Low Financial Literacy Rates Among Young People Indicate Retirement Savings Delays

On average, respondents to a survey by the SPARK Institute said they believe 30 is the proper age to begin saving for retirement.

A lack of financial education in both high school and college tends to correlate not only with low levels of overall financial literacy, but also with a lack of urgency to start saving for retirement, according to a new study conducted by the SPARK [Society of Professional Asset Managers and Recordkeepers] Institute in partnership with Corporate Insight Inc.

SPARK’s research examined the aptitude, behavior and confidence of nearly 1,600 recent hires (ages 19 to 35), college students (ages 18 to 23) and high school students (ages 14 to 18). More than 50% of all surveyed groups exhibited low levels of financial literacy, and respondents generally underestimated the time needed to save for retirement.

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On average, respondents thought 30 was the proper age to start saving for retirement. Among recent hires who still thought they have time to start saving, the average age increased to 40. Most student respondents also thought retirement savings began with a life milestone, like landing a first job or buying a house.

Savings Gap Causes

In the report accompanying the survey, SPARK pointed out that a lack of urgency in saving for retirement may delay workers from starting to save and therefore limit their ability to benefit from compounded growth over time.

Michael Ellison, president and CEO of Corporate Insight Inc., says waiting even a few years to begin saving for retirement can result in million-dollar losses to one’s retirement portfolio in the long-run.

Workers’ lack of awareness of the importance of starting to save early traces back to a lack of financial literacy, argues Tim Rouse, the SPARK Institute’s executive director. He emphasizes that there continues to be a “widening gap” between children who grow up wealthy—and are more likely to receive helpful financial advice from their parents—and children who grow up in lower-income households and do not have access to the same advice or resources.

Rouse also points out that many young people today look to social media for investing advice—primarily on TikTok—and are relying on information from uncertain sources.

According to the survey, parents were the most popular overall source of financial information and advice. Recent hires slightly preferred internet search results as their source, parents remained a strong source for them, as well. Employers, teachers and professional financial advisers were among the least frequent sources of information.

Continued Need for Education

In general, respondents felt their formal education did not prepare them well to make financial decisions. However, those who took specific finance education classes thought more favorably about their preparation level. Some 58% of high school respondents and 40% of college respondents reported taking one of these classes.

In terms of overall financial literacy rates, the survey found literacy aptitude rates consistent across all surveyed groups and that recent hires—despite being the oldest surveyed group—did not perform better on the assessment than respondents who were still in school. The respondents struggled most to understand the basics of inflation and the different between a stock and a mutual fund.

Rouse says SPARK is currently pushing for legislation that would require states to offer financial education classes in public high schools. According to Next Gen Personal Finance, only 26 states currently require students to take a stand-alone personal finance course in order to graduate. Two states—Alaska and Wyoming—and the District of Columbia currently have no financial literacy requirements.

The SPARK study also found that financial literacy rates were much lower among those who do not have a retirement account. Most of the respondents in the survey (69%) did not currently have a retirement account. Respondents said the top reasons they do not have a retirement account were because they have expenses that take priority over retirement and they do not make enough money to save for retirement.

Meanwhile, 76% of those who think they do not need to start saving and have more time said they were “very or extremely confident” in their ability to retire comfortably.

Ellison notes that automatic enrollment has helped recent hires start saving for retirement, regardless of their financial literacy level, but he argues that it does not make up for the issue of a lack of financial education. He says workers should not just “set it and forget it” when it comes to their retirement savings, because it is important to be at least somewhat engaged.

Ellison also says it is important that plan sponsors leverage their financial education and financial wellness resources with employees just entering the workforce. But overall, Rouse argues that more financial education is needed to encourage savings at an earlier stage of life.

Key Terms and What They Mean

Explaining the basics of the infrastructure underpinning 401(k) retirement accounts.

 

Key Terms and What They Mean

Retirement plans involve numerous legal requirements and terms. Given the scrutiny plans receive, sponsors should understand what key terms mean for their plan and its participants. Online definitions from the IRS are a good starting place; the Department of Labor also provides definitions for plans and for compliance with the Employee Retirement Income Security Act.

Plan Eligibility

Generally, a plan may require an employee to 1) be at least 21 years old and 2) have a year of service, typically defined as working at least 1,000 hours in a 12-month period, before the employee can participate in a plan. However, plans can allow employees to begin participation before reaching age 21 or before completing one year of service.

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Employers frequently provide more generous enrollment requirements to enhance employee recruitment, says Marc Fowler, director of retirement education with retirement plan provider Human Interest in San Francisco: “Often what we see is that they put immediate eligibility in place because that is very attractive in terms of being able to bring new talent into the organization.”

Matching Contributions

Defined contribution plans can structure matching contributions in several ways. These include:

  • Dollar-for-dollar match: Employers contribute $1 for every $1 an employee contributes, up to a certain percentage of the employee’s salary;
  • Single-tier percentage-based match: Employers match a fixed percentage of employee contributions, often up to a specified limit;
  • Multi-tier match: The match rate varies based on the employee’s contribution level or years of service;
  • Discretionary match: Employers determine the match amount yearly based on company performance or other factors; and
  • Safe harbor match: The plan’s match allows it to pass several nondiscrimination tests automatically.

Among Human Interest’s plans, about 70% use a single-tier formula; 23% have multiple tiers; 6% use dollar caps; various formulas are split among the remaining 1%.

“Typically, people want an easily describable, easily implemented plan when it comes to matching, and that tends to be the single-tier formula,” says Fowler.

Vesting Options

Some contributions vest 100% immediately, including:

  • Employee contributions, such as salary deferrals and Roth contributions;
  • Rollover contributions; and
  • Traditional safe harbor contributions.

The DOL states that, for an employer’s matching 401(k) contributions, employers can choose from two vesting schedules. The first option is cliff vesting, under which employees are 100% vested in employer contributions after three years of service. The second option is graded vesting, which requires employee vesting of at least 20% vested after two years, 40% after three years, 60% after four years, 80% after five years and 100% after six years. However, automatic enrollment 401(k) plans that require employer contributions must vest those contributions after two years.

Employers facing highly competitive hiring markets might consider immediate vesting, says Fowler. Companies with more frequent turnover of newer employees are likelier to use a graded vesting schedule.

True-Ups

A 401(k) plan true-up is an additional contribution the employer makes at the end of the year to give employees the total matching contribution to which they are entitled based on their total annual contributions. Shortfalls can occur when the employer matches annually but calculates matching contributions with each pay period. This practice can affect employees who make uneven contributions during the year, front-load their contributions early or join a plan later in the year.

 

Carol Buckmann, a partner in the law firm Cohen & Buckmann P.C. in New York City, notes that true-ups are not required, but the transactions benefit employees. She explains that at year-end, sponsors review employees’ total contributions for the year and calculate the hypothetical match if the employee had contributed evenly throughout the year. If the employee has received less than the calculated matching contribution, the employer adds additional funds to “true up” the account. Buckmann says this puts participants in the same position as if they had contributed evenly throughout all payroll periods.

Safe Harbors

401(k) plans face annual nondiscrimination tests to ensure that the plans benefit all employees and not just business owners or highly paid employees. Retirement plan safe harbor provisions allow 401(k) plans to satisfy specific nondiscrimination testing requirements automatically. Employers must commit to making the required contributions for the entire plan year.

Funding methods can include:

  • Basic match: The employer matches 100% of employee contributions up to 3% of compensation, plus 50% of contributions between 3% and 5%;
  • Enhanced match: The employer’s match that is at least as generous as the basic match. For example, a 100% match on the first 4% of employee contributions; and
  • Nonelective contribution: The employer contributes at least 3% of each eligible employee’s compensation, even if the employee does not contribute anything.

 

Safe harbor provisions simplify plan administration and benefit both employers and participants because:

  • Safe harbor plans automatically pass critical nondiscrimination tests;
  • Employer contributions are typically 100% vested immediately;
  • Higher contribution limits allow all employees, including highly compensated employees, to maximize their contributions; and
  • They reduce compliance burdens and associated costs for employers.

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