Can 401(k) Accumulations Generate Significant Income for Future Retirees?
Nov 1, 2002, 00:00 AM
Young workers with high earnings who maintain 401(k) plans throughout their working years and retire at 65 are expected to receive median initial annual retirement benefits of 83-85 percent of what they were earning at the end of their careers, according to a study released today by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI). The study finds that this "replacement rate" of preretirement income—which also includes expected Social Security benefits under the current system—could exceed 100 percent of preretirement income for those with low earnings.
Can 401(k) Accumulations Generate Significant Income for Future Retirees?
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• This Issue Brief develops a model that projects the proportion of an individual’s preretirement income that might be replaced by 401(k) plan accumulations at retirement, under several different projected scenarios. The 401(k) participant behaviors are derived from an analysis of 2.5 million 401(k) participants drawn from the year-end 2000 database collected by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) in their collaborative effort known as the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project.
• The most significant factor affecting projected replacement rates at retirement is having access to a 401(k) plan. Projected replacement rates at retirement are reduced significantly when participants are not offered a 401(k) plan in all portions of their careers.
• Most 401(k) participants tend to have contributions in any given year. Thus, projecting that participants always have contributions (their own and/or employer contributions) every year raises projected replacement rates, but not by much compared with the importance of being offered a plan to begin with.
• The model simulations show that participant activities such as taking loans, taking preretirement withdrawals, or cashing out account balances at job change reduce projected 401(k) accumulations and thus replacement rates at age 65. Because loans are forecast to be paid back to the account in full, their effect on replacement rates at retirement in the model is the smallest.
• Even if equity returns in the future are projected to replicate the worst 50-year segment in the Standard & Poor’s (S&P) 500 history (1929 to 1978), 401(k) accumulations are still projected to replace significant proportions of projected pre-retirement income.
• Another projection scenario forecasts participants experiencing a simulated three-year bear market (negative equity returns) either early in their careers, near the middle of their careers, or at the end of their careers. Forecasts of the effects of bear markets on 401(k) balances show that a bear market in equities is projected to have the largest effect the closer it occurs to age 65 (retirement), even though older participants typically have diversified their portfolios away from equities.
• Similarly, a simulated three-year bull market (positive equity returns) is projected to have a larger positive effect on projected account balances and replacement rates the closer to retirement it occurs.
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Can 401(k) Accumulations Generate Significant Income for Future Retirees?
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Can 401(k) Accumulations Generate Significant Income for Future Retirees?
Summary
• This Issue Brief develops a model that projects the proportion of an individual’s preretirement income that might be replaced by 401(k) plan accumulations at retirement, under several different projected scenarios. The 401(k) participant behaviors are derived from an analysis of 2.5 million 401(k) participants drawn from the year-end 2000 database collected by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) in their collaborative effort known as the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project.
• The most significant factor affecting projected replacement rates at retirement is having access to a 401(k) plan. Projected replacement rates at retirement are reduced significantly when participants are not offered a 401(k) plan in all portions of their careers.
• Most 401(k) participants tend to have contributions in any given year. Thus, projecting that participants always have contributions (their own and/or employer contributions) every year raises projected replacement rates, but not by much compared with the importance of being offered a plan to begin with.
• The model simulations show that participant activities such as taking loans, taking preretirement withdrawals, or cashing out account balances at job change reduce projected 401(k) accumulations and thus replacement rates at age 65. Because loans are forecast to be paid back to the account in full, their effect on replacement rates at retirement in the model is the smallest.
• Even if equity returns in the future are projected to replicate the worst 50-year segment in the Standard & Poor’s (S&P) 500 history (1929 to 1978), 401(k) accumulations are still projected to replace significant proportions of projected pre-retirement income.
• Another projection scenario forecasts participants experiencing a simulated three-year bear market (negative equity returns) either early in their careers, near the middle of their careers, or at the end of their careers. Forecasts of the effects of bear markets on 401(k) balances show that a bear market in equities is projected to have the largest effect the closer it occurs to age 65 (retirement), even though older participants typically have diversified their portfolios away from equities.
• Similarly, a simulated three-year bull market (positive equity returns) is projected to have a larger positive effect on projected account balances and replacement rates the closer to retirement it occurs.
