Running Head: The Impact of 401(k) Plans on Timing of Retirement
Introduction and Background of the Study
401 (k) plans are a type of defined contribution plans that fall under the Cash or Deferred Arrangements (CODAs). Legally, the term is used to refer to plans that qualify under section 401(k) of the Internal Revenue Code (Engelhardt & Kumar, 2008). Researchers, media and policy makers however usually use the term simply to describe plans that offer elective worker pre-tax contributions derived from salary reduction. There are various plans with this future including the savings or thrift plans, and the profit sharing plans. These plans generally allow workers to make elective contributions from their salary on a pre-tax basis.
The growth in the 401 (k) plans over the past two decades indicates a significant increase in retirement plan savings in the United States (Engelhardt & Kumar, 2008). Most of this increase is attributed to new companies embracing the 401 (k) plans and not to replacement of defined benefit plans. This increase is however misleading because two thirds of contributions to 401 (k) plans come from the employee while many of the defined benefit plans are non-contributory (Furgeson, et al., 2009). Shift in retirement pension coverage from defined benefits to the 401(k) plans is attributed to increased mobility of workers in the US. It is argued that this mobility causes these workers to lose a significant amount of their of their retirement benefits under the traditional defined benefit plan compared to those covered by defined contribution plans such as 401(k) plans hence the shift (Gough & Hick, 2009). Most companies in the private sector are freezing and replacing traditional defined benefit plans with 401(k) plans or converting them to cash balance plans (GAO, 2008; McFarland, 2011). Traditional defined benefits plans provide incentives for employees to retire early and not work beyond the normal retirement age. 401(k) plans are however neutral with regards to retirement age as workers have incentives to work as long as they wish or is possible and on average, employees under this plan retire a number of years later than those covered under the defined benefit plan (Furgeson et al., 2009). It is therefore obvious that 401(k) plans have a significant impact on retirement patterns.
Traditionally defined benefit plans are designed to encourage workers to remain with the firm until they retire and also to retire by a certain specified age (McFarland, 2011). These plans do this by providing significant pension benefits at early retirement age. Workers can only claim this with less than a full actuarial pension if stay to the specified age of early retirement, usually 55. The benefits of those who leave earlier before reaching this age is determined based on the regular benefit formula. Under this plan, the value of an employee’s benefits rise gradually until they are 54 years old, after which it suddenly increases at 55. The increased value of pension benefits at 55 and the income it provides becomes a key incentive to retire (Munnell et al., (2015). After that, the subsidy embedded in the less-than actuarial reduction gradually declines and entirely disappears at the normal retirement age. This disappearance of the subsidy also provides a strong incentive to retire before the normal retirement age under the plan.
Defined contribution plans such as the 401(k) plans operate differently. The accumulated pension wealth of an employee changes each year by the contributions and the earnings on the accumulated amount, but is not affected by the employee’s decision to retire (Engelhardt & Kumar, 2008). Pension wealth on the already accumulated assets under these plans continues to rise even if the employee is no longer making any more contributions (as long as the earnings on the invested assets are positive). According to Munnell et al., (2015), the only aspect of these plans that may affect retirement is the constraint enforced by the government that any withdrawals before the worker reaches the age of 591/2 attracts penalties. According to the 401 (K) plan, one cannot take their money out before the age of 591/2 years as this attracts taxes and penalties on the withdrawn amount. Investors who withdraw before this age do not also enjoy the tax-deferred growth that their savings would have amassed had they left the money in the plan or rolled it over to an individual retirement account. Taking out money from the plan attracts the following disadvantages; income tax on each withdrawal from the plan, early withdrawal penalty of 10 percent of the amount being withdrawn, lost investment growth and less money at retirement (Samwick & Skinner 2008). Otherwise 401(k) plans do not encourage retirement of workers at any particular age.
There is evidence suggesting that the shift to 401(k) plans will alter retirement patterns (Munnell et al., 2015). Findings from a number of empirical studies such as VanDerhei and Copleland (2011) demonstrate that the financial incentives designed in benefit plans encourage employees to retire earlier than those that are covered by defined contribution plans. This change resulted raised the median retirement age between 1983 and 1993 by about three months. Findings from another study indicated that workers under the defined benefit plan retire two to three years earlier than those that are covered by 401(k) plans. The second evidence is suggestive and not really scientific. According to Munnell, et al., (2015), men in the US have over the course of the last century retired at younger and younger ages. However, the downward trend in age of retirement seems to have stabilized since 1985. Although there are many factors that may have contributed to this change including changes in the environment, the shift from defined benefit plans towards defined contribution plans seems to be the strongest. In summary, elimination of the incentives that encourage early retirement usually found in defined benefit plans should result in later retirement. This effect on retirement raises questions on earlier studies which assumed that a typical employee covered by a defined benefit plan and that covered by 401(k) plan retire at the same sage. However, recent studies suggest that if everything else is kept constant, the worker covered by the 401(k) plan is likely to retire at a later age as they seek to end up with more wealth at retirement. Wyatt (2008) points out that increase in all the different categories of wealth accumulation such as housing equity, retirement plan, and other financial wealth increase the likelihood of retiring while good earning prospects, indicating high opportunity cost of retirement, encourage continued employment. According to this author, the type of retirement plan employees are covered with has a significant impact on their timing of retirement. According to this report, employees under defined benefit plan retire early compared to those under defined contribution plans who tend to delay their retirement because most of the defined benefit plans have work disincentives beyond particular ages but are said to provide retirement income flow that is more secure which lowers exposure to risks while defined contribution plans are generally more neutral. Empirical studies to confirm this are however scarce hence the need for the present study.
The Problem Statement
The shift from defined benefit pension plans to defined contribution plans including 401(k) plans has had effect on financial security of retirees, job mobility as well as on retirement decisions (Gough & Hick, 2009). Studies indicate that the shift to defined contribution has eliminated most of the incentives to retire early implying a change in timing of retirement. While previous suggest that 401(k) plans have resulted in employees retiring much later compared to those under defined benefit plans, empirical studies seeking to establish the exact impact of 401(k) plans on timing of retirement are scarce. Most of the existing studies have focused on impact of the 401(k) plans on job mobility, workers’ retirement decisions, amount of retirement wealth and on the strengths and weaknesses of 401(k) plans. Most of these studies are also very old as most were conducted just after introduction of defined contribution plans. There is need for current studies to be conducted to provide empirical evidence on the impact of 401(k) plans on timing of retirement of workers.
The Purpose of the Study
The purpose of this study is to conduct an in-depth empirical study to evaluate the impact of 401(k) plans on timing of retirement of workers. The study seeks to use mixed method approach so as to obtain findings that will provide a deep understanding of the impact of the 401(k) plans on retirement decisions.
The Significance of the Study
This study is important as it seeks to fill the existing gap in literature by examining in depth the impact of 401(k) plans on timing of retirement so as to provide up to date knowledge as most of the existing studies are old and not based on empirical data. The findings of this study are important as they can be used by policy makers to understand the impact of plan characteristics on retirement savings as well as timing decisions and ways through which these plans can be improved. The study will also contribute towards research by providing a basis for future research which can be conducted to validated the findings of the present study or to address the gaps that this study will identify as needing further research
Theoretical Framework of the Study
Researchers have used various approaches to study retirement behaviors among employees. Some of the theories used include regulatory analysis, psychological theory and theory of pensions. This study will be developed based on the current theory of pensions developed by Lazear (1986) when defined benefit plans were common. According to his theory, pensions alter the incentives that encourage long-term employment. This theory will be extended in this study to explain the impact of 401(k) plans on timing o retirement. As a type of defined contribution plan, 401(k) plans do not offer incentives for long-term employment like defined benefits plans do but they encourage long-term savings. This study will therefore focus on the incentives in the 401(k) plans for long-term employment as well as long-term savings so as to establish how they affect retirement decisions of employees.
The aim of this study is to determine the impact of 401 (K) plans on the timing of retirement. To achieve this, the study will explore the following objectives;
- To establish whether people with 401(k) plan retire early compared to those covered by traditional defined benefit plan
- To establish how the 401(k) plans affect retirement decision
- To determine how 401(k) plans affect expected and actual retirement ages
- To establish whether 401 (k) pension plans are more important to employees as they grow older
- To establish whether employees at older age prefer 401(k) plans or defined benefit pensions
- To determine whether there is any difference in retirement age between those covered by 401(k) plans and those covered by traditional defined benefit plans
- To determine the effect of 401(k) plans on job retention among workers in the US
H1: People with 401(k) plan retire later compared to those covered by traditional defined benefit plan
H2: 401(k) plans have significant impact on expected and actual retirement ages
H3: There is significant difference in retirement ages between employees covered by 401(k) plans and those covered by traditional defined benefit plans
H4: Employees at older age prefer 401(k) plans to defined benefit pensions
The Nature of the Study
In order to conduct an in-depth study and obtain detailed and rich analyses, a mixed-method approach will be adopted whereby the study will use both qualitative and quantitative methods to collect data. This approach has an advantage as it allows triangulation which is a good strategy for ensuring that study findings are not only valid and reliable but can also be generalized (Saunders et al., 2013; Fassinger & Morrow, 2013).
A survey approach will be used whereby employees from various organizations and walks of life will be surveyed to determine the effect of 401(k) plans on the timing of their retirement. Survey strategy will be used because of its compatibility with interviews and questionnaire as methods of data collection and the fact that it also allows one to study multiple variables (Creswell, 2013).
The study subjects will be employees in the United States both male and female between the ages of 25 and 65 and who are covered by either 401(k) plans or the defined benefits plans and are either retirees or still working. These will be selected using snowball sampling whereby the researcher will use proxy to recruit subjects. The researcher will identify people from various organizations and use them to recruit subjects from whom data will be collected from.
Data will be collected using questionnaires and semi-structured interviews. The questionnaire will be sent to various employees via email, in person and through mail. These will be used to collect quantitative data from the different types of employees. The questionnaire will be based on a likert scale with five points. Survey questionnaire was selected because of its ability to collect data from large samples, to provide data that can be statistically analyzed to test hypotheses and to study various variables simultaneously (Creswell, 2009).
Semi-structured interviews will be used to collect qualitative data from a few selected employees (about 10) so as to get in-depth data that is not possible to obtain using the survey. The purpose for selecting semi-structured interviews is because of their ability to provide detailed data and analyses as they allow use of secondary questions to probe the respondent for further explanations and clarification which enhances richness of data (Creswell, 2013). Data from the interviews will be used to answer the research questions.
Quantitative data will be analyzed using statistical methods including descriptive statistics that will provide data on age, type of pension plan and gender while inferential statistics such as Chi-square and t-tests will be used to test the hypotheses.
Creswell, J. W. (2009). Research design: Qualitative, quantitative and mixed methods approaches. London, UK: Sage.
Creswell J. W. (2013). Qualitative Inquiry and Research Design: Choosing among Five approaches (3rd ed. Chapter 7). Thousand Oaks, CA: Sage Publications
Engelhardt, G. V., & Kumar, A. (2008). Understanding the Impact of Employer Matching On 401(K) Saving. Research Dialogue, Issue 76, pp. 1-11
Fassinger, R., & Morrow, SL (2013). Toward Best Practices in Quantitative, Qualitative, and Mixed-Method Research: A Social Justice Perspective. Journal for Social Action in Counselling and Psychology, Vol.5, No. 2, pp. 69-83
Feldman, D. C., & Beehr T. A. (2011). “A Three-Phase Model of Retirement Decision Making,” American Psychologist, February 21, 201
Furgeson, J., Strauss, R. P., Vogt, W. B. (2009). The Effects of Defined Benefit Pension Incentives and Working Conditions on Teacher Retirement Decisions. Education Finance and Policy, 1(3): 316-348.
GAO, “Plan Freezes Affect Millions of Participants and May Pose Retirement Income Challenges,” July 2008, retrieved from <http://www.gao.gov/new.items/d08817.pdf
Gough, O., & Hick, R. (2009). Employee Evaluations of Occupational Pensions. Employee Relations, 31(2):158-167.
Lazear, E. P. (1986). Retirement from the Labor Force” in O. Ashenfelter and R. Layard, eds., Handbook of Labor Economics. Volume 1, Handbooks in Economics Series. New York: Elsevier Science Publishers, pp. 305-55.
McFarland, B. (2011). “Prevalence of Retirement Plan Types in the Fortune 100 in 2011”, Towers Watson Insider US. Retrieved on 6th August 2015 from <http://www.towerswatson.com/united-states/newsletters/insider/5010
Modugno, V. (2012). The Effect of Changes in Retirement Plans on Employee Savings and Retirement Age and the Financial Impact on Employers of Delayed Retirement. Sponsored by Society of Actuaries’ Pension Section Research Committee, pp. 1-30
Munnell, A. H., Cahill, K. E., & Jivan, N. A. (2015). How Has the Shift to 401(K)s affected the Retirement Age? Center for Retirement Research, pp. 1-7. Retrieved on 6th August from < https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&uact=8&ved=0CB0QFjAAahUKEwjw58aWkJfHAhWGWxQKHc4TDEY&url=http%3A%2F%2Fcrr.bc.edu%2Fbriefs%2Fhow-has-the-shift-to-401ks-affected-the-retirement-age%2F&ei=MbnEVbCLF4a3Uc6nsLAE&usg=AFQjCNEoR054SXB81gy5adKYVIELdYABRA&bvm=bv.99804247,d.ZGU>.
Samwick, A. A., & Skinner, J. (2008). How Will 401 (k) Pension Plans Affect Retirement Income? The American Economic Review, 94(1):329-343
Saunders, M., Lewis, P. & Thornhill, A. (2013). Research Methods for Business Studies. Sixth Edition. Pearson Education, Boston, MA.
VanDerhei, J., & Copleland, C. (2011). The Impact of Deferring Retirement Age on Retirement Income Adequacy. Employee Benefit Research Institute. 58: 1-33
Wyatt, W. (2008). Predictive Factors for Retirement Timing. Financial Engines, pp. 1-3