CRS Examines Retirement Savings and Household Wealth Trends

Since about 1980, the proportion of workers who participate in employer-sponsored retirement plans has remained stable at about half of the workforce. Over the past 25 years, however, there has been a shift by employers from defined benefit (DB) pensions -- which pay a retirement benefit in the form of a lifelong annuity -- to defined contribution (DC) plans, which are more like savings accounts maintained by employers on behalf of each participating employee. One of the key distinctions between a defined benefit plan and a defined contribution plan is that in a DB plan, it is the employer who bears the investment risk. The employer must ensure that the pension plan has sufficient assets to pay the benefits promised to workers and their surviving dependents. In a DC plan, the worker bears the risk of investment losses. The worker's account balance depends on how much he or she contributes to the plan and how the plan's underlying investments perform.

Once every three years, the Federal Reserve Board collects data on household assets and liabilities through the Survey of Consumer Finances (SCF). According to the most recent survey, 47.9% of workers under age 65 participated in employer-sponsored retirement plans -- both DB and DC -- in 2004, down from 49.6% in 2001. The decline in retirement plan participation between 2001 and 2004 was most heavily concentrated among workers under 45 years old, male workers, non-white workers, unmarried workers, those who did not attend college, and those with household incomes in the bottom half of the income distribution.

The Survey of Consumer Finances shows that 56.3 million households owned at least one retirement account in 2004 -- whether an individual retirement account (IRA), a 401(k) plan, or other employment-based savings plan -- compared with 56.9 million households that owned at least one such account in 2001. The proportion of households that owned a retirement account fell from 53.4% in 2001 to 50.2% in 2004. The median balance in all such accounts (measured in 2004 dollars) rose from $30,462 in 2001 to $36,000 in 2004. The number of households that owned a defined contribution plan from current or past employment rose from 38.3 million in 2001 to 38.8 million in 2004. The median balance in these accounts (in 2004 dollars) rose from $19,172 in 2001 to $28,000 in 2004. The number of households that owned an IRA or Keogh plan for the self-employed fell from 33.4 million in 2001 to 32.6 million in 2004. The median balance in these accounts (in 2004 dollars) rose from $28,758 in 2001 to $30,000 in 2004.

The median value in 2004 of all retirement accounts owned by households headed persons between the ages of 55 and 64 was $88,000, up from $58,580 in 2001. For a 65-year-old retiring in May 2006, $88,000 would be sufficient to purchase a level, single-life annuity that would pay $653 per month, based on the federal Thrift Savings Plan's current annuity interest rate of 5.375%. This amount would replace just 15% of the median household income of $53,400 among households headed by individuals who were 55 to 64 years old in 2004.

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Since about 1980, the proportion of workers who participate in employer-sponsored retirement plans has remained stable at approximately half of the workforce. Over the past 25 years, however, there has been a shift by employers from defined benefit plans to defined contribution plans. Defined benefit ("DB") plans usually are funded solely by employer contributions and investment earnings on those contributions and they pay a retirement benefit in the form of a lifelong annuity. The amount of the annuity usually is based on the employee's length of service and average salary. Defined contribution ("DC") plans, in contrast, are more like savings accounts maintained by employers on behalf of each participating employee. In the most common type of DC plan -- those established under Section 401(k) of the tax code -- the employee defers a portion of his or her salary, which is invested in stocks, bonds, or other assets. The employer often matches some or all of the employee's contribution to the plan. At retirement, the balance in the account is the sum of past contributions plus interest, dividends, and capital gains -- or losses. The account balance is often distributed to the departing employee as a single lump sum. One of the key distinctions between a defined benefit plan and a defined contribution plan is that in a DB plan, the employer bears the investment risk. The employer must ensure that the plan has sufficient assets to pay the benefits promised to workers and their surviving dependents. In a DC plan, the worker bears the risk of investment losses. The worker's account balance depends on how much he or she contributes to the plan and how the plan's underlying investments perform.

401(k) plans. In 1978, Congress added section 401(k) to the Internal Revenue Code. Three years later, the Internal Revenue Service (IRS) published regulations for "cash or deferred arrangements" established under Section 401(k). Since that time, DC plans have overtaken traditional defined benefit pensions in the number of plans, the number of participants, and total assets. Typically, in a 401(k) plan, the employee must decide whether to participate, how much to contribute, and how to invest the assets. In 1998 and 2000, the IRS issued rulings that permit employers to enroll employees automatically in 401(k) plans. Revenue Ruling 98-30 allows employers to automatically enroll new employees in 401(k) plans. Revenue Ruling 2000-8 allows automatic enrollment in 401(k) plans of current employees who previously had not elected to participate. In either case, employees who are enrolled automatically must be given the option to drop out of the plan. In 2004, the IRS published a general information letter clarifying that the amount deducted from the employee's pay and contributed to the plan can be any amount up to the annual contribution limit under IRC § 402(g), and that the plan can automatically increase the employee's contribution over time, such as after each pay raise. Again, the IRS emphasized that employees must be informed of these plan provisions and must have the option to change the amount of their contribution or to stop contributing to the plan altogether.

Over the past 10 years, many large employers have converted their traditional DB pensions to "hybrid" plans that have characteristics of both DB and DC plans. The most popular hybrid is called a cash balance plan. In a cash balance plan, the benefit is defined in terms of an account balance. The employer makes contributions to the plan and pays interest on the accumulated balance. However, these account balances are merely bookkeeping devices that describe the employee's accrued benefit. They are not individual accounts owned by the participants, as is the case with 401(k) plans. Because the employer is required to provide a benefit that is equal to at least the sum of the employer's contributions plus the accrued interest on those contributions, a cash balance plan is legally considered to be a defined benefit plan.

The Survey of Consumer Finances

This Congressional Research Service (CRS) report presents data on retirement plan participation and retirement savings account ownership collected through the Survey of Consumer Finances (SCF) in 2001 and 2004. The SCF is an interview survey sponsored by the Board of Governors of the Federal Reserve System in cooperation with the Department of the Treasury. It is conducted once every three years to collect information on the assets and liabilities of U.S. households, the sources and amounts of their income, their demographic characteristics, employment, and participation in employer-sponsored health and retirement plans. Data from the SCF are widely used by economists at the Federal Reserve, other government agencies, and by private-sector research organizations and academic institutions to study trends in the amount and distribution of assets and liabilities among U.S. households. Since 1992, SCF data have been collected by the National Organization for Research at the University of Chicago (NORC). In 2001, 4,449 households were interviewed for the SCF, representing a total of 106.5 million U.S. households. For the 2004 SCF, members of 4,522 households were interviewed.¹ The 2004 interview sample represented 112.1 million households.

Most of the information collected in the Survey of Consumer Finances -- such as total assets and liabilities -- is reported at the household level. The only data reported separately for the householder and his or her spouse or partner describe these individuals' employment, pension coverage, and demographic characteristics. In the tables that follow, Table 1 and Table 2 show participation in retirement plans by individual workers, who were either the householder or the spouse or partner of the householder.² All of the other tables in the report, which describe ownership of retirement accounts and the average balances in those accounts, represent ownership of those accounts by households rather than by individual members of households.

Participation in Employer-Sponsored Retirement Plans

Social Security, employer-sponsored retirement plans, and personal savings are sometimes called the "three-legged stool" of retirement income, but for many workers at least one of the legs of the stool is missing. Coverage of workers under Social Security is nearly universal, but only about half of all workers in the United States are included in employer-sponsored retirement plans.

Recent Trends in Retirement Plan Participation. Data from the Survey of Consumer Finances indicate that the percentage of workers under age 65 who participated in employer-sponsored retirement plans fell from 49.6% in 2001 to 47.9% in 2004.³ (See Table 1 and Table 2.) Three-fourths of workers who participated in employer-sponsored retirement plans in 2004 were enrolled in defined contribution plans, such as 401(k) plans. Just 18.4% of workers participated in defined benefit pension plans, and only 7% of workers participated in both types of plan. The decline in retirement plan participation between 2001 and 2004 was most heavily concentrated among workers in particular demographic groups:

• Among workers under 35 years old, retirement plan participation fell from 40.5% in 2001 to 35.6% in 2004. Participation among workers 35 to 44 years old fell from 54.2% in 2001 to 50.0% in 2004.

• Among non-white workers, participation in employer-sponsored retirement plans fell from 45.7% in 2001 to 39.1% in 2004.

• Among working men, participation in employer-sponsored retirement plans fell from 53.4% in 2001 to 49.2% in 2005.

• Participation in retirement plans among workers who were widowed, divorced, or never-married declined from 44.6% in 2001 to 40.6% in 2004.

• Participation among workers under age 65 who did not graduate from high school fell from 24.1% to 18.0% between 2001 and 2004, while among those who had only a high school diploma or a G.E.D. certificate, retirement plan participation fell from 43.5% in 2001 to 39.8% in 2004.

• Among workers with household incomes in the lowest quarter of the income distribution, participation in employer-sponsored retirement plans fell from 23.2% in 2001 to 18.7% in 2004, while among those with household incomes in the next-lowest income quartile, retirement plan participation fell from 43.7% to 42.8%.

Congress has acted several times over the years to encourage workers to save for retirement, mainly by allowing income taxes to be deferred on amounts that workers or their employers contribute to certain types of savings plans established to prepare for retirement. For example:

• The Technical Amendments Act of 1958 (P.L. 85-866) added Internal Revenue Code Section 403(b), authorizing deferral of taxes on employer and employee contributions to retirement plans of religious, charitable, educational, research, and cultural institutions.

• The Self-Employed Individuals Tax Retirement Act of 1962 (P.L. 87-792) authorized tax-deferred Keogh Plans (after Representative Eugene J. Keogh of New York) for workers who are self-employed.

• The Employee Retirement Income Security Act of 1974 (P.L. 93-406) authorized Individual Retirement Accounts (IRAs) in which eligible contributions and investment earnings are tax-deferred.

• The Revenue Act of 1978 (P. L. 95-600) added Internal Revenue Code Section 401(k). Employers and employees can make pre-tax contributions to retirement plans established under § 401(k). Investment earnings accrue on a tax-deferred basis until withdrawn.

• The Revenue Act of 1978 also added Section 457 to the Internal Revenue Code, permitting state and local government employees to defer income taxes on a portion of salary deposited into a retirement plan. Investment earnings are not taxed until they are withdrawn.

• The Taxpayer Relief Act of 1997 (P.L. 105-34) authorized the Roth IRA, which accepts only after-tax contributions but provides for tax-free distributions of funds held for at least five years in the account.

• The Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16) increased the maximum contribution to IRAs and employer-sponsored § 401(k), § 403(b), and § 457 plans and allows people age 50 or older to make additional contributions to IRAs and to retirement plans authorized under § 401(k), § 403(b), and § 457.

• Congress has authorized retirement savings plans that are designed specifically for small employers. These include the Simplified Employee Pension (SEP) -- a type of IRA -- authorized in 1978 and the Savings Incentive Match Plan for Employers (SIMPLE), authorized in 1996.

With the trend away from defined benefit plans to defined contribution plans, workers now bear much of the responsibility of preparing for retirement. Workers whose employers offer savings or "thrift" plans such as those authorized under Sections 401(k), 403(b), and 457 of the Internal Revenue Code can accumulate assets on a tax-deferred basis while they are working. In addition, most people with earned income may contribute to an IRA. In both cases, taxes are paid when the funds are withdrawn, and a penalty may apply if the withdrawal occurs before retirement.⁴ For many people, the marginal income tax rate that they will face in retirement will be lower than the rate that was applied to their earnings prior to retirement.

The following tables show the retirement savings of all households and those households in which there was at least one worker under age 65. According to the SCF, of the 106.5 million U.S. households in 2001, there were 75.7 million households in which the head or spouse was an employed adult under age 65. In 2004, out of 112.1 total households, there were 79.6 million households that included at least one worker under age 65. The tables show the number of households that owned at least one retirement account as well as the average balances held in those accounts. The tables do not include the portion of retirement wealth that is represented by the present value of benefits accrued under Social Security and employer- sponsored defined-benefit pension plans. They include only the balances accumulated in IRAs, Keogh plans for the self-employed, and employer-sponsored defined contribution plans, including -- but not limited to -- those authorized under § 401(k), § 403(b), and § 457 of the tax code.

Although the percentage of U.S. households that owned a retirement account fell between 2001 and 2004, the mean and median account balances among those who owned such accounts rose during this period. Measured in constant 2004 dollars, among households who owned a retirement account of any kind, the median combined balance of their accounts rose from $30,462 in 2001 to $36,000 in 2004, an increase of 18.2%. The mean combined account balance increased from $110,210 to $129,310, a rise of 17.3%. Among households that owned at least one defined contribution plan from current or past employment, the median combined balance of all their defined contribution accounts rose from $19,172 in 2001 to $28,000 in 2004, an increase of 46.0%. The mean value of the accounts rose from $73,313 to $99,993. Among households that owned at least one IRA or Keogh plan, the median combined balance of all their IRA and Keogh accounts rose from $28,758 in 2001 to $30,000 in 2004, an increase of just 4.3%. The mean value of these accounts remained virtually unchanged at about $104,000.

According to the SCF, there were 75.7 million households with an employed head or spouse under age 65 in 2001, and 79.6 million such households in 2004. (See the bottom panels of Table 3 and Table 4.) Both the number and percentage of these households that owned at least one retirement account fell between 2001 and 2004. An estimated 46.3 million households with a worker under 65 owned one or more retirement accounts in 2004, 1.2 million fewer households than owned at least one retirement account in 2001. The number of worker-households that owned a defined contribution plan from current or past employment remained unchanged at about 36.2 million, while the number of worker-households that owned an IRA or Keogh plan fell from 25.0 million in 2001 to 23.8 million in 2004. While the number and percentage of households with a worker under age 65 that owned a retirement account fell between 2001 and 2004, the average account balances of those who owned these accounts increased. Among worker-households that owned a retirement savings account of any kind, the median value (in 2004 dollars) of all such accounts rose from $28,760 in 2001 to $35,000 in 2001. The mean value of all the households' accounts rose from $101,422 in 2001 to $122,349 in 2004.

        Table 3.  Household Retirement Account Balances in 2001

Between 2001 and 2004, the percentage of households that owned a retirement account of any kind fell among households in which the householder was under 55 years old. Among households in which the householder was under 35 years old, the proportion that owned a retirement account fell from 46.0% in 2001 to 40.8% in 2004. Among households in which the householder was 35 to 44 years old, the proportion that owned a retirement account fell from 62.7% in 2001 to 56.7% in 2004. Among households in which the householder was 45 to 54 years old, the proportion that owned a retirement account fell from 64.2% in 2001 to 58.5% in 2004. The only households in which the rate of ownership of retirement plans increased between 2001 and 2004 were those in which the householder was 55 to 64 years old. Among this group, the proportion who owned at least one retirement account increased from 60.2% in 2001 to 63.5% in 2004. Among households headed by an individual age 65 or older, the proportion that owned a retirement account of any kind fell slightly from 2001 to 2004, declining from 36.9% to 36.3%.

The changes in average retirement account balances between 2001 and 2004 differed substantially according to the age of the household head. The median combined balance (in 2004 dollars) of all retirement accounts owned by households in which the householder was under age 35 rose from $7,456 in 2001 to $11,000 in 2004. Among households headed by individuals between 35 and 44 years old, the median retirement account balance actually fell between 2001 and 2004, declining from $30,888 to $30,000. Among households headed by persons between the ages of 45 and 54, the median combined balance of all retirement accounts grew from $51,125 in 2001 to $60,00 in 2004. The greatest increase in median retirement account balances between 2001 and 2004 -- both in constant dollars and in percentage terms -- occurred among households in which the household head was 55 to 64 years old. Among these households, the median balance of all retirement accounts rose from 58,580 in 2001 to $88,000 in 2004, an increase of 50%.

The increase in retirement account balances in the age group that is nearest to retirement age is encouraging, but the median account balance of $88,000 is still not very large. For an individual retiring at age 65 in May 2006, $88,000 could purchase a level, single-life annuity that would pay $653 per month ($7,836 per year), based on the federal Thrift Savings Plan's current annuity interest rate of 5.375%. This amount would replace just 15% of the median household income of $53,400 among households headed by individuals who were 55 to 64 years old in 2004. Moreover, these median values reflect only the balances of households that owned a retirement account. When we take into account households that had no retirement account -- and thus had retirement account balances of zero -- a total of 11.7 million households headed by individuals 55 to 64 years old had retirement savings of $88,000 or less in 2004. This represents 68.3% of all households headed by persons who were 55 to 64 years old in 2004.

      Table 5.  Household Retirement Account Balances, by Age of

• IRA ownership and average account balances rose steadily with household income through age 65, after which they declined;

• Households whose head was white were nearly three times likely as those in which the head was non-white to own an IRA, and their median account balance was 2.5 times greater;

• Married couples were much more likely than unmarried individuals to have owned an IRA, in part because these data measure retirement plan ownership at the household level, and many married couples include two workers;

• IRA ownership rose with education, and college graduates were more than twice as likely than those who had not graduated from college to have owned an IRA in 2004;

• More than half of households in the top 25% of the income distribution owned an IRA in 2004, compared to one-third of households in the second-highest quartile, one-fifth of households in the third quartile and just 8% of households in the bottom 25%;

• homeowners were almost four times as likely as renters to have owned an IRA;

• IRA ownership differed little between full-time workers and parttime workers;

• IRA ownership among employees of businesses with fewer than 20 employees differed little from that of workers at large businesses;

• Union membership appears to have little relationship to IRA ownership.

        Table 6.  Household Ownership of Individual Retirement

        Table 8.  Median Household Net Worth in 2001 and 2004,

Conclusion

Are Americans saving adequately for retirement? The median retirement account balances reported on the 2004 Survey of Consumer Finances would not by themselves provide an income in retirement that most people in the United States would find adequate. Among the 10.8 million households headed by persons aged 55 to 64 in 2004 and that owned at least one retirement account, the median balance of all their accounts was $88,000. Moreover, an estimated 6.2 million households headed by persons 55 to 64 years old had no retirement savings accounts in 2004. Including the households with zero balances, a total of 11.7 million households headed by persons age 55 to 64 -- 68% of all households in this age group -- had retirement account balances of $88,000 or less in 2004. Among the 79.6 million households that included at least one worker under age 65 in 2004, 33.3 million -- or 42% -- did not own a retirement savings account of any kind. The median balance among the worker-households that owned an account was just $35,000.

For workers who are not included in a defined-benefit pension where they are employed -- which is about 80% of all workers -- saving from current income is essential to preparing for retirement. Whether workers save by putting money into accounts that are earmarked for retirement or by accumulating other assets on which they can draw after they have retired is not necessarily important. The act of saving is of greater consequence to retirement security than the manner in which it is accomplished. Nevertheless, the fact that 33 million households that included a worker under age 65 had no retirement savings accounts in 2004 indicates that many households are not taking advantage of the tax deferrals available to virtually all workers through IRAs and to many workers through employer-sponsored plans.

On the one hand, the widespread adoption of tax-favored retirement savings plans over the past 25 years indicates that many workers are taking seriously their responsibility to save for retirement. On the other hand, the balances in these accounts -- even among those who are near retirement -- are generally low. For example, if the median retirement account balance of $88,000 among households headed by persons 55 to 64 years old in 2004 were converted to an annuity, it would provide a monthly income of $653 per month ($7,836) to a person retiring at age 65. This amount would replace just 15% of the median income of households headed by individuals who were 55 to 64 years old in 2004.⁵

The uncertain future of Social Security and the declining prevalence of defined-benefit pensions that provide a guaranteed lifelong income have put much of the responsibility for preparing for retirement directly on workers. The low rate of personal saving in the United States and the lack of any retirement savings accounts among millions of American households indicate that there is a need for greater awareness among the public about the importance of setting aside funds to prepare for life after they have stopped working. Most workers in the United States will need to begin saving more of their income if they wish to maintain a standard of living in retirement comparable to that which they enjoyed while working. The alternatives would be to work longer or to greatly reduce their standard of living in retirement.

References

Brian K. Bucks, Arthur B. Kennickell, and Kevin B. Moore. "Recent Changes in U.S. Family Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances." The Federal Reserve Bulletin, 2006. [http://www.federalreserve.gov/pubs/bulletin/2006/financesurvey.pdf]

² This report refers to households rather than to families because, according to the researchers at the Federal Reserve Board, the unit of analysis in the SCF is more comparable to the Census Bureau's definition of a household than to its definition of a family. In the survey, the head is designated as the male in a mixed-sex couple and the older person in a same-sex couple. This designation is not intended to convey "a judgment about how an individual family is structured." It is merely a means of organizing the data consistently. (For more information, see Bucks, Kennickell, and Moore, Federal Reserve Bulletin, 2006.)

³ The Congressional Research Service (CRS) found similar results in an analysis of the Census Bureau's Current Population Survey (CPS). Data from this survey show that between 2001and 2004, participation in employer-sponsored retirement plans among working householders and spouses under age 65 fell from 50.5% to 48.8%.

⁴ In a traditional IRA, pre-tax contributions can be made only if the worker is not covered by an employer-sponsored retirement plan or has income below amounts specified in law. All investment earnings accrue on a tax-deferred basis. Roth IRAs accept only after-tax contributions; however, withdrawals from a Roth IRA during retirement are tax-free.

⁵ The median income of households headed by persons aged 55 to 64 in 2004 was $53,400.