Helping Lower-Income Employees Save for Retirement

Transcription

1 Helping Lower-Income Employees Save for Retirement The struggle of managing a family household on a low income is well understood. Often, there isn t enough money to go around, and prioritizing saving for retirement over other needs can be difficult. Many workers may be facing the difficult decision of either saving for retirement or meeting day-to-day expenses while younger employees may be juggling student loan or credit card debt and don t see how they can afford to start saving for retirement. Plan Sponsors have several questions when it comes to engaging lower-income employees: Will lower-income employees save in the retirement plan? Which plan design features are effective in increasing retirement readiness? Are lower-income employees risk-averse and more likely to invest in fixed income and cash? Is retirement education and guidance helpful for lower-income employees? We examined the retirement savings behaviors of over 1.4 million lower-income employees across the United States enrolled in for-profit and tax-exempt workplace retirement plans 1 recordkept by Fidelity. We also conducted interviews with Fidelity representatives who provide education and guidance to lower-income employees every day. Based on comprehensive analysis, this report offers plan sponsors, advisors and consultants a set of best practices to help increase the retirement readiness of lower-income employees.

2 Profile of Lower-Income Employees We categorized lower-income, full-time, employees by both age and income 2. The younger the age, the lower the income threshold. Total Workforce Comparison (Lower Income vs. All Other) Early Career Mid Career Late Career lower-income employees lower-income employees lower-income employees 44 % 41 % 42 % Younger than 35 years old, annual income range $20,000 $34,000 55% are women years old, annual income range $20,000 $48,000 58% are women 50+ years old, annual income range $20,000 $48,000 62% are women Of importance, women are more likely to be lower-income than men across all age ranges. Employees often juggle many demands on their paycheck beyond simply saving for retirement but this is more acute for lower-income employees. Our research 3 uncovered that the top financial priorities for lower-income workers are: Paying bills on time and day-to-day finances Reducing debt (student loans, credit cards, mortgage) Building emergency savings I know saving is important, but it seems like I m always reacting to the next bill that s due or some unexpected cost that comes up. I m not sure how to get started or how to get a better handle on my finances. My financial life is stressful and overwhelming; I m not sure I ll ever be able to retire or get rid of all my debt. 2

3 Saving Behaviors Conventional wisdom and economic studies 4 suggest that lower-income employees are less likely to actively contribute to a workplace retirement savings plan. In fact, some economic models suggest that lower-income employees have zero propensity to save for retirement, while other models suggest a low but positive propensity to save 4. Fidelity s data shows that while lower-income employees do save for retirement, their savings rates, as expected, are lower than all other employees. Lower-income employees have an average deferral of 5.7% vs. 8.6% for all other employees. To look deeper into this question, we analyzed retirement plans with no auto-enrollment features and no employeroffered incentive to save at any particular level, i.e. no employer matching contributions. In other words, every participant in these plans had enrolled on their own and chosen their deferral rate. Surprisingly, the majority of lower-income employees in these plans tend to gravitate toward one of three savings rates 3%, 5%, or 10% with 5% being the most commonly selected. This trend held true across all age ranges. Figure 1: Lower-Income Employees Tend to Gravitate toward Savings Rates of 3%, 5%, and 10% Distribution of Lower-Income Participants by Elective Deferral Rates in Plans Without Automatic Enrollment and Without an Employer Match % of Participants 25% 20% 15% 10% 3% 5% 10% Lower Income Employees <35 Years Old Lower Income Employees 35 Years Old 5% 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15+% Employee Deferral % 3

4 THE POWER OF AUTOMATIC PLAN DESIGN Although we observed that lower-income employees do have a propensity to save, we also discovered that there is tremendous inertia within this group. Remembering that the savings data illustrated in Figure 1 is for lower-income employees who are participating in retirement plans, we also investigated those who are not participating and the important role that automatic enrollment can play in getting them to save. Automatic Enrollment (AE) When considering plan design elements that will be beneficial to lower-income employees automatic enrollment (AE) should be at the top of the list. In workplace retirement plans without automatic enrollment, the average participation rate for lower-income employees is just 45%. That rate jumps to 79% on average in plans with AE. There is a positive impact of AE on all other employees as well with average participation rates increasing from 72% to 88%. Figure 2: Auto Enrollment s Positive Impact on Participation Rates Lower-income employees show significantly greater inertia toward enrolling in retirement plans 45% 79% With AE 34% point increase 72% No AE 88% With AE 16% point increase No AE Lower-Income Employees All Other Employees Automatic Enrollment (AE) Default Deferral Rate In choosing a default deferral rate, three primary considerations are (1) how much income the plan is designed to replace in retirement, (2) the estimated number of employees who may opt-out of the plan, and (3) the cost to the plan sponsor in employer match. Many plan sponsors express concern that setting a default deferral rate higher than 3% will cause a significant portion of their lower-income population to stop participating in the plan. Not only could this limit an employee s long-term savings, it could also negatively impact the employer s non-discrimination testing performance. Counter to what many plan sponsors believe, our analysis shows that young, lower-income employees are just as likely to stay enrolled in a plan with a 6% default deferral rate than they are in a plan with a 2% 3% default deferral rate. Overall, 81% of lower-income participants remain in the plan once auto-enrolled regardless of deferral rate only slightly less than all other employees (86%). 4

5 Figure 3: Lower Default Deferral Rates Do Not Cause Higher Levels of Employee Participation Similar Opt-Out Rates at 1% vs. 6% Default Deferral Rates Automatic Enrollment Opt-Out % 14% 11% 25% 14% 20% 15% 16% 14% 1% 2% 3% 4% 5% 6% Overall 11% 12% Automatic Enrollment Default Deferral % Lower-Income Employees <35 Years Old All Other Employees <35 Years Old This data suggests that a best practice plan design is to set the automatic default deferral rate to 5% or 6%. There is a positive trend in the number of employers increasing the automatic default deferral rate in their plan with 35% of Fidelity clients setting the default at 4% or higher, up from 24% just 3 years ago 5. In order to maintain their lifestyle in retirement, we believe most people will need to replace at least 45% of their income using their workplace and personal savings, in addition to Social Security benefits. In the long run this plan design choice can significantly improve the retirement readiness of many lower-income employees. 17% 11% 19% 14% Annual Increase Program (AIP) When it comes to annual increase programs 6, our analysis discovered that the majority of lower-income employees under age 35 will remain in the program if they are automatically enrolled. This strong adoption rate is another demonstration of how auto solutions can leverage participant inertia to help get them on a proper path with their retirement savings. Figure 4. Few Employees Opt-Out When Automatically Enrolled in Annual Increase Programs 85 % 76 % Remain Enrolled Remain Enrolled Lower-Income Employees All Other Employees Fidelity recommends using automatic AIP 7 coupled with automatic enrollment at 5% or 6% as the most effective plan design options to help drive positive saving behavior across all employee groups, especially lower-income employees. 5

6 Putting it all together We embarked on extensive behavioral research and testing to determine if a simplified enrollment process could also improve participation outcomes. Based on the results of our study, and subsequent learnings, we believe the answer is an unqualified yes. Fidelity s EasyEnroll smartphone-based application was developed to help make enrollment easier for employees by simplifying complicated decision making that can lead to abandonment. The application uses behavioral economics anchoring and choice framing techniques to help drive savings rates that are significantly higher than those achieved through traditional auto-enroll (9.2% vs. 7.2%). Surprisingly we found little difference in the average deferral rate selection of lower-income employees (9.1%) and all other employees (9.2%) who use EasyEnroll. 8 This has important implications for how behavioral economics can continue to inform how lower-income employees make decisions and the mechanisms that drive choice. Figure 5. EasyEnroll Deferral Rate Comparison % of Employees Choosing Deferral Option 100% 80% 60% 40% 20% 0% 20% 22% 58% Lower-Income Employees 21% 23% 56% All Other Employees Option 3: 12% deferral Option 2: 10% deferral Option 1: 8% deferral Average Deferral Rate Using EasyEnroll 9.1% 9.2% 6

7 Asset Allocation Behaviors Many plan sponsors we meet with express concern about the asset allocation of the lower-income employees in their retirement savings plan. They generally believe that this population is risk averse and therefore more likely to invest in fixed income or cash, thus minimizing any potential growth of their retirement savings during the early or mid-stages of their employment. Our analyses shows something quite different lower-income employees on average exhibit slightly better age-based asset allocation than all other employees, and are less likely to be overly invested in fixed income. Figure 6. Lower-Income Employees Exhibit Greater Age-Based Asset Allocation Than All Other Employees 9 < 35 Years < 35 Years 35+ Years 35+ Years 87% 82% 12% 63% 20% 55% 13% Lower-Income Employees 17% All Other Employees 26% Lower-Income Employees 25% All Other Employees Overly Conservative More than 10% under appropriate age-based equity allocation Age Appropriate Appropriately allocated to equities based on age Overly Aggressive More than 10% over appropriate age-based equity allocation This data also shows that younger employees, of all income ranges, are exhibiting greater age-based asset allocation than their older peers. This is partially explained by plan sponsors increased use of target date fund default investment designs over the last decade coupled with participants low propensity to change investment choices. In fact, 85% of employers with workplace retirement savings plans recordkept at Fidelity use a target date fund as the default investment option. Fidelity suggests using a target date fund as a default investment option for all employees. 7

8 Guidance Utilization and Impact For lower-income employees, the financial challenges they face are often more immediate in nature and bring with them a certain level of financial stress. This stress, and the distraction it creates, impacts employee productivity and leads to a lack of benefits engagement and retirement readiness. In fact, 37% of employees reportedly spend 3+ hours a week handling financial matters at work 10 and 25% have missed work to handle a financial matter. 11 The lower-income population often lacks financial confidence yet only a small percentage take advantage of guidance that is available to them through their workplace savings plan. This holds true across all age groups. However, a third of those who do utilize guidance take steps to improve their retirement readiness at rates similar to their more highly compensated co-workers. Figure 7. Low Rate of Guidance Utilization among Lower-Income Employees % of Participants Who Utilized Fidelity s Retirement Guidance (over a 12-month period) 12 < 35 Years Years 50 Years Overall 12% 17% 24% 19% 15% 16% 15% 21% Lower-Income Employees All Other Employees Figure 8. Lower-Income Employees Using Guidance Take Action at Nearly the Same Rate as All Other Employees % Take Action < 35 Years Years 50 Years Overall 33% 33% 32% 33% 36% 37% 34% 35% Lower-Income Employees All Other Employees Fidelity Retirement Planner Cleo Morgan describes her experience working with participants: Many low-income employees don t take steps to save because they are afraid. Once we educate them on how to invest and where to save their next dollar that fear starts to fade and it breaks the inertia. We ve got to continue to encourage them and empower them to make good decisions. 8

9 For lower-income employees, providing guidance on financial basics such as budgeting, debt management, and saving will help employees get on a path to financial wellness. Employees may be more likely to engage with guidance if they have a better understanding of the type of help that is available and it is supported by their employer. Fidelity recommends that plan sponsors take advantage of guidance resources available through their retirement plan provider and actively promote these services to their participants. Summary We set out to challenge pre-existing ideas about the savings and investing behaviors of lower-income employees with the hopes of uncovering characteristics that may help plan sponsors address the financial wellness and retirement security of this population. Key findings of our research are: 1. Lower-income employees will save more than 1% 2% in their retirement plan! This population has a propensity to save at least 5% 6% in their retirement plans. Best practice: Set automatic enrollment default deferral rates at 5% or 6%. 5% 6% 2. Lower-income employees embrace auto solutions. Given all the competing financial priorities many employees face, saving for retirement is often put off. Auto-solutions help break this inertia. Best practice: Construct retirement plan designs to include automatic enrollment and annual increase programs that help employees reach a total savings rate of 15% across employee and employer contribution sources. Use engagement methods, such as EasyEnroll, to simplify employee decisionmaking throughout the enrollment process. 9

10 3. Default investment options play an important role in asset allocation. With increased adoption of target date funds as default investment options our research shows the majority of lower-income employees exhibiting positive age-based asset allocation. Best practice: Consider using target date funds as the default investment option in your plan. Target Date 4. Financial education and guidance are helpful and necessary. Improving lowerincome employees engagement with your workplace savings plan starts with increasing their confidence and helping them get control over today s financial challenges so that they can have an improved financial outlook for tomorrow. Best practice: Integrate financial wellness programs into your overall benefits offerings and ensure education provided is addressing relevant topics for lower-income employees (budgeting, debt management, saving) and in formats designed to engage, such as mymoneybasics Actively promote the type of guidance and resources available to your employees so they have a better understanding of what is available. 10

11 For plan sponsor use. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money. Guidance provided is educational. Asset allocation does not ensure a profit or guarantee against loss. 1 Fidelity recordkept plans and data as of 3/31/15. For comparison purposes, an additional 4,660,000 participants were also analyzed who had incomes higher than our definition of lower-income employee. We refer to this group as all other employees throughout this paper. 2 Analysis excludes participants with an annual salary below $20,000 due to significant overlap of part-time and full-time employees in this salary band. The retirement readiness of part-time employees requires additional information and assumptions that we do not address in this report. 3 Fidelity survey of 7,226 defined contribution participants conducted August A number of technical articles explore the propensity to save, including Do the Rich Save More? by Dynan, Skinner and Zeldes, which can be accessed at: 5 Fidelity recordkept data as of 3/31/ Annual Increase Program (AIP), also known as Auto-Escalate, is a plan automation feature whereby participants who enrolled in it will automatically increase their deferral rates by a predetermined amount (usually 1%) every year until they reach a deferral rate cap, which is often set at 10% but can be set higher. 7 When implementing an annual increase program, plan sponsors should seek guidance on the various features and configurations, including setting the AIP cap. Fidelity suggests that the AIP cap could be set so that when participants reach the cap, their total employee and employer contributions should equal at least 15%. For example, if an employer has a 5% contribution, the AIP could be set at 10% so that the sum of 5% + 10% = 15%. 8 Average deferral rates are based on Q results. EasyEnroll data is for those who elect the preset packages offered by the employer (for plans offering 8%, 10%, or 12% choices) and the standard enrollment data reflects the people in those plans who choose their own amount and don t go with the preset packages. Average deferral rates are employee contributions only. 9 For Asset Allocation purposes, the participant s current age and equity holdings are compared with an example table containing age-based equity holding percentages based on an equity glide path. The Fidelity Equity Glide Path is an example we use for this measure and is a range of equity allocations that may be generally appropriate for many investors saving for retirement and planning to retire around ages 65 to PwC Employee Financial Wellness Survey, April State Street Global Advisors, Bi-Annual DC Investor Survey, March Activity measured from 4/1/2014 3/31/2015.

12 Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI FMR LLC. All rights reserved