Why Are 401(k)/IRA Balances Substantially Below Potential?

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For most workers, 401(k)/IRA assets represent the main source of retirement savings outside of Social Security.  These accounts can generate significant wealth if workers contribute consistently from a young age, keep their money in their accounts, and minimize their investment fees.  However, most workers have 401(k)/IRA balances at retirement that are substantially below their potential.  For example, a 25-year-old median earner in 1981 who contributed regularly would have accumulated about $364,000 by age 60, but the typical 60-year-old in 2016 had less than $100,000.  The discrepancy is somewhat less if those under 30 and those with defined benefit plans are excluded from the analysis, but still significant.  This study uses the Survey of Income and Program Participation, linked with administrative tax records, to explore the reasons for this gap between potential and actual balances and their relative importance.  The potential reasons include: the immaturity of the 401(k) system, lack of universal coverage, leakages, and fees.

The paper found that:

  • The main reasons why 401(k)/IRA balances fall short of their potential are the immaturity of the 401(k) system and the lack of universal coverage, followed by leakages and fees.
  • The same pattern holds if workers under 30 and those with defined benefit plans are excluded from the analysis.
  • Even in a mature system, the lack of universal coverage means that balances are still expected to fall well below potential.

The policy implications of the findings are:

  • Providing continuous access to a workplace-based saving vehicle for all workers could substantially increase retirement saving.
  • Encouraging less leakage by modifying pre-retirement withdrawal rules could also increase 401(k)/IRA balances at retirement, albeit more modestly.