, or comprehensive advice program, or if they are self-directed or (2) invested in at least two different classes of equity funds and at least one fixed income fund and less than 20% invested in employer stock.
Is Gen X feeling the squeeze?
Gen X has seen an 11% uptick in participation over the last five years. However, they’re leading the pack in loans from their 401(k) plans: 25% of Gen X participants have a loan, compared to 16% of millennials and 19% of Boomers.
“This may be a case of sandwich-generation syndrome, in which people are juggling the challenge of raising kids and helping aging parents — all during a period of increasing financial complexity in their lives,” said Hooker. “Unless you need the money for an emergency, however, it’s best to resist the urge to tap your retirement funds. And if you need to do it, be sure to understand the terms.”
While many 401(k) plans allow participants to borrow from their 401(k) accounts, there can be some unintended consequences that people need to be aware of before making that decision.
Smaller retirement savings: When you take out a loan, you are losing the benefits of investment growth, and that could leave you with a smaller retirement savings. How much smaller? This depends on a number of factors, including the size of the loan, the repayment period, whether you continue contributions during this period, the earnings on your account, and the loan interest rate. Also, if you stop contributing while you are paying back your loan, you won’t receive any employer matching contributions.
Repayment requirements: If you lose your job or take another one, you’ll have to repay the money quickly, usually within 30 to 60 days. If you can’t, the IRS considers the money you’ve taken out to be a withdrawal, which means you’ll have to pay taxes — and if you’re under age 59½, you may owe a penalty as well.
Boomers participate at higher rates, but lag in diversification
Early this year, the first wave of Boomers turned 70½, reaching the age at which they are required to start drawing down their 401(k) savings. As this population nears retirement, the number of those participating in their plan has increased by 8.3% over the last five years; although this is a lower rate of increase than millennials and Gen X, overall more Boomers participate than younger generations.
A little over a third of all participants are more conservative in their own investments than a typical target-date fund appropriate to their age. But more than half of Boomers have greater equity exposure than an age-appropriate target-date fund, which could expose them to significant investment risk.
“It’s a delicate balance; lower returns for overly conservative participants can hurt balances in the home stretch to retirement, but overly aggressive participants face an even larger potential threat to their retirement income in the form of investment risk,” said Hooker. “It’s important to encourage employees to create a plan for saving and stick to it. Consistency in contributions and diversification are a better path to success than chasing returns or trying to time the market, because retirement success is a long-term proposition.”
Who is on track?
For the purposes of setting a goal and tracking progress, Wells Fargo measures the percentage of participants on track to replace 80% of their pay in retirement*, and it appears that many of the behaviors in which millennials take the lead are pointing to a higher percentage on track: 66% of millennials are on track to reach this goal in retirement, compared to 51% of Gen X and 41% of Boomers.
*Income replacement assumptions include a goal of replacing 80% of income during retirement, a retirement age of 65, and Social Security beginning immediately. In addition, the calculation assumes income increases of 2% per year, investment returns averaging 7% annually before retirement (and 4% after retirement), and 3% annual inflation in retirement.
How employers are helping
While there are many ways employers can help their employees save more for retirement, this analysis points to some stand-out opportunities for employers.
1. Closing the participation gap through automatic enrollment
While participation remains lowest among younger, more recently hired, and lower-earning employees, these populations have seen greater gains than their counterparts, leading to a narrowing of the participation gap for all three demographic dimensions. The biggest driver? Automatic enrollment — when this younger age group is automatically enrolled, 85% stay in the plan. In the absence of automatic enrollment, the participation rate falls to 38%.
2. Increasing default deferral rates
When employers automatically enroll their employees in the 401(k) plan, the most common default deferral rate is 3%. At this rate, 11.1% of people opt out of the plan — meaning nearly nine in 10 employees stay in the plan. However, when people are automatically enrolled at a 6% contribution rate, participants have a nearly identical reaction, with 11.3% opting out of the plan. Given contribution-rate challenges, defaulting employees at a higher contribution rate to begin with may help significantly.
3. Automating regular contribution increases
Today, 20% of plans include a feature that automatically increases their employees’ contribution rate on a regular basis (often annually) and requires employees to take action to turn it off, or “opt out.” This is a significant uptick from 8% of plans that offered this feature in this fashion five years ago. In addition to encouraging higher contribution rates by defaulting employees into a plan at a higher rate to begin with, adding automatic contribution increase as a feature employees need to elect to turn off, rather than offering it and making them take the steps to turn it on, will drive employees to a 10% contribution rate more quickly than if they simply stagnate at the automatic enrollment contribution rate.
“Employers don’t have to guess anymore. The data reveal exactly what they need to do to move the needle on each behavior,” said Hooker. “In particular, when we see retirement plan contribution rates are in a stagnant state relative to other important behaviors, we can put in place the plan design features that will help improve this metric. Employers can use the data to inform their decisions based on their defined goals for helping their employees save for retirement.”