The relationship between job characteristics and retirement savings in defined contribution plans
In our analysis, we follow private-sector workers who participated in a DC plan in 2007 and had the same employer throughout the recession. This allows us to present estimates that are not influenced by job change, unemployment, or time spent not in the labor force. The results bring into focus several job characteristics as they relate to a reduction in DC plan contributions over the recession. We find that the higher the employment losses in the industries in which DC plan participants work, the greater the probability of observing a substantial reduction in real contributions between 2007 and 2009, holding important covariates constant. The likelihood of reduced contributions was also greater for DC plan participants who worked for a small employer and for those who experienced a decrease in individual earnings.
The next section further elaborates the background of the study. This is followed by a description of the data, methods, and results. The final section summarizes the main findings and implications.
Along with Social Security and personal savings, employer-sponsored pensions represent a key pillar of U.S. retirement security. The movement away from the use of traditional DB pensions and toward the use of DC retirement accounts has been well documented.6 In recent years, DC plans have become the dominant employer-sponsored retirement plan for private-sector workers with pensions.7 Workers participating in these plans elect to defer some portion of their salaries or wages into a qualified retirement savings account.
A central advantage of DC plans to employees is that the plans are portable from job to job.8 They are also more flexible than traditional DB pensions (e.g., under certain circumstances, employees may access funds before retirement). Employees typically decide how much to contribute (some employers also match employee contributions) and how the account is to be invested. The opportunity to change contribution amounts has potential advantages and risks. An advantage is that workers are able to reduce their contributions to smooth consumption and improve well-being when experiencing an income shock. A risk is that workers who reduce their contributions, especially over the long term, potentially reduce their retirement resources; contributions generally need to occur regularly over one’s worklife to provide adequate income during retirement years.9 Moreover, consistency can provide “dollar averaging,” and DC-plan participants who choose to not contribute during a falling market, or who contribute less, probably fail to “buy low.”
In this context, an important research and public policy focus is the consideration of whether (and why) workers participate in a retirement plan and how much and for how long over their working lives they contribute. This issue is particularly relevant in light of the 2007–2009 recession.10
There are several reasons why DC plan participants might change—namely, reduce—their contributions during an economic downturn. First, individuals’ financial outlook may change. Compared with regular savings, savings in DC accounts are less liquid and, therefore, not as easily tapped for current consumption in the event of a financial emergency. If workers are worried about the economy or perceive rising unemployment as a threat to job security, they may be less willing to participate in a 401(k) plan or to contribute as much as they had before the downturn began. Participants may choose to divert some savings from retirement accounts to general purpose savings out of a reluctance to withdraw money from retirement accounts before reaching retirement age.11
6 O’Rand and Shuey, “Gender and the devolution of pension risks in the US”; and Poterba, Venti, and Wise, “The changing landscape of pensions in the United States.”
9 Patrick Purcell and Debra Whitman, “Retirement savings: how much will workers have when they retire?” Journal of Pension Planning and Compliance, vol. 33, no. 2, 2007.
10 Michael D. Hurd and Susann Rohwedder, “Effects of the economic crisis on the older population: how expectations, consumption, bequests and retirement by the older population responded to market shocks,” in Maurer, Mitchell, and Warshawsky, eds., pp. 64–80; Alicia H. Munnell, Dan Muldoon, and Steven A. Sass, “Recessions and older workers,” working paper no. 9-2 (Center for Retirement Research at Boston College, January 2009); and Steven A. Sass, Courtney Monk, and Kelly Haverstick, “Workers’ response to the market crash: save more, work more?” working paper 10-3 (Center for Retirement Research at Boston College, February 2010).
11 Mental accounting occurs when households assign specific purposes to particular asset classes, and the households are reluctant to use those assets for other purposes. When a household has assigned an asset to the category of retirement saving, it may be reluctant to use that asset for other purposes. For more explanation of the theory of mental accounting and empirical evidence, see Richard H. Thaler, “Anomalies: saving, fungibility and mental accounts,” Journal of Economic Perspectives, Winter 1990, pp. 193–205; Steven F. Venti and David A. Wise, “Have IRAs increased U.S. saving?: Evidence from consumer expenditures surveys” Quarterly Journal of Economics, August 1990, pp.661–698; and Annamaria Lusardi, “Precautionary saving and the accumulation of wealth,” working paper no. 204 (Joint Center for Poverty Research, Harris Graduate School of Public Policy Studies of the University of Chicago, August 2000).