2 5 3 4 6 Figure 3 Figure1 Change in Average Account Balances Among a Consistent Sample of Additional Research 401(k) participants present from Needed to Better Understand year-end 1999 through How the Fin year-end 2006, ancial Crisis is Affecting by age and tenure for three 401(k) Change in Average Account Balances Among a Consistent Sample of Impact of the Current Financial Crisis on Retirement Security Testimony for the a a different periods: Participants 401(k) Participants, by Age and Tenure, Jan. 1, 2000–Oct. 1, 2008 401(k) Participants, by Age and Tenure, Jan. 1, 2008–Oct. 1, 2008 By Jack VanDerhei, EBRI The primary reason for using the consistent sample as the basis for analysis in the preceding • January 1, 2008, through October 1, 2008 (Figure 1); 800% 0% House Education and Labor Committee section is the current inability to track workers as they move from one 401(k) sponsor to another, and/or • January 1, 2007, through October 1, 2008 (Figure 2); and Job Tenure (in years) Job Tenure (in years) Mr. Chairman and members of the committee, thank you for your invitation to testify today on to follow their retirement assets if the 401(k) assets are rolled into an IRA. EBRI is currently in the as of 2006 • January 1, 2000, through October 1, 2008 (Figure 3). as of 2006 700% the impact of the financial crisis on retirement security. I am Jack VanDerhei, research director of the -2% process of enhancing our research capabilities to allow this kind of data to be captured. This will allow 6–10 6–10 Employee Benefit Research Institute. EBRI is a nonpartisan research institute that has been focusing on 600% Youngest workers, linking of accounts across data providers within our universe of individual account plans, resulting in a This “consistent sample” of 401(k) participants w as created several years ago in the annual analysis 11–20 shortest tenure 11–20 retirement and health benefits for the past 30 years. EBRI does not take policy positions and does not -4% more complete and accurate retirement picture—such as measuring the effect of rollovers, multiple of EBRI/ICI 401(k) data to provide an estimate of changes in average annual account balances that was 500% 21–30 lobby. 21–30 Youngest workers, accounts, job turnover, account leakage, etc. not biased downward by job turnover of 401(k) participants. Oldest workers, shortest tenure Although there is no clear definition of the time period for the “current financial crisis,” this -6% longest tenure 400% Another research topic that is urgently needed to better understand the vulnerability of 401(k) For this analysis, contributions in 2007 and the first nine months of 2008 were assumed to be equal to The Impact of the Financial Crisis testimony defines it as the first nine months of 2008. During that time, major equity indexes were participants to volatility in the equity markets deals with the topic of target date funds. Figure 4 shows for the participant’s 2006 contributions, adjusted for changes in average national wage during that period. 300% negative, with the S&P 500 Index l on Workers’ Retirement S osing 19.29 percent. Fixed-income investm ecurity ents fared much better -8% the consistent sample described above the asset allocation distribution of 401(k) participant account Loan and withdrawal behavior were estimated based on 2006 experience for similar employees. These Oldest workers, during this period, with the Lehman Aggregate Index gaining 0.63 percent and three-month T-bills longest tenure balances to “ 200% equity” by age, as of December 31, 2006. Equity in this figure is defined as the percentage of estimates will be biased if asset allocation of current contributions, or contribution, loan or withdrawal gaining 1.54 percent. -10% Oct. 7, 2008 the participant’s 401(k) funds in equity funds, company stock and the equity portion of balanced and/or behavior has changed since 2006 (presumably in response to the fluctuations in the financial markets). 100% The impact of the current financial crisis on defined benefit (pension) plans is impossible to 2175 Rayburn HOB, Washington, DC target date funds. The figure shows that 43 percent of young 401(k) participants (those 35 or younger in However, Hewitt Associates, LLC, has recently stated that participants “appear to be taking a long- quantify, but it is obvious that a marked reduction in funding ratios and/or increase in volatility may make -12% 2006) have 90 percent or more of their 401(k) assets in equities (broadly defined). Another 15 percent of 0% term investment strategy for their 401(k) retirement assets by choosing an asset allocation and staying Up to Age 35 Up to Age 35 Age 36–45 Age 36–45 Age 46–55 Age 46–55 Age 56–65 Age 56–65 continued sponsorship of these plans less attractive under some forms of pension accounting 4 this cohort have 80–90 percent of their assets allocated in this fashion, and another 11 percent have 70–80 with it,” and that net transfer activity was “consistently low.” Fidelity has also reported that participants Age Age modifications. Moreover, the Pension Protection Act of 2006 (PPA) has established specific restrictions 5 (as of 2006) (as of 2006) percent allocated to equities. did not increase their borrowings from 401(k) accounts in 2007 and the first half of 2008. However, with respect to freezing of accruals, plan amendments and lump-sum distributions as a function of 6 Although many asset allocation models and/or financial advisors may suggest that extreme Sources: 1999 and 2006 Account Balances: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. hardship withdrawals are on the rise in the first half of 2008 compared with the first half of 2007. Sources: 1999 and 2006 Account Balances: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. funding ratios 2007 and 2008 Account Balances: EBRI estimates. The analysis is based on a consistent sample of 2.2 million participants with a . Recent estimates from Watson Wyatt projected that pension plans would be ccount balances at 84 percent concentrations to equities for the 2007 and 2008 Account Balances: EBRI estimates. The analysis is based on a consistent sample of 2.2 million participants with a young cohorts would be acceptable, it is less certain that thos ccount balances at the end of e Figure 1 shows that for the first nine months of 2008, the percentage loss in average account the end of each year from 1999 through 2006. 1 each year from 1999 through 2006. funded as of Sept. 24, down from 91 percent in the second quarter. a a approaching retirement would receive similar recommendations. Nevertheless, Figure 4 shows that more Age and tenure groups are based on participant age and tenure at year-end 2006. balances a Age and tenure groups are based on participant age and tenure at year-end 2006. mong 401(k) participants in the consistent sample varies from a low of –7.2 percent for the Considerably more is known about the immediate impact of the current financial crisis on defined than 1 in 4 (27 percent) of the oldest 401(k) participants (age 56-65 in 2006) had 90 percent or more of oldest cohort (age 56–65 in 2006) with the shortest tenure with the 401(k) sponsor (six to 10 years in Presented by: contribution plan (primarily 401(k)) participants. It should be emphasized that while older employees their 401(k) assets in equities. Another 11 percent had 80-90 percent in equities, and 10 percent had 70– 2006), to a high of –11.2 percent for the youngest cohort with 21–30 years of tenure. The reason that this have average equity allocations that are lower than their younger counterparts (and hence are thought by 80 percent in equities. particular group has the lowest average loss is a function of the reduced equity exposure they take (on Jack VanDerhei some to be less vulnerable to negative returns in the equity markets), their average account balances are Target date funds with automatic rebalancing and a “glide path” ensuring “age-appropriate” asset average), as well as the larger ratio of contributions to account balance given their relatively short tenure. significantly larger and therefore have more to lose in a significant downturn. Employee Benefit Research Institute (EBRI) allocation are likely to become much more common after full implementation of PPA, with the expected The group with the largest average loss is those young enough to still have a relatively large equity Research has shown that a worker’s age is a major factor in his or her ability to recover from an T-156 increase in automatic enrollment for 401(k) plans and the attendant interest in QDIAs. Based on exposure in their accounts, compared with the others in the long-tenure cohort. economic downturn. Holden and VanDerhei (2002) simulated the likely impact of a major bear market— unpublished EBRI research, the average equity allocation for target date funds designed for individuals in Figure 3 broadens the time span under analysis and shows that, even with the financial market defined as three consecutive years of a –9.3 percent annual return—on the overall (nominal) replacement the 56–65 age range was 51.2 percent at year-end 2006. That would imply that approximately one-half of setback suffered so far in 2008, the percentage change in average account balances from January 1, 2000, rates that could be provided by “401(k) accumulations” as a function of when the downturn occurred the consistent sample participants in the age 56–65 age category would have had at least a 20 percent Figure 4 through October 1, 2008, was significantly positive for all groups and all age cohorts in the two shortest- 7 during the employee’s tenure with the plan sponsor. reduction in equities at year-end 2006 if they were allocated 100 percent to target date funds. tenure categories to have at least doubled their account Dec. 31, 2006 Asset Allocation Distribution of 401(k) balances (in nominal terms). The largest increase Figure2 Based on a median replacement rate of about 51 percent of final income, the modeled three-year EBRI is currently conducting an analysis of target-date funds for defined contribution plans. This was again experienced by the group with the youngest workers and shortest tenure (706 percent), in large Participant Account Balances to “Equity,” by Age Change in Average Account Balances Among a Consistent Sample of downturn would result in a lower replacement rate for 401(k) participants in the lowest-income quartile of project will incorporate three distinct, but interrelated, phases. The first phase will provide an empirical part due to greater weight of their contributions as compared with investment earnings or losses. Those a only –3.2 percentage point 401(k) Participants, by Age and Tenure, s at the beginning of their career, or –7. Jan. 1, 2007–Oct. 1, 2008 5 percentage points for those in mid- analysis of the use of target-date funds in 401(k) plans. The second phase will focus on a conceptual having the lowest increase were the oldest workers with the longest tenure (55 percent); however this 2 career (ages 39–41), or – “Equity” 13.4 percent for is defined as equity funds + company stock + the those at the end of their career. analysis of the optimal construction of target-date accumulation principles for defined contribution plan 8% number needs to be interpreted carefully in light of the ability of many employees to start taking in- However, building and/or modifying a simulation model that is able to quantify the likely impact relevant portion of balanced and target date funds participants, including the extension of these principles into the decumulation phase. The third phase will service distributions from their plans at age 59-½. 80% of a market downturn on eventual retirement income is a lengthy process. Consequently, attention is include an empirical analysis of the choice of target-date funds by plan sponsors and correlates with 6% Youngest workers, typically focused on how a decline in the financial markets has impacted the average defined contribution employee demographics shortest tenure 70% and plan design variables. Hopefully, the additional insights generated by this Job Tenure (in years) plan balances. For purposes of this testimony, EBRI has taken the most recent information in the research will assist in providing a more informed asset allocation for those nearing retirement age. 0.7-0.8 4% as of 2006 0.7-0.8 60% EBRI/ICI 401(k) database (year-end 2006) and used employee-specific information as well as financial 6–10 3 market indexes to estimate the percentage change in average account balances am 0.7-0.8 ong the 2.2 million 50% 0.8-0.9 11–20 2% 0.8-0.9 21–30 1 0.7-0.8 “DB plan funding40% and DC allocations steady,” Pensions and Investments, Sept. 29, 2008. 0.8-0.9 0% 2 0.8-0.9 4 For 401(k) participants in the highest income quartile, the median replacement rate decreased by 3.7 percentage 30% The Employee Benefit Research Institute (EBRI) is a nonprofit, nonpartisan research institute that focuses “DB plan funding and DC allocations steady,” Pensions and Investments, Sept. 29, 2008. points if the market downturn would occur at the beginning of the career. The decrease was estimated to be 10.4 on health, retirement, and economic security issues. EBRI does not take policy positions and does not 5 -2% >0.9 Financial Week, “W 20% orkers swearing off 401(k) lo >0.9ans, says survey,” (Aug. 19, 2008). Online at percentage points if it took place at the middle of the career. If the market downturn took place at the end of the lobby. www.ebri.org >0.9 Oldest workers, www.financialweek.com/apps/pbcs.dll/article?AID=/20080819/REG/860878 career, the estimated decrease was 17.7 percent. These percentage point decreases for this group were based on a >0.9 longest tenure 10% -4% 6 median replacement rate of 67.2 percent of final income, assuming a regular stochastic simulation of equity returns. Business Insurance, “Large Plan Providers Report Drop in 401(k) Loans by Workers – But Hardship Withdrawals Up to Age 35 Age 36–45 Age 46–55 Age 56–65 3 0% on the Rise As Employees Struggle with Economic Difficulties Arising Out of Credit Crisis,” (Sept. 8, 2008). For purposes of this analysis, investment returns were proxied Age by one of the following three index returns: S&P (as of 2006) up to 35 36-45 46-55 56-65 Online at www.businessinsurance.com/cgi-bin/article.pl?articleId=25814&a=a&bt=large+plan+providers 7 500 Index, Lehman Aggregate Index or three-month th T-bills. These asset classes were assumed to have fees of 45, Employee Benefit Research Institute, 1100 13 It is possible that some of these participants were i Street, NW, Suite 878, Washington, DC 20005 nvested in company stock via employer matching contributions Sources: 1999 and 2006 Account Balances: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. Age (as of 2006) 45 and 75 basis points, respectively. 2007 and 2008 Account Balances: EBRI estimates. The analysis is based on a consistent sample of 2.2 million participants with account balances at the end t hat were not able to be diversified. of each year from 1999 through 2006. a Source: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. The analysis is based on a consistent Age and tenure groups are based on participant age and tenure at year-end 2006. sample of 2.2 million participants with account balances at the end of each year from 1999 through 2006. Jack VanDerhei, EBRI— Jack VanDerhei, EBRI— Jack VanDerhei, EBRI—H H House Ed ouse Ed ouse Educ uc ucation and Labor ation and Labor ation and Labor C C Co o ommittee Testimony— mmittee Testimony— mmittee Testimony—07 Octobe 07 Octobe 07 October r r 2008 2008 2008 Jack VanDerhei, EBRI—House Education and Labor Committee Testimony—07 October 2008 Jack VanDerhei, EBRI—House Education and Labor Committee Testimony—07 October 2008