401(K) Plan Outflows Exceed Contributions as Baby Boomers Retire

Before discussing this week’s topic I want to share a quick observation about this week’s Federal Open Market Committee (FOMC) meeting. The forecasts released yesterday show reduced expectations for where the Fed funds rate will be over the few years. For example, seven members now expect the target to remain at or below 1.5% next year. Three months ago, only two members were this dovish. The forecasts can be seen by looking at the “dots,” meaning the charts included in the release of the FOMC’s economic projections. (You can see the current set of forecasts and those from previous meetings on the Federal Reserve’s website. Click on “PDF” under “Projections Materials” for a given meeting). This change in forecasts implies expectations for a slower pace of future rate increases—after the first one occurs—though what actually does happen remains very much dependent on future data.

The investment industry reached a generational milestone. The Wall Street Journal says withdrawals from 401(k) plans exceeded contributions in 2013, the latest year complete data is available for. The shift ends of streak of expansion that had lasted decades.

Baby boomers are responsible for this shift. Citing data from JPMorgan Chase & Co. and the Census Bureau, the newspaper says 3.5 million Americans are projected to retire this year, up from 2.7 million in 2010.

The actual amount to be pulled from 401(k) plans is unknown. Two forecasts published by The Wall Street Journal estimate outflows to persist until at least 2019 or until 2030—a big difference. Vanguard, which recently published its annual “How America Saves” report, says just 3.6% of defined-contribution (DC) plan (e.g., 401(k) plan) participants took a withdrawal last year from plans offering withdrawals (84% of Vanguard DC plans do). Though a higher percentage of participants took cash withdrawals (3.3%), participants rolling over their savings to an IRA (0.3%) were significantly older—a median age of 62, versus 51 for all participants taking a withdrawal.

What happens next is uncertain. The demographic trends have been well-known for a long time, so to see withdrawals starting to exceed contributions is not surprising. But a person in relatively good health cannot expect to retire at age 65 or 70 and live off of cash savings unless he or she has a large enough pension and/or considerable net worth, due to the combined risks of inflation and longevity (meaning a long lifespan). As such, most new retirees will need to keep investing their retirement savings. This makes “where will they put their savings?” the big question for the investment industry.

As an association of individual investors, we believe individuals can be empowered to become effective managers of their own portfolios. Many of you reading this are proof that this is true. The definition of what an effective manager is varies by person, with some AAII members hand-selecting all of their stocks and bonds, while others use funds, an adviser, annuities or some combination thereof. There is never a one-size-fits-all approach, and the investment industry is trying to adapt to this reality.

Those of you entering retirement or merely switching jobs face a decision about what do with your 401(k) plan savings. The decision whether to keep your account unchanged or move it elsewhere depends on both your employer’s plan and what you would do with the money if you withdrew it from the plan. Rolling over your 401(k) to an individual retirement account (IRA) dramatically increases investment choices. Too many choices, however, can lead to no decision being made. Keeping your 401(k) where it is, or with your plan sponsor—if your (former) employer requires you to roll it over (contact your HR department to ensure you know exactly what the rules are)—may allow you to keep your current allocations unchanged.

When deciding what to do, pay attention to costs. Depending on your employer’s plan, you may be able to get a similar allocation at a lower cost by not rolling the account over to an IRA. This may hold true for actively managed funds, especially if your (former) employer’s plan offers access to institutional funds. On the other hand, rolling over your 401(k) savings to an IRA (traditional or Roth) would give more choice and more control even if the fees on the actively managed funds are higher.

The big thing is to spend time thinking through what you want to do and execute on the strategy, realizing that you can change your decision in the future.