Same Income, Same 401(k), Different Account Balances? Plan Design Is Key to Wealth Gaps

How do plan sponsors and employers narrow the wealth gap in 401(k) plans?  The Collaborative for Equitable Retirement Savings (CFERS), which collects data on retirement income disparities, attempted to provide some clarity on this topic in a June 21 webinar titled “Investors First: Strategies for Narrowing the Savings Gap in 401(k) Plans.”

“We’ve been able to collect a lot of information from plan sponsors and the recordkeepers they work with to basically come up with different measures of what retirement income adequacy looks like,” said Jack VanDerhei, director of retirement studies, Morningstar Center for Retirement and Policy Studies. CFERS, a joint initiative of Morningstar Retirement, Aspen Institute Financial Security Program and DCIAA, conducts research, aiming to identify plan design solutions for plan sponsors and employers. The initiative is gathering data from plan sponsors and looking for solutions for retirement income inadequacy. Here are some of the key issues discussed in the webinar:

Race and gender disparities. The percentage of US households that will likely run short of money in retirement, said VanDerhei, includes 59% Hispanics, 57% blacks and 39% whites.  However, the disparities seem to be related to income levels, not race or gender, said Pamela Hess, executive director of research, Defined Contribution Institutional Investment Association (DCIIA).

Shift from DC to DB plans. “Conventional wisdom will tell you it’s been the shift from defined benefit plan to defined contribution,” said VanDerhei. However, it is much more complicated, particularly when looking at the research, he said. “Basically, if you look at 401(k) participants and you compare what they’re generating with what they would have had under DB plan and you account for job turnover, it really is not a situation where the DB would have done better job than the 401(k) plan.”

Pre-retirement withdrawals. “This is without a doubt the single biggest factor causing these disparities,” said VanDerhei. In particular, “black females, once they hit their 40s have an annual pre-retirement withdrawal rate of 25%. [Pre-retirement withdrawals] is basically what’s causing a lot of that money to no longer stay in those account balances.”

401(k) plan features. “We have some employers looking at their automatic features – frequency, eligibility, match, overall design,” said Hess. “Default features have already made a big difference for workers, but the challenge I see is ‘Have we gone far enough?’ We can do more back-sweeping. I think about the folks who stopped saving through hardship withdrawal. All of a sudden they are not participating in the plan. How do we get them back in? Potentially with re-enrollment: If an employee is saving under 6%, start to escalate them up to that point – something that is a little more systematic and ongoing link.”

Managed accounts. A managed 401(k) account is a retirement plan account that is professionally managed by an investment manager for a participant, and are usually charged for a percentage of individual assets. “From preliminary evidence, it’s just absolutely amazing how much of a difference it makes for those participants who do have managed accounts in terms of pre-retirement withdrawals. Overall, they have just a fraction of the rest of the population,” said VanDerhei. “We’ve also seen a healthy Increase in contribution rates for those who have managed accounts.”

Saver’s Match program. The Saver’s Match, a provision in the SECURE 2.0 legislation, could go much further toward addressing the savings disparities seen today, said VanDerhei. The Saver’s Match, which becomes effective in 2027, offers a 50% federal match on the first $2,000 of retirement savings for low-income workers, however, “people in the industry should work hard to educate both employers and employees on how to take advantage of the program,” he said.

“There are still 57 million Americans who still don’t have access to retirement savings …,” said Ida Rademacher, vice president, Aspen Institute. “We need to fix the retirement savings system so that all workers in all workplaces, regardless of where they work or how they get paid, are part of the American workplace savings system.”