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Retirement Readiness on the Rise ... for Some

Home-price appreciation and a strong stock market have brightened the picture for savers, but not across the board, says Morningstar's Christine Benz.

Adam Zoll: For Morningstar, I'm Adam Zoll. Has a rising U.S. stock market helped improve the retirement-funding landscape in the U.S.? Here to talk about this and other topics in the realm of retirement planning is Christine Benz, Morningstar's director of personal finance.

Christine, thanks for being with us.

Christine Benz: Adam, it's great to be here.

Zoll: So, 2014 is coming to a pretty volatile close in terms of stocks, but overall it has been a pretty good year--which I assume is good news for retirement savers, right?

Benz: That's right. We periodically get these snapshots from different financial-services providers that look at their average participant balances in 401(k)s and IRAs and so forth. And so when we look at these numbers, we do see some pretty encouraging data--some really nice pickups versus, say, five years ago. Fidelity periodically releases its data on both 401(k) plan participants as well as IRA participants.

And the typical 401(k) participant balance was about $91,000 as of midyear. For people who had their money in for at least 10 years in the 401(k) plan had, in fact, a much nicer balance of $240,000. And Fidelity was sending out some similar numbers for its average IRA balances, right around $91,000. Vanguard's How America Saves report kind of corroborated that trend. Vanguard showed a really nice uptick in 401(k) participant balances. Since 2008, the average participant balance rose about 80% during that time. So, that's some pretty encouraging data. It appears that investors--at least some investors--have benefited from the rising equity market. They have been there participating as stocks have taken off over the past five years.

Zoll: And Vanguard also noted that more and more retirement savers seem to be warming up to the idea of professionally managed accounts?

Benz: That's right. So, this doesn't necessarily mean that they have a hands-on manager making active bets on his or her behalf, but it does mean that investors are at least investing in target-date funds or balanced funds or, in some cases, professionally managed accounts. Vanguard saw very strong growth in assets in all of those account types over the period examined. And that's probably not surprising, given that target-date funds are now an allowable default option in 401(k) plans. A lot of people are just automatically put into these funds and tend to stay in them once they've been enrolled in those fund types.


Zoll: So, do these higher account balances then mean that we are in an improved state when it comes to retirement readiness?

Benz: Well, somewhat. For this data, we looked to a study that is released annually by the Employee Benefit Research Institute. The EBRI data show that the three main cohorts that they look at--these are the Gen X-ers, early baby boomers, and late boomers--all three groups have seen their retirement readiness improve over the past few years. So, that's a positive. And EBRI points to rising housing market values as contributing here but also the rising equity market has lifted people's retirement plans. So, those two factors in conjunction with one another have both contributed to a slightly improved state of retirement readiness.

Zoll: But the data also shows that it is not a universal improvement across the board.

Benz: That's right. The EBRI data breaks down retirement readiness by income during working years, and what it shows--probably not surprisingly--is that folks who are in the lower income bands tend to be much less prepared for retirement than people who are in the higher income bands.

Another thing I was struck by in the Vanguard data: They helpfully supply median 401(k) participant account balances as well as average balances. So, the average balance in a Vanguard defined-contribution plan was about $100,000. When you look at the median, it's a much less impressive number of just $30,000. So, that indicates that you've got a lot of people with very small balances, who are in fact occupying those smaller slots below the median. So, that's an issue, and I would expect to see a large segment of the population continue to be pretty underfunded when it comes to retirement savings.

Zoll: We also heard some discussion this year about new ways to save for retirement--new savings vehicles or modifications to existing vehicles. One of the terms we heard for the first time was the myRA. What can you tell us about what that is?

Benz: This is a new initiative launched by the Treasury Department. The Treasury Department just issued some new regulations regarding the myRA. The key thing to know about it is that it's designed as kind of an entry-level savings vehicle, kind of a savings vehicle with training wheels. And the interesting thing about it is that money that goes into the myRA will be invested in a product a lot like the G Fund that's found within the Thrift Savings Plan. So, the nice thing about the G Fund, even though yields are pretty low right now, is that investors' principals are guaranteed and yet they are able to earn a bond-like rate of return on their money. So, right now that's about 2%; but in a higher-yielding environment, that could, in fact, look like a more impressive number. I think this product could, in fact, be a pretty good deal for entry-level savers.

Zoll: What about the tax treatment for the myRA? How does that work?

Benz: It's going to be a lot of like a Roth IRA. So, people will put in aftertax contributions, the money will grow on a tax-free basis, and qualified withdrawals will come out tax-free as well. It's also important to note that people can withdraw their contributions at any time and for any reason if they need to. So, it really gives people quite a bit of flexibility, like a Roth IRA. I think it's a really nice multitasking vehicle for people who are just starting out. The key words, though, are "just starting out," because the cap on the amount that you'll be able to have in the myRA is $15,000. Once you hit that limit, you need to get the money out of the account. So, it's not going to be a great vehicle for people who want to accumulate a lot of money for, say, a big goal like retirement. And the other thing to keep in mind is, even though the G Fund or this proxy for the G Fund has some pretty attractive qualities, people who are just starting out who want to really accumulate money for retirement need to have the bulk of that money in stocks, if they want to earn a stronger rate of return over time. So, I think of it as a good starting point--kind of a nice vehicle with training wheels--but it won't be appropriate for many people.

Zoll: Another important development this year was the Treasury Department issuing some regulations that will allow for a certain type of annuity to be used in retirement savings accounts. What can you tell us about that?

Benz: Right. This is the Qualified Longevity Annuity Contract [QLAC]. Essentially, it's a deferred-income annuity and the idea is that you give the insurer a sum of your money at, say, age 65 and then they send it back to you as a stream of payments at some later date--say, [at age] 85. And the benefit of having a product like this is that it can help hedge against longevity by providing you a certain source of lifetime income that begins at a later date in retirement. It also allows you to plan for a knowable time horizon, so you can say, "Well, I know that my portfolio will, for sure, be able to make it until age 85. After that, if I live to be 98, I'm not so sure." So, this is where such a product can come in handy. The Treasury guidelines make this type of product much more widely available within IRAs and within defined-contribution plans.

Zoll: So, what type of retirement saver is this option going to work best for? And by the same token, who doesn't need to consider this?

Benz: In the first camp--the people who might give it a look--would be people who expect to have longer-than-average life expectancy. Such a product would be especially beneficial for them--and especially if they do not have a lot of guaranteed income sources, lifetime income sources, throughout their retirement years. So, people who don't have pensions, for example, but maybe just have Social Security as their sole lifetime income source. They might be good candidates for such a product. On the flip side, people with pensions [along with] Social Security, where that's supplying a lot of their needed income, such people will probably tend to have less of a need for a product like this.

Zoll: Any caveats for someone who may be considering this option?

Benz: One of the big ones, according to Morningstar Investment Management's David Blanchett, is that this is still a pretty thin market right now for these deferred-income annuities. Now that the floodgates are open for people to hold these more widely in their retirement plans, he expects to see a lot more products come to market. So, there's probably not a great benefit to being an early adopter of these products. He expects to see more products come to market. Pricing might become more competitive at that point, and people may have more features to choose from. Right now, it's a pretty thin market, so you'd probably need to do your homework. But potentially, waiting could give you more choices down the road.

Zoll: That's definitely good advice to keep in mind if you're looking at one of these products. Christine, thanks so much for sharing your thoughts with us on the many interesting developments with regard to retirement planning this year.

Benz: Thank you, Adam.

Zoll: For Morningstar, I'm Adam Zoll. Thanks for watching.