Industry Voices

Barry’s Pickings Online: A Default Payout Solution

Michael Barry, president of the Plan Advisory Services Group, discusses the fundamental principles of the 401(k) system, defaults and plan leakage.

By PS | May 02, 2017
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PS-Portrait-Article-Barry-JCiardiello.jpgArt by J.CiardielloOne of the things we are learning, as we strive to understand what “retirement policy” looks like in the 21st century, is that not everyone’s retirement income needs and capacities are the same. A variety of factors—different for every worker—affect that calculation.

Consider “family.” A worker/couple who has children will, on the one hand, have competing demands for available income—education and child raising expenses versus retirement savings—limiting her/their capacity to save. The USDA estimates the cost of raising one child at $233,610. That will put a strain on anyone’s ability to save, say, 10% to 15% of income for retirement. Think about what that strain is if you’re raising three or four children. On the other hand, even in an age in which personal autonomy is one of our highest values, the existence of family—and, particularly, working children—can provide a vital Plan B: in the worst case, you can move in with your kids. Lots of people do it. Obviously, workers/savers without children/family don’t have child-raising costs, but they also don’t have that emergency Plan B. They really need to save.

Also, some workers may have more outside resources than others: e.g., some people own their own homes; some don’t. Some workers have more flexibility than others: some people may, at retirement, be able to move to a low-cost of living community, dramatically reducing their income needs. For others, that is not an option. Some workers may have health issues that affect what they will need in retirement—on the one hand, (perhaps) larger health expenses, on the other (perhaps) a shortened life expectancy.

And, finally, some humans may simply have different views of time and life. Some may value time in their younger years more than time in their older years. I realize this notion is a controversial: conventional wisdom is that humans “hyperbolically discount” future values. But even accepting that theory, there is room for differing preferences. If you really like mountain climbing, you’re probably going to want to do it while you’re younger. For others, the goal of total financial independence and (perhaps) an early retirement is a more important value.

One of the features of 401(k) plans is that they allow different workers to make different choices about saving (and spending) levels. One worker can save a lot. Another can save nothing. This flexibility is one of the two major reasons why 401(k) plans have, for most sponsors and workers, replaced defined benefit plans, with their rigid, one size fits all design. (The other major reason is 401(k) plans’ greater transparency.)

Nevertheless, the consensus—with which I agree—is that humans have a natural bias towards spending rather than saving and thus should be encouraged to save. I’m prepared to accept some level of coercion to achieve that goal—e.g., the current levels of Social Security taxation/benefits. Beyond that, I favor non-coercive encouragement, the most effective and efficient version of which is (again, in my opinion) a “nudge”—defaulting individuals into some rough version of adequate savings, allowing those with a strong preference for a different (and conceivably lower) savings rate to affirmatively elect out of the default.

NEXT: 401(k) plan flexibility and “leakage”