Automatic 401(k)s Aid Retirement Readiness

Study shows that new account rules are making a big contribution to financial preparedness.

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People are more prepared for retirement than they were seven years ago, according to a recent study by the Employee Benefits Research Institute (EBRI), one of the major think tanks in the retirement space. EBRI compared its 2010 Retirement Readiness Rating with a similar rating it did in 2003. While anywhere from 43 to 47 percent of adults aged 36 to 62 are at risk of not having enough money for retirement, the comparable percentages in 2003 ranged from nearly 55 to 59 percent. The main cause of the improvement, EBRI said, was the 2006 Pension Protection Act, which requires the automatic enrollment of employees in 401(k) plans unless they opt out of the programs.

[ See America's Best Affordable Places to Retire.] The benefits of the law extend to the emergence of target date funds as the primary default investment choice for 401(k) plans. These funds are geared to the planned retirement date of employees, and automatically shift assets into increasingly conservative investments over time. They also provide automatic rebalancing of portfolios, which is a fundamental recommendation from investment experts but one that is often not followed when investors have to do the rebalancing themselves. While the funds were criticized for losing a lot of money in the 2008-09 market downturn, subsequent studies have shown that they lost less money than many other investments and have performed well since then.

Underneath the improvement, the EBRI study noted, Americans remain poorly prepared for retirement. Only a bare majority of people even have a 50-50 chance of having enough money in retirement. And "enough" is defined as a very modest level of household spending and money to pay for uninsured medical expenses. EBRI provided other snapshots of the data that found much less preparedness for people who wanted higher odds they would have enough money. For example, among people in the top quarter of all income earners, nearly 20 percent don't have enough set aside to assure a 100 percent chance of an adequate retirement. For the lowest-income quarter, more than 75 percent fail to have such complete assurance.

[See 10 Essentials for Successful Retirements.]

EBRI also looked at when people would run short of money:

-- After 10 years of retirement, 41 percent of those in the lowest (preretirement) income quartile are assumed to have run short of money, but only 23 percent of the next-lowest quartile, 13 percent of the third quartile, and less than 5 percent of the highest-income quartile.

-- After 20 years of retirement, the numbers are 57 percent of those in the lowest-income quartile, 44 percent of the next-lowest quartile, 29 percent of the third quartile, and 13 percent of the highest-income quartile.

The study also calculated how much more money people would have to set aside to achieve varying likelihoods of having sufficient retirement incomes.

"If additional savings were to be provided at levels high enough for 3 of 4 households . . . to have a 50/50 chance of retirement income adequacy," the study said, "the lowest-income quartiles of both the Early and Late Boomers would need to save more than 25 percent of compensation per year. The lowest-income quartile for 'Gen Xers' would require less (17 percent), but this is still an amount that would be extremely difficult for most households to save."

The EBRI study was based on extensive information on the status and performance of all major sources of retirement income, including 401(k)s, IRAs, private pensions, and Social Security. It said its projections assumed that stocks would return 8.9 percent a year and bonds 6.3 percent. Using lower returns -- 4.45 percent for stocks and 3.8 percent for bonds -- adds between 6 and 9 points to the percentages of people who are not prepared for retirement.

[See Lifetime Income is an Elusive Goal.]