For 401(k) plans to work well, individuals need to sign up, contribute a portion of each paycheck, appropriately invest their savings, and not take any money out of the plan prematurely. Until 2007, 401(k) participants had been gradually improving upon each of these behaviors. But that progression stopped during the recession, and in some cases even reversed. Here is how the recession impacted 401(k) plans:
Account balances declined. The typical household approaching retirement had only $120,000 in 401(k) and IRA accounts in 2010, up only slightly from $118,000 in 2007, according to a Center for Retirement Research at Boston College analysis of the Federal Reserve Board's Survey of Consumer Finances data. “Assuming that the household purchases a joint-and-survivor annuity, its monthly income amounts to only $575,” according to the report. “Many participants are likely to be surprised and disappointed when they find out how little their 401(k) plans provide.”
[See Retiree Net Worth Declines.]
Younger workers now have less in their 401(k) accounts than they did at the beginning of the three-year period. Households headed by people ages 45 to 54 saw their median 401(k) balance drop by $5,000, from $75,000 in 2007 to $70,000 in 2010. And younger households of people ages 35 to 44 had a median balance of $35,000 in their 401(k) plans in 2010, down from $44,000 in 2007.
Less saving. Employees could have contributed up to $16,500 to their 401(k) plan in 2010, and another $5,500 in catch up contributions if they were age 50 or older. But very few people ever save this much. Only 6.7 percent of workers contributed the most they could to their 401(k) plans in 2010, which is defined in the report as the tax deferral maximum or 25 percent of salary, down from 7.7 percent in 2007. Unsurprisingly, high income households earning $100,000 or more (28 percent) were much more likely to max out their 401(k) than middle income households earning $40,000 to $60,000 (1 percent).
Lower participation. The Pension Protection Act of 2006 made it easier for employers to automatically enroll workers in 401(k) plans. Some 42 percent of 401(k) plans automatically signed workers up for the 401(k) plan unless they opted out in 2010, up from 36 percent in 2007, according to Plan Sponsor Council of America data. However, despite the increased adoption of automatic enrollment, the portion of eligible employees who choose not to participate in their 401(k) plan increased slightly from 20 percent in 2007 to 21 percent in 2010, CRR found.
Less risky assets. Investors seem to have learned an important lesson about the importance of diversification in the wake of the recession. Retirement savers are now less extreme in their investment choices. The proportion of people who invest their entire 401(k) account balance in equities declined from 28 percent in 2007 to 23 percent in 2010. And some 13 percent of 401(k) participants held no equity in 2010, down slightly from 14 percent in 2007. Most retirement savers (64 percent) now hold a mix of stocks, bonds, and other assets, up from 58 percent in 2007. “Two explanations are possible: People moved away from all-stock portfolios in the wake of the 2008 stock market crash, and/or the increased use of target-date funds produced more diversified holdings,” according to the Boston College report. In 2010, 10 percent of all assets were invested in company stock, a proportion that has remained consistent since 2008, but is down from 14 percent in 2004.
More borrowing and early withdrawals. The job loss and financial hardships of the recession caused many people to use their retirement savings for everyday expenses. The proportion of individuals borrowing from their 401(k) plan increased from 13 percent in 2007 to 16 percent in 2010. And the average balance of the loan doubled from $6,607 in 2007 to $13,923 in 2010.
Up until the financial crisis, the share of 401(k) participants who received a lump sum distribution and did not roll the money over into another retirement account had been declining steadily from 55 percent in 2001 to 40 percent in 2007. But that decline reversed by 2010, when 45 percent of participants who withdrew money from a 401(k) plan failed to roll it over to another retirement account. “Cashing out even small amounts—that is, taking money out instead of rolling it over into an IRA or into an employer’s 401(k) —can substantially reduce ultimate accumulations,” according to the CRR report. “The 2010 Survey of Consumer Finances suggests that whereas the 401(k) system was starting to function better, progress has slowed and even reversed in the wake of the financial crisis and ensuing recession.”