LEWIS MANDELL, Aspen Institute - Initiative on Financial Security
Email: lewis.mandell@aspeninstitute.org
PAMELA J. PERUN, Aspen Institute - Initiative on Financial Security
Email: pamela@planetnow.com
LISA MENSAH, Aspen Institute - Initiative on Financial Security
Email: lisa.mensah@aspeninstitute.org
RAYMOND O'MARA III, Aspen Institute - Initiative on Financial Security
Email: raymond.omara@aspeninstitute.org

The Obama administration has proposed bold new policies to expand retirement savings. Through a program of Automatic IRAs, the approximately 78 million, largely lower-income, American workers not currently covered by a plan at work would be able to save through automatic individual retirement accounts. The Administration also plans to simplify and expand the Saver’s Credit to give eligible lower-income savers a 50 per cent “match” on contributions of up to $1,000 to qualified retirement accounts. Together, these proposals promise to enhance the retirement security of millions of Americans. They provide both the savings vehicle and the savings incentive to enable more low- and moderate-income households to arrive at retirement with significant financial assets to supplement Social Security.

In this paper, the Initiative on Financial Security at the Aspen Institute proposes an investment option for the Automatic IRA: Real Savings (RS ). RS combines two widely traded and highly liquid assets – Treasury Inflation Protected Securities (TIPS) and a broad-based equity market index – to provide savers with a personalized, automatic target date investment option. RS ensures the preservation of the purchasing power of contributions while at the same time offering the significant – and important – upside potential of market participation. RS thus provides low- and moderate-income savers with the opportunity for both growth and safety for their savings. Through an automatic, inexpensive blend of TIPS and the market index, RS protects all savers from the three most likely risks to retirement income – inflation, default by the bond issuer, and falling stock prices. By design, RS fully protects every dollar saved against economic cycles, market declines and loss of purchasing power.

YOUNGKYUN PARK, Employee Benefit Research Institute (EBRI)
Email: park@ebri.org

Target-date funds (TDFs) are an important and growing investment option in 401(k) retirement plans, and are giving rise to a new class of 401(k) investor: “mixed” target-date fund users who hold the funds in combination with other non-TDF funds in the plan menu. Although “pure” TDF users holding only TDFs in their accounts have grown due to auto-enrollment and TDFs’ status as a qualified default investment in 401(k) plans, mixed TDF users account for a significant portion of all TDF users. About 7 percent of all 401(k) assets were invested in TDFs as of year-end 2008, and mixed TDF users accounted for about 55 percent of the participants holding target-date funds in their accounts as of year-end 2007. Pure TDF users are more likely to be younger or lower-salary participants who are automatically enrolled into target-date funds, while mixed TDF users are likely to be middle-income and middle-wealth participants.

This paper examines how mixed TDF users utilize other funds (except TDFs) in their 401(k) plan menu. In order to minimize the effects of plan menu design on participants’ investment behavior, this analysis constructs a sample from the EBRI/ICI 401(k) database of plans offering six fund categories including TDFs: equity funds, bond funds, non-TDF balanced funds, money market funds, and guaranteed investment contracts (GICs)/stable-value funds. However, the sample does not include plans offering company stock. Overall, this analysis finds that some mixed TDF investors apparently fail to understand that a TDF is designed as an “all-in-one” portfolio solution. For instance, mixed TDF users are more likely to hold multiple TDFs than are pure users who invest only in TDFs, and low-level mixed TDF users (who invest less than half of their account balances in the funds) are more likely to use two or more TDFs than are high-level mixed users (who invest more than half their balance in the funds). Last, mixed users holding relatively aggressive TDFs for their age group (such as someone in their 50s investing in 2050 funds) are more likely to actively invest in equity funds than those following the age-specific investment rule.

The PDF for the above title, published in the December 2009 issue of EBRI Notes, also contains the full text of another December 2009 EBRI Notes article abstracted on SSRN: “What Do We Know About Enrollment in Consumer-Driven Health Plans.”

ANGELA HUNG, RAND Corporation - Labor and Population
Email: ahung@rand.org
ERIK MEIJER, RAND Corporation
Email: meijer@rand.org
KATA MIHALY, affiliation not provided to SSRN
Email: kmihaly@rand.org
JOANNE YOONG, RAND Corporation
Email: jyoong@rand.org

As employer-provided pension plans have largely shifted from defined benefit (DB) to defined contribution (DC) pension plans, responsibility for plan investments and the accompanying risks have also shifted from the provider to the employee. Employees have to decide how much to contribute to their plans, how to allocate their retirement accounts between various investment options, and how they will spend down or decumulate their retirement funds during retirement. This raises the question of whether most employees are well-equipped to make such decisions. Empirical research suggests that large segments of the United States population do not feel financially well-prepared for retirement, and suboptimal financial decisions have been attributed to lack of financial literacy. The authors investigate this hypothesis by constructing multidimensional financial literacy indices using modern psychometric methods. They assess the relationships between a wide array of DC contribution, investment and (planned) decumulation behaviors on the one hand and these financial literacy indices on the other hand, controlling for other socio-economic and demographic determinants. Their indices measure financial literacy well, but the dimensions that they represent (objective and self-assessed financial literacy, broken down by topics) are very highly correlated, so that the multidimensional nature does not offer much additional explanatory power over a simpler one-dimensional index. Consistent with earlier empirical findings, they find large fractions of “investment mistakes”. Surprisingly, however, the relationships between investment behavior and financial literacy are often weak and nonsignificant. They do find that financial literacy is related to retirement planning, but not to retirement preparedness.

KAREN E. DYNAN, Brookings Institution
Email: kdynan@brookings.edu

The principal force behind the many changes in household finances during the past several decades has been an expansion of financial opportunities. Such opportunities can yield benefits in terms of household economic security. However, the financial crisis that began in 2007 has powerfully illustrated that expanded financial opportunities can also pose dangers for households. To explore these issues, I examine household data on wealth, assets, and liabilities going back 25 years and, in some cases, 45 years. I argue that changes in household finances in the decades leading up to the mid-1990s – including the gradual rise in indebtedness – likely increased household well-being, on balance, and contributed to a decline in aggregate economic volatility. However, changes in finances since the mid-1990s – in particular, a much sharper rate of increase in household debt – appear to have been destabilizing for many individual households and ultimately for the economy as a whole. I conclude the paper with some speculations about how the lessons learned in the current crisis might change household financial opportunities and choices going forward.

WADE PFAU, National Graduate Institute for Policy Studies (GRIPS)
Email: wpfau@grips.ac.jp

In choosing a glide path strategy for asset allocation over their working lives, retirement savers face a tradeoff between the higher expected wealth provided by strategies that maintain or increase equity holdings over time, against the greater potential security offered from shifting into more conservative assets. We quantify this tradeoff with an expected utility framework for our simulated distribution of target date wealth accumulations under a variety of lifecycle, fixed, and contrarian glide path strategies. We find justification for the lifecycle strategy for savers with very reasonable amounts of risk aversion, and we also provide guidance about utility-maximizing glide paths.

JACK VANDERHEI, Employee Benefit Research Institute (EBRI), Temple University - Risk Management & Insurance & Actuarial Science
Email: vanderhei@ebri.org

This paper reviews the results of many empirical and simulation studies EBRI has undertaken to determine whether future cohorts of retirees in the US are likely to have retirement income adequacy and the extent to which the voluntary retirement system is contributing to this objective in its current form as well as possible modifications that may increase its efficiency.