Household Income in America and Retirement Savings

Household income in America typically refers to all income of residents in every household over the age of 18. Income is usually made up of:

• Wages and Salaries
• Unemployment Insurance
• Disability Payments
• Child Support Payments
• Regular Rental Receipts
• Personal Business, Investment, or other Income received routinely

In 2007, the Median Annual Household Income rose 1.3% to $50,233 according to the Census Bureau, with approximately $7.896 Trillion in total income.

Median Annual Household Income for the state of Washington ranked #10 in 2008 at $58,078.

If every American Household deferred 10% of Household Income into tax-deferred retirement savings vehicles such as 401(k)s or IRAs, based on 2007 Census Bureau numbers, approximately $790 Billion would be tax deferred. Unfortunately, the Average American defers significantly less (closer to 5%).

Interestingly enough, the U.S. Department of Commerce, Bureau of Economic Analysis shows the following earnings changes from 2001-2009 in this Interactive Chart:

• $4,183B ('01) to $5,148B ('09) in Private Sector
• $804B ('01) to $1,184B ('09) in Government

All Private Sector earning Americans had an earnings increase of 23%, and All Government earning Americans as a whole had an earnings increase of 47%.

The same source reports Personal Savings Rate, as a percent of Disposable Personal Income in Flow of Funds Accounts (FFAs) was:

2006: (0.2)%
2007: 4.8%
2008: 8.7%
2009: ?

Problem with the 401(k) System?

Here is a great article that illustrates one of the shortfalls of our current 401(k) retirement system: the people in charge either don’t want to be in charge or don’t have the time, skills and/or knowledge to be successful in managing the 401(k) plan.

The article gives three case studies that in my experience are representative of many plan sponsors.

Case 1: [The Business Owner] only agreed to set up the plan on two conditions: It wouldn’t cost the company a dime, and he wouldn’t have to deal with it.

Case 2: “As long as you don’t charge us any fees”

Case 3: “It was nice to think there was enough smartness in the group to help pick [the plan’s investment options],” says…the general surgeon who chairs the committee…Smartness isn’t always enough, though.

Quite often 401(k) plans sponsors believe that once they setup the plan and hire the broker all responsibility has been passed to someone else (e.g. the broker and/or participants). However, from a legal standpoint, and I would argue from a business and policy standpoint, this is wrong. See our webinar on Fiduciary Best Practices: A Guide for Small Employers for details.

Also, many 401(k) plans sponsors, being good business people, will make sure the fees paid by the company are reasonable and fair. (Or even better then fair as illustrated by the above quotes!)

However, sponsors are much less likely to worry about the investment fees paid by the plan participants. 401(k) providers know this and use it to their advantage by burying hidden fees in the various investment products they sell.

Even really smart people – doctors, lawyers, scientists – generally don’t have the knowledge or time to unravel the complicated mess that is their 401(k) plan fees, again a fact that providers know and exploit.

There are a number of bills currently pending in congress that would require full fee disclosure both to plan sponsors and, most importantly, to plan participants. Let’s hope one of these bills can make it into law without being too watered down.

For more information on plan fees see our recently completed webinar: Understanding Retirement Plan Fees.

Will the Pension Protection Act of 2006 (PPA) accomplish its purpose - Part 1 of 2

I had a client ask me a great question last week: “In your opinion will the Pension Protection Act of 2006 (PPA) accomplish its purpose and why to yes or no?“

Of course before responding I had to define the purpose behind PPA. After reading some committee reports and public statements made by the president and the congress I believe there were two main purposes to this legislation:

• Strengthen protections for the American workers’ pensions.
• Expand opportunities to build retirement nest eggs.

So now the question is: did PPA strengthen protections for pensions and expand opportunities to save? This first entry will address purpose #1: Strengthen Protections for Pension Plans

A detailed explanation of the changes made to DB plans under PPA is beyond the scope of this blog, but the basics are as follows: The Pension Protection Act of 2006

1. changed the funding rules, generally increasing the funding requirement to 100% of the present value of benefits earned,
2. changed the interest rate assumptions from Treasury rates to yield curves,
3. added additional requirements for at-risk plans,
4. placed restrictions on the use of credit balances.

In general, the legislation tried to balance the need to increase funding requirements with concerns that more stringent rules will cause employers to drop defined benefit plans in favor of 401(k) type arrangements.

Most of the actuaries I spoke to believe that legislation was needed to shore up the defined benefit plan system. However, some believe the details of PPA were “flawed” and that it was “rushed.” (The PPA technical correction bill from 2008 addressed some but not all of these flaws.)

A good and relatively understandable explanation of the legislative history surrounding these issues can be found here. It is interesting to note the roles played by the administration, various committees, and lobbyists in the creation of this law.

The general consensus, with which I agree, is that PPA was a good first step for fixing problems with our pension system, but is by no means a comprehensive solution. The bigger issue now is of course the recession. The recent economic downturn has had a much more profound impact on our defined benefit system. How we respond to this “crisis” will be important to the security of our retirement.

(Side note: interestingly enough 82% of US respondents to a recent CFO Research Services / Towers Perrin survey claim they have adequate access to cash in order to fund their DB plans for the next 2 years.)

First Mutual Fund Family Cuts Management Fees

During a time when Employers, Employees, and Governments are all doing what they can to cut hours, costs, and run a successful enterprise, finally, a Mutual Fund family is following suit.

Putnam Investments made an announcement this week, subject to shareholder approval, that it would lower costs for its mutual funds by:

1) Cutting expense ratios,
2) Implementing performance driven expense ratios, and/or
3) Adjusting pricing breakpoints

Analysts expect a 10-13% price reduction.

Who else will follow suit, and why did it take so long?