Most Americans have fallen far behind in retirement savings, but the outlook for 401(k) retirement plans looks brighter as both employers and employees bolster contributions that fell or stopped altogether during the Recession.
Defined contribution - or 401(k) - plans are emerging from the financial wreckage of the Recession as the most viable retirement savings programs available. Economic hardship has accelerated trends by employers – both public and private – to curtail traditional pension plans and offer 401(k) plans as an alternative. At the same time many employers, faced with shrinking profits in the past few years, lowered or discontinued employer matches to the plans. Workers also reduced their contributions as they struggled with layoffs, reduced hours and wages, increased health care costs and the rising costs of educating their children. Assets held in 401(k) also fell sharply with the stock market declines of the Recession.
These and other factors have combined to create a “retirement deficit” of $6.6 trillion, said the non-profit Retirement USA. The group defines the deficit as the gap between what Americans have saved and what they should have saved to maintain their current standard of living in retirement.
This deficit covers workers in peak earning and savings years – those 32 to 64 – as well as retirees, and takes into account Social Security, pensions, 401(k) plans and other forms of savings, and assumes that retirees will spend down all their wealth, including home equity, in retirement.
The 401(k) is the primary retirement savings vehicle for private sector employees and accounts for 62 percent of the assets held in private sector retirement plans, said Spectrem Group in its 2011 Retirement Market Insights. The 401(k) provides tax-deferred growth, as well as matching contributions from employers. The matches are voluntary and are typically calculated as a percentage of the employees’ contribution. The plan terms depend on the arrangements the employer makes with one of the many companies who provide 401(k)s.
The picture is improving for 401(k) plans, which have recovered value during the stock market’s sustained recovery. Total assets in employer-sponsored retirement plans increased to $10.2 trillion in 2010, up 11 percent from $9.3 trillion at the end of 2009, reports Spectrem, but over the past five years growth averaged just under 5 percent annually.
“Assuming the country avoids another major market decline similar to that of 2008, asset growth should return to more robust levels over the next five years,” said Gerald O’Connor, Spectrem retirement specialist. “Assuming investment returns at historic averages, asset growth should average 8 percent to 10 percent annually over the next five years.”
Employers are also moving to restore matching contributions that were reduced or eliminated due to the financial crisis, but overall the percentage of match and the average matching amount remains below 2007 levels, Spectrem reports. Three-fourths of small businesses now offer 401(k) retirement plans, but of these 20, percent are offering lower matches than two years ago, 13 percent have discontinued matches within the last two years and 14 percent do not offer matches.
Investment in 401(k) plans is shifting back toward diversified equities following two years of strong stock market returns. Features, such as asset-allocation funds and target date funds, which are designed to help investors achieve their long-term goals, are growing in popularity.