Good news from Wells Fargo (wait, what?)—millennials have demonstrated the biggest gains in participation rates and diversification in 401ks.
The generation known for wanting, and getting, it all saw an increase of 13 percent overall in the past five years, and 83 percent met Wells Fargo’s minimum diversification goal.
Boomers participate in 401k plans at a greater rate than younger coworkers, but investment diversification lags, and Gen X borrows the most from their 401k plans, according to company research.
“This engagement among Millennials is encouraging because the sooner they get started, the more prepared they will be for retirement—they have the power of time to help grow their nest egg,” Mel Hooker, director of relationship management for Wells Fargo Institutional Retirement and Trust, said in a statement. “This generation is benefitting from legislation that made it easier for employers to automatically enroll employees into their 401k plan, and from the use of default investments that help them meet a minimum level of diversification.”
Millennials are also the greatest users of Roth 401k plans. Millennials use this option, when offered by their employer, at a rate of 16 percent, compared to 11 percent of Gen X and 8 percent of Boomers.
“It’s important to note that the use of Roth 401k plans is an intentional choice on their part, perhaps as a tax diversification strategy,” Hooker added.
Is Gen X feeling the squeeze?
Gen X has seen an 11 percent uptick in participation over the last five years. However, they’re leading the pack in loans from their 401k plans: 25 percent of Gen X participants have a loan, compared to 16 percent of millennials and 19 percent of Boomers.
“This may be a case of the sandwich-generation syndrome, in which people are juggling the challenge of raising kids and helping aging parents — all during a period of increasing financial complexity in their lives,” said Hooker. “Unless you need the money for an emergency, however, it’s best to resist the urge to tap your retirement funds. And if you need to do it, be sure to understand the terms.”
While many 401k plans allow participants to borrow from their 401k accounts, there can be some unintended consequences that people need to be aware of before making that decision.
Smaller retirement savings: When you take out a loan, you are losing the benefits of investment growth, and that could leave you with a smaller retirement savings.
How much smaller? This depends on a number of factors, including the size of the loan, the repayment period, whether you continue contributions during this period, the earnings on your account, and the loan interest rate. Also, if you stop contributing while you are paying back your loan, you won’t receive any employer matching contributions.
Repayment requirements: If you lose your job or take another one, you’ll have to repay the money quickly, usually within 30 to 60 days. If you can’t, the IRS considers the money you’ve taken out to be a withdrawal, which means you’ll have to pay taxes—and if you’re under age 59½, you may owe a penalty as well.
Boomers participate at higher rates, but lag in diversification
Early this year, the first wave of Boomers turned 70½, reaching the age at which they are required to start drawing down their 401k savings. As this population nears retirement, the number of those participating in their plan has increased by 8.3 percent over the last five years; although this is a lower rate of increase than millennials and Gen X, overall more Boomers participate than younger generations.
A little over a third of all participants are more conservative in their own investments than a typical target-date fund appropriate to their age. But more than half of Boomers have greater equity exposure than an age-appropriate target-date fund, which could expose them to significant investment risk.
“It’s a delicate balance; lower returns for overly conservative participants can hurt balances in the home stretch to retirement, but overly aggressive participants face an even larger potential threat to their retirement income in the form of investment risk,” said Hooker. “It’s important to encourage employees to create a plan for saving and stick to it. Consistency in contributions and diversification are a better path to success than chasing returns or trying to time the market because retirement success is a long-term proposition.
Who is on track?
For the purposes of setting a goal and tracking progress, Wells Fargo measures the percentage of participants on track to replace 80 percent of their pay in retirement, and it appears that many of the behaviors in which millennials take the lead are pointing to a higher percentage on track: 66 percent of millennials are on track to reach this goal in retirement, compared to 51 percent of Gen X and 41 percent of Boomers.
How employers are helping
While there are many ways employers can help their employees save more for retirement, this analysis points to some stand-out opportunities for employers.
- Closing the participation gap through automatic enrollment
While participation remains lowest among younger, more recently hired, and lower-earning employees, these populations have seen greater gains than their counterparts, leading to a narrowing of the participation gap for all three demographic dimensions. The biggest driver? Automatic enrollment — when this younger age group is automatically enrolled, 8 percent stay in the plan. In the absence of automatic enrollment, the participation rate falls to 38 percent.
- Increasing default deferral rates
When employers automatically enroll their employees in the 401k plan, the most common default deferral rate is 3 percent. At this rate, 11.1 percent of people opt out of the plan—meaning nearly nine in 10 employees stay in the plan. However, when people are automatically enrolled at a 6 percent contribution rate, participants have a nearly identical reaction, with 11.3 percent opting out of the plan. Given contribution-rate challenges, defaulting employees at a higher contribution rate to begin with may help significantly.
- Automating regular contribution increases
Today, 20 percent of plans include a feature that automatically increases their employees’ contribution rate on a regular basis (often annually) and requires employees to take action to turn it off, or “opt out.”
This is a significant uptick from 8 percent of plans that offered this feature in this fashion five years ago.
In addition to encouraging higher contribution rates by defaulting employees into a plan at a higher rate to begin with, adding automatic contribution increase as a feature employees need to elect to turn off, rather than offering it and making them take the steps to turn it on, will drive employees to a 10 percent contribution rate more quickly than if they simply stagnate at the automatic enrollment contribution rate.
“Employers don’t have to guess anymore. The data reveal exactly what they need to do to move the needle on each behavior,” Hooker concluded. “In particular, when we see retirement plan contribution rates are in a stagnant state relative to other important behaviors, we can put in place the plan design features that will help improve this metric. Employers can use the data to inform their decisions based on their defined goals for helping their employees save for retirement.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
