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The Impact of PPA on Retirement Income for 401(k) Participants

The Impact of PPA on Retirement Income for 401(k) Participants Jack VanDerhei and Craig Copeland, EBRI May 8, 2008 Simulation studies based on 401(k) participants in EBRI/ICI database Holden and VanDerhei (2002): “Can 401(k) Accumulations Generate Significant Income for Future Retirees?”

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The Impact of PPA on Retirement Income for 401(k) Participants

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  1. The Impact of PPA on Retirement Income for 401(k) Participants Jack VanDerhei and Craig Copeland, EBRI May 8, 2008

  2. Simulation studies based on 401(k) participants in EBRI/ICI database • Holden and VanDerhei (2002): “Can 401(k) Accumulations Generate Significant Income for Future Retirees?” • Used EBRI/ICI database to project “401(k) projections” to retirement age • Median (nominal) replacement rates varied by income quartile from 51–69 percent under continuous coverage assumption • Decreased to 21–26 percent if coverage with a subsequent employer was purely random • Only modeled 401(k) participants with current balances • Holden and VanDerhei (2005): “The Influence of Automatic Enrollment, Catch-Up, and IRA Contributions on 401(k) Accumulations at Retirement” • Examined current 401(k) participants and (synthetically) those who were assumed to be eligible nonparticipants • Increase in median replacement rates due to automatic enrollment with a 3 percent default contribution and life-cycle fund varied from 83 percent for lowest income quartile to 2 percent for highest income quartile • Written a year prior to PPA • Did not include any modeling on automatic escalation of employee contributions • VanDerhei (2007): The Expected Impact of Automatic Escalation of 401(k) Contributions on Retirement Income • PPA passed in 2006: Auto escalation provisions likely to be more prevalent • Extant literature has some examples of what would likely happen under auto escalation • However only a very short time horizon in each case • As part of the 2007 Retirement Confidence Survey (fielded several months after the enactment of PPA) this information was elicited from 456 employees who were currently contributing to a 401(k) plan

  3. Simulation studies based on all workers • Holmer (2007): “PENSIM Analysis of Impact of Final Regulations on Defined-Contribution Default Investments” • GAO (2007): “Low Defined Contribution Plan Savings May Pose Challenges to Retirement Security, Especially for Many Low-Income Workers” • Based on a sample of workers born in 1990 • New model constructed for May 2008 EBRI Issue Brief • Basic structure from VanDerhei and Copeland (2003): “Can America Afford Tomorrow's Retirees: Results From the EBRI-ERF Retirement Security Projection Model” • With additional information from EBRI/ICI 401(k) database • Focus on account balance in current or previous employer’s 401(k) as well as any IRA rollovers originating in 401(k) accounts • Forward looking: only accumulations post-PPA (2008 or later) • Reported as multiples of final earnings available at age 65

  4. Model assumptions • Employee behavior in voluntary enrollment plans • Asset allocation and contribution behavior as a function of employee age and income from EBRI/ICI data • Participation for voluntary and automatic enrollment plans; contribution and asset allocation for automatic enrollment plans • Fidelity (2007): Building Futures Volume VIII • Nessmith, Utkus, Young (2007): Measuring the Effectiveness of Automatic Enrollment • Choi, Laibson and Madrian (2004): Plan Design and 401(k) Savings Outcomes

  5. Automatic enrollment with automatic increase vs voluntary enrollment: 50th percentiles

  6. Automatic enrollment with automatic increase vs voluntary enrollment: 75th percentiles

  7. Automatic enrollment without automatic increase vs voluntary enrollment: 50th percentiles

  8. Automatic enrollment without automatic increase vs voluntary enrollment: 25th percentiles

  9. Automatic enrollment without automatic increase vs voluntary enrollment: 75th percentiles

  10. Automatic enrollment with automatic increase vs voluntary enrollment: 50th percentiles

  11. Automatic enrollment with automatic increase vs voluntary enrollment: 25th percentiles

  12. Automatic enrollment with automatic increase vs voluntary enrollment: 75th percentiles

  13. Target Final Earnings Multiples, by Gender and Retirement Age Source: Jack VanDerhei, "Measuring Retirement Income Adequacy: Calculating Realistic Income Replacement Rates" EBRI Issue Brief, September 2006

  14. Sensitivity analysis on automatic increase assumptions: 50th percentiles

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