Benefits May 18, 2021

What a Year Without Retirement Savings Can Do to Participant Outcomes

Scenarios show what a break in savings, as well as distributions and loans, can do to a participant’s retirement account balance, and experts share tips for helping participants get back on track.
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Art by Dan Page

As Americans faced financial hits related to the COVID-19 pandemic, their retirement savings might have suffered. Many employees were laid off or furloughed, and the Coronavirus Aid, Relief and Economic Security (CARES) Act made it possible for retirement plan participants to tap into their savings through increased distribution and loan amounts if they needed the money to make ends meet.

Fidelity Investments’ Pandemic Impact research, conducted last September, found employees were not only impacted by layoffs and furloughs during the pandemic, but that 5% stepped out from their jobs due to caregiving responsibilities. Nearly half (48%) of respondents said they or their spouse/partner were considering leaving work or reducing their current work hours. Women were two times as likely as men to make the decision to step out of the workforce due to caregiving responsibilities.

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“The problem compounds because women tend to live longer and will need more to live on,” notes Wei Hu, vice president of financial research at Edelman Financial Engines.

Aside from the pandemic, however, individuals might experience their own personal crises, and, in turn, stop saving for retirement or withdraw funds from their retirement plan accounts.

Ted Beal Jr., executive vice president with Equitable Advisors, says when a crisis happens—be it a personal loss of income or a spouse losing a job—“we see the innocence of people reacting to the moment.” People quickly turn to what they can do to manage their monthly cash flow and don’t realize the impact their actions may have, he says.

“It’s important to show the impact,” Beal says. “Plan sponsors don’t always do that, but it’s important to get that message through.”

Ed Farrington, head of retirement and institutional investing at Natixis Investment Managers, says retirement plan professionals spend a lot of time talking about the rate of return on investments, but with retirement planning, other things often have a greater impact. A person’s contribution rate, consistency in making deferrals and the length of time they contribute are of greater significance for account balances.

“So taking a break from contributing has a tremendous amount of impact,” he says. “Many folks were out of work so they couldn’t contribute, but some became scared and suspended contributions.”

In addition, Farrington notes that many participants took advantage of the greater loan and withdrawal provisions of the CARES Act—Natixis saw about three in 10 do so—which creates a long-term disruption in the ability to accumulate enough savings for retirement.

“When it came to contribution rates and tapping into savings, while much was driven by very real circumstances, for many people the reason was fear,” Farrington says. “Sometimes our own perceptions cause us to make mistakes. We all learn over time that patience and trying to avoid rash decisions can have a positive effect.”

Farrington adds that missing out on the days when the market goes up has an outsized impact on the ability to capture long-term returns.

“We owe it to participants to continue that message of contribution rate, consistency and time,” he says. “And we should tell participants not to let fear drive them to make decisions that have a negative impact. Understand that events change.”

Scenarios

Beal provides some scenarios that show how consistency in contributing to a retirement plan makes a difference to participant outcomes:

Scenario 1: “Jenny” started contributing $300/month at age 25. Assuming a rate of return on investments (ROI) of 6%, her account value at age 67 would be $684,453.30.

Scenario 2: Jenny started contributing $300/month at age 25 but stopped contributing at age 30. Then, at age 31, she restarted with the same $300/month contribution amount. Assuming the same 6% ROI, her account value at age 67 would be $652,376.95.

Scenario 3: Jenny started contributing $300/month at age 25 but stopped at age 30. Then, at age 35, she restarted with the same $300/month contribution amount. Assuming the same 6% ROI, her account value at age 67 would be $541,654.70.

Jenny's Account Values at Age 67

no break in contributions
$684,453.30
one-year break in contributions
$652,376.95
five-year break in contributions
$541,654.70

Not contributing for one year reduced Jenny’s account value at age 67 by $32,076.35. Not contributing for five years increased the reduction to $142,798.60. The scenarios show how important it is to restart contributions as soon as possible, as well as the reality for many women who have to take an extended break from work due to caregiving responsibilities.

Eliza Guilbault, vice president on Fidelity’s Thought Leadership team, offers a scenario that considers not only a career break for a woman, but what happens if the woman dips into her retirement savings during the break to make ends meet.

Scenario: A woman, starting at age 50, making $100,000/year, takes a three-year career break and takes $40,000 out of her account in year one, another $40,000 out in year two, and yet another $40,000 out in year three (for a total of $120,000). She goes back to work at an 18% pay cut after the third year and continues to save (at a 9% deferral rate plus a 3% match) until age 67. This assumes a 4.5% real rate of return each year until age 67 and estimates the woman would have experienced a 1.22% real annual salary growth rate. It doesn’t account for any penalties or taxes that might apply to the distributions.

Account Balance at Age 67 Without Withdrawals

no career break
$1,400,941
one-year career break
$1,322,341
two-year career break
$1,301,278
three-year career break
$1,281,254

Account Balance at Age 67 With Withdrawals and a Three-Year Career Break

withdrawals at the beginning of each year
$1,038,411
withdrawals at the end of each year
$1,048,869

The difference between those two calculations occurs because the $40,000 would have participated in investment returns for the year if she took it out at the end of each career break. Guilbault’s scenario also demonstrates how retirement savers who take a break miss out not only on returns, but also on any employer match that is provided.

Brad Griffith, a financial planner at Buckingham Advisors, a registered investment adviser (RIA) in Dayton, Ohio, notes that while the CARES Act waived early withdrawal tax penalties for coronavirus-related distributions (CRDs), individuals still have to report the withdrawal as income when filing tax returns, although the law said they can do so over a three-year period.

“In addition to having a large tax hit, participants taking a distribution at that time would have unplugged the funds from investments and missed out on the rapid stock market recovery,” he says. “From March 31, 2020, to April 30, 2021, the S&P 500 rebounded about 62%, so those who took the maximum $100,000 distribution shortly after the passage of the CARES Act could have locked in a federal tax hit of up to $37,000 and missed out on over $62,000 in market appreciation.”

Adding in compounding, with an 8% assumed rate of return, the distribution would result in a $213,000 reduction in the participant’s account balance after 10 years, a $461,000 reduction after 20 years and a $996,000 reduction after 30 years, he says.

Helping Participants Catch Up

Employees who have taken a break from saving for retirement might not be able to restart at the same savings level, but they should start with something, and they can increase contributions later as their situations change, Beal says.

“Plan sponsors should also help employees understand that when they make a pre-tax contribution to their retirement account, they won’t see a decrease in pay at 100% of their savings level,” he says. “Reiterating that message every year will encourage people to save.”

Beal notes that employees may get busy and forget to restart their contributions or, for young people, think that retirement just seems too far off. “Using numbers to show how a little deviation early in life can have a tremendous impact will help employees jump back in,” he says.

Guilbault says plan sponsors should encourage employees who return from a work break or who have stopped contributing to their retirement plans to get right back into saving, but emergency savings may be the priority. “Plan sponsors should provide education about why having short-term savings is important, so employees won’t have to dip into their defined contribution [DC] plan again,” she says.

For those who can restart retirement savings contributions, Hu says plan sponsors should encourage them to defer enough to get the full company match, if one is provided.

“We also encourage automatic enrollment and increasing deferral amounts automatically,” Guilbault adds.

Hu suggests plan participants be given access to a financial adviser to develop a savings and investing plan.

Farrington says it is very difficult for participants to make up for lost time, but there are things they can do to make up some of it. “If someone feels better financially—jobs are coming back, vaccinations lead to less fear—they may start to ask, ‘Can I afford to contribute more?’ They can look at their budget and see if it is feasible,” Farrington says. “If the person is 50 or older, they should determine if they can avail of catch-up contributions. Some folks are unaware of the ability to contribute catch-ups.” The key, he says, is to act quickly and contribute more, and really prioritize retirement savings now.

Griffith and Beal say participants who are able to repay the CRDs back to their qualified plan accounts within the three-year period should do so to replenish their savings and get back on track for their retirement goals.

“Participants need to be encouraged to pay the money back if they are able so they won’t have a big tax bill,” Beal says. He suggests plan sponsors and participants work with recordkeepers to set up installments to repay the CRDs.

“There are no structured repayments as there are with participant loans. Participants have to stay on track with loans or they will default, but there was no guidance or mandatory time frame regarding paying back CRDs,” Beal says. “Plan sponsors should educate employees about coming up with some kind of payment schedule and work with their providers to make that efficient, whether through payroll deductions or self-payments.”

If participants can’t manage to make regular contributions and pay back distributions, Guilbault says contributing up to the maximum match rate should come first. “We encourage a total savings rate—employee plus employer contribution—of 15%,” she adds.

Re-establishing contributions might take baby steps, Beal says. Plan sponsors can remind participants to align their savings with the return of their cash flow.

Plan sponsors can also lean on service providers for guidance in helping participants reset, Beal says. Providers can offer illustrations to identify the potential loss of savings and provide easy ways to opt in. Plan design features such as automatic enrollment and automatic deferral escalation are other ways to help participants. “The more plan sponsors can make it easy for participants, the more likely participants will make the right choices,” he says.

Going forward, plan sponsors can also take a broader benefits approach to help employees avoid having to step out of the workforce. Guilbault suggests a benefits package that includes access to child care, family leave policies and employee assistance programs (EAPs) for mental health support.

“Some people took money out of their plan accounts to pay medical bills. If they had HSAs [health savings accounts], they could have used them,” she adds. “All benefits are related to financial well-being.”

Farrington says plan sponsors are increasingly understanding that holistic benefits help with retirement savings.

“It’s about the participant’s personal balance sheet. They can increase their assets, but if their liabilities are increasing at a faster rate, it is not helpful,” he says. “Employers can have a huge impact on an employee’s quality of life now and in retirement by offering financial wellness benefits, such as student loan debt help.”

Beal adds that it’s important to educate participants about taking loans and distributions and the effect that will have on their savings.

Investing April 16, 2021

The Benefits of Stable Value Funds for Plan Participants

Stable value is touted as helping near-retirees manage sequence risk, should they have the misfortune of retiring into a downturn, but these investments offer advantages for participants of all ages.
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If plan sponsors are looking for reassurance that stable value investments are beneficial to retirement plan participants, they need look no further than the Stable Value Investment Association (SVIA)’s fourth quarter 2020 survey, which found that assets in these vehicles rose 12% throughout the year to $906 billion, to now comprise 10% of all defined contribution (DC) plan assets.

Even though the market rebounded last year after a sharp drop-off, participants reacted differently to that decline, with many moving to the safety of stable value, notes Gina Mitchell, president of the SVIA.

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“That 12% increase was pretty tremendous, compared to what we have seen from year to year,” she says. “What participants respond to so favorably with stable value is that the investment contracts provide capital preservation, as well as positive returns and the liquidity that people in defined contribution plans want. At the end of 2020, the credit rate for stable value was 2.17%.

Looking at a decade’s worth of stable value data gathered from recordkeepers, SVIA found that 85% of stable value assets are held by participants age 50 and older, says Nick Gage, head of stable value contract strategy at Galliard Capital Management and chairman of SVIA’s board of directors. The research, which looked at data between 2010 and 2019, covered 125,000 plans with a total of $4.5 trillion in assets and 42 million participants.

Another important consideration for older workers, particularly those nearing retirement, is that they face sequence risk, meaning, for example, that at the start of the pandemic, similarly to the situation in 2008, the portfolios of anyone close to retirement or actually retiring would have been hit hard as they took withdrawals in a down market, says Patricia Selim, head of stable value at The Vanguard Group and chairwoman of SVIA’s communication and education committee.

“This is the very reason Congress passed legislation to pause on required minimum distributions [RMDs] last year, to try to limit the impact of sequence of return risk,” she adds. “With stable value, we think of preservation of investments, stability of return and help mitigating sequence risk. When you cannot manage volatility, stable value investments provide stability.”

Gage adds: “Our experience validates the information in the survey. Participants nearing or in retirement rely on stable value’s preservation and attractive rate of return, as they look to transition from accumulating and investing their assets to maintaining their standard of living in retirement. This is a meaningful contributor for participants.”

Selim notes that stable value delivers higher returns than money market funds and appears to be sponsors’ preferred principal preservation offering. “Sixty-three percent of plans offer them,” Selim says.

Younger participants investing in stable value are likely interested in the funds because knowing that a portion of their money is in safeguarded investments permits them to take higher risks with other assets, Gage and other executives say. Mitchell notes that it can be used as a buffer that permits retirement plan investors to dial up their equity asset allocations. “Stable value acts as a shock absorber,” she says.

Tom Schuster, head of stable value at MetLife, says financial goals, risk tolerance, total assets held, time to invest and experience differ for each individual. Schuster says depending on these factors, he can see stable value being appropriate, at least at some level, for individuals of all ages.

“The percentage is really a factor of risk tolerance,” he says. “We view stable value as the pre-eminent fixed-income asset allocation in a portfolio. Whatever their age, the participant can adjust their equity-to-stable value mix for their own risk tolerance.”

He says, generally speaking, younger participants have a longer time horizon, so they should have more equity in their portfolio—but they might have individual objectives that would warrant more exposure to stable value. “Perhaps they are planning to use a loan from their 40(k) to finance a down payment on a house,” he says. “In that instance, it might be completely appropriate for them to have 100% of their money in stable value. Ultimately, the right mix comes down to individual goals and objectives and what they are hoping to achieve in their retirement plan.”

Schuster says he is increasingly hearing about people retiring before their full retirement age, when Social Security benefits would be at their maximum, and investing in stable value to “bridge” those gap years.

“For someone born in 1960 who delays taking their Social Security from age 62 to age 70, that would increase their monthly benefit by 77%. If they took that leap without investing in stable value or another safe asset, they might see their available assets dwindle, which could potentially force them to return to the workforce, so, instead, they allocate 100%, or a large portion of their portfolio, to stable value, and once they commence Social Security benefits, they have that guaranteed floor that allows they to invest a portion of their portfolio back into equities.”

James Martielli, head of investment solutions in the institutional investor group at The Vanguard Group, says his firm views retirement plans as achieving four main goals: basic income, discretionary income, contingency income and legacies. “Stable value can give retirees peace of mind that they can meet those contingency goals, such as unexpected expenses.”

When selecting a stable value option, Martielli says it is important for sponsors to assess a fund’s performance, risk mitigation, team and process.

“Taking a look at performance is as important as understanding the market to book value,” he says. “Sponsors need to look at what the overall market value of the bond is relative to its book value. It should be higher than its peers. By risk mitigation, I mean looking at the underlying credit quality of the bonds. Some stable value products may generate higher returns but take on higher risk. Look for an experienced team doing this for quite some time and using a robust process. These are all important criteria to look at because not every stable value fund is the same.”

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