Last week we looked at one of the six major challenges for retirement security and personal savings in America outlined in a report from the Bipartisan Policy Center (BPC). Another one of these important problems is that many Americans lack the income or resources to save for short-term financial needs, something which can be just as critical as saving for retirement. For example, a 2011 joint academic study explored the financial fragility of U.S. households and found that one in 4 surveyed Americans said that they “certainly could not” come up with $2,000 in 30 days if needed. An additional 19 percent said that they could only cope with such a financial shock by selling or pawning possessions or taking payday loans.
Similarly, a report by the Financial Industry Regulatory Authority (FINRA) found that only 39 percent of surveyed U.S. adults feel certain they could come up with $2,000 if an unexpected financial need arose within 30 days, and one in 5 respondents are certain that they could not come up with $2,000. Further, not even half (46 percent) of respondents are confident that they currently have enough emergency savings to cover at least 3-months’ worth of potential expenses. Part of the problem is likely due to a combination of relatively weak wage growth and rapidly rising healthcare costs. Over the past decade and a half, for instance, inflation-adjusted income growth is actually negative for many Americans, meaning that these individuals are earning less now than they did around the turn of the century.
At the same time, average health insurance premiums for working adults with employer-sponsored family coverage have surged by 27 percent between 2010 and 2015, according to the Kaiser Family Foundation. Add to this higher annual deductibles and it is not too surprising why many families feel like their ability to save is restricted. Ballooning education costs are another savings hurdle (+66 percent between 2000 and 2015) because many Americans will try to improve their earnings potential by pursuing advanced degrees but the burden of student loan payments after graduation can severely limit their ability to set money aside for both short- and long-term needs.
What is worse is that many people with insufficient emergency funds will often dip into their retirement savings in the event of a sudden financial setback. There are various forms of retirement plan leakage, e.g. in-service distributions, loans, etc., and such cash-outs allow for roughly 1.5 percent of assets to exit the 401(k) and IRA system each year, according to a study from the Center for Retirement Research (CRR) at Boston College. That might not seem particularly large at first glance but the CRR researchers estimate that aggregate retirement wealth in America is at least 20 percent lower than it would have been without the current level of allowed plan leakage.
Evidence of plan leakage still being a problem was also found in the FINRA study mentioned earlier: Thirteen percent of surveyed non-retirees said that they had taken a loan from their retirement account last year, and 10 percent had taken a hardship withdrawal (both increases compared to 2009). Moreover, Federal Reserve Board calculations suggest that 40 cents of every dollar savers under the age of 55 contribute to defined contribution (DC) accounts will eventually leak out of the system prior to retirement.
Vanguard research suggests that plan leakage is more common among workers with smaller retirement account balances but regardless of a person’s unique financial situation, this behavior can be counterproductive. Indeed, DC plans are intended to help participants amass a significant retirement nest egg through routine contributions and the return generated from properly investing those savings. Tapping into these assets early can therefore have a negative impact on a person’s financial future by lowering the amount of money that can be invested, and thereby potentially even diminishing the various tax advantages that such plans can offer.
Since a lack of emergency savings likely plays a role in why many Americans dip into their retirement assets early, the BPC authors have a few recommendations that they believe will help promote personal savings for short-term needs and preserve savings for old age:
- Introduce new regulations to harmonize early-withdrawal rules for IRAs and 401(k)-type plans.
- Simplify the process for transferring retirement savings from plan to plan.
- Make technical adjustments to enable transfers and rollovers from all 457 plans.
- Clear barriers to automatic enrollment in multiple savings accounts.
More details can be found on pages 58-60 of the report, and we will explore some of the other challenges and potential solutions outlined by the Bipartisan Policy Center in subsequent parts of this series.
Sources: Bipartisan Policy Center, FINRA, U.S. Census Bureau, KFF, The College Board, Boston College (CRR), FRBG, VanguardPost author: Charles Couch