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: ?

Is Participant Choice a Good Idea?

The mainstream media has often commented on the shift from defined benefit plans to defined contribution plans over the last few decades (see PBS FRONTLINE report). But there has also been a shift within defined contribution plans from “trustee” directed “pooled” accounts to “participant” directed “individual” accounts.

Years ago it was common place for employers to sponsor a “pooled profit sharing” plan. Each year the employer would determine how much to contribute and these contributions were held in a single account. The employer would appoint a trustee and/or investment manager to determine how to invest the contributions on behalf of all participants.

Then came the rise of the 401(k) plan. For some reason in a 401(k) plan it was decided that participants ought to choose their own investments. At the meetings I attended where sponsors contemplated adding a 401(k) provision, the logic went something like this: because participants would see the money comes out of their paychecks they will want to (and perhaps ought to) be more involved in the investment decisions.

Some providers also told employers that by handing over investment choices to participants they rid themselves of fiduciary responsibility (for more on the fallacy of this idea please see our recent webinar on Fiduciary Best Practices: A Guide for Small Employers.)

We have moved from a situation where employees didn’t have to make any decisions, or have any choices, about retirement savings (e.g. the traditional DB plan) to a situation where employees have all the decisions, and have perhaps too much choice, (e.g. today's typical 401(k) plan).

Is this good or bad? Here are two studies that provide some illumination:

# 1: The Deloitte 401(k) Benchmarking surveys
In these annual surveys,

• Employers consistently report that the biggest barrier to plan participation is a “lack of employee understanding.”
• Employees most often report “Where to invest/which funds to use” and “How Much to Save for Retirement” as the more confusing parts of their retirement plans.

While automatic enrollment features and default investments may alleviate some of these problems, they are not perfect solutions (see prior post on PPA’s automatic enrollment provisions).

# 2: Pension Research Council Working Paper: The Efficiency of Pension Menus and Individual Portfolio Choice in 401(k) Pensions
This working paper analyses a rich set of participant account data from Vanguard. Their findings include:

• The vast majority of the plans in their study offer reasonable investment menus (i.e. the menus are “efficient” compared to market benchmarks)
• Most “real-world” participants make mistakes by investing inefficiently and not diversifying their investments enough.
• The participant’s investment mistakes account for the majority (76%) of their poor performance.
• These investment mistakes have a significant impact on retirement savings, reducing wealth by 1/5th over a 20 year career.

The study also has interesting findings regarding investment menus:

• More is not always better: adding more than about 9 well chosen mutual funds does not improve participant investment performance.
• Index bond and index domestic equity funds improve plan efficiency.
• Actively managed domestic equity funds hurt plan efficiency.

So what does this mean for today’s 401(k) plan sponsor? If you offer participants a choice, do it right:

• Have a well chosen list of investment options covering all asset classes.
• Use no more than 9-12 funds.
• Consider having participants select between pre-mixed model portfolios instead of individual mutual funds.
• To the extent you provide investment education, focus on answering the basic questions: How to enroll in the plan?, How much to save? and Where to invest?
• Provide employees easy to use savings guidelines when they enroll in the plan (try the FPA Journal - National Savings Rate Guidelines for Individuals).
• Periodically review participant asset allocation, individual investment performance, and retirement readiness. You can’t manage what you don’t measure.