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U.S. stock indexes broke new ground last week, claiming fresh all-time highs. The news was greeted with muted response, from most, except the financial press. (Even there, the usual graphics were overshadowed by political news.) Meanwhile, the IRS finally announced new limits on everything from income ranges of tax brackets to retirement plan contributions for tax year 2020. The agency does this annually, in order to apply the rate of inflation to statutory limits of the tax code.
Some 60 provisions are affected, including the limits for employer based retirement plans. If you participate in a 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan, you’ll be able to contribute a maximum of $19,500 next year, up $500 from 2019. The catch-up contribution for employees’ aged 50 and over in these plans will increase from $6,000 to $6,500. However, the limit on annual contributions to traditional and Roth IRAs remain unchanged at $6,000, as does the catch-up contribution limit for those over 50, which stays at $1,000.
For a large portion of Americans, these plan limits are irrelevant because they are not even close to maximizing their retirement contributions. It’s not due to some moral flaw.
According to a recent paper from the Center for Retirement Research at Boston College (CRR), for workers to accumulate substantial retirement savings, they must contribute regularly into their plans, keep their money in the accounts, and they also need to maximize after-fee returns. That’s a tall order, according to authors Andrew G. Biggs, Alicia H. Munnell, and Anqi Chen. The reason that most workers have 401(k)/IRA balances at retirement that are “substantially below their potential” is due to four aspects of the U.S. retirement system, which make it difficult to achieve these goals.
The two biggest factors that contribute to the low level of retirement savings are “the immaturity of the system” and “the lack of universal coverage.” The paper notes that the shift from employer-funded pensions to employee funded retirement accounts occurred in the 1980’s, which means “many of today’s 60-year-olds did not participate in a 401(k) plan when they were young workers.” Additionally, many workers today still do not participate in plans, either because the employer does not offer one or because they are not eligible to participate.
Additionally, those who do participate may see their retirement balances shrink over time due to “leakages,” which include the ability to cash out when changing jobs, in-service withdrawals (hardship and tax-free withdrawals beginning at age 59 ½), and loans; and of course, those dastardly fees.
The analysis concludes “the typical older worker has less than $100,000 in 401(k)/IRA assets, instead of the $364,000 he would have had under a system in which workers participated throughout their careers, paid zero fees on account balances, and did not withdraw money prematurely from their accounts. The discrepancy is somewhat less if individuals under 30 and those with defined benefit plans are excluded from the analysis, but it is still significant.”
The low level of savings, combined with increasing life expectancies, explains why many older Americans are staying in their jobs longer. According to AARP, “Americans 55 and older make up slightly less than a quarter of the nation’s labor force, but they filled almost half (49 percent) of the 2.9 million jobs gained in 2018, the biggest share of any age group.”