Houses and Cars and Savings, Oh My!

(Is there something wrong with workers who save up and borrow to make a major purchase?)

Throughout the past few weeks, several articles highlighted workers’ retirement saving behavior and debt. For example: 

1. John Manganaro, PlanSponsor.com, “Pressing Financial Needs Derail Successful Savers,” January 16, 2018. “Survey data shows a sizable group of retirement plan participants have lowered their contributions in the last year to address debt, unexpected bills, health care costs, and other challenges. …[T]he data shows 27% cited ‘needing to pay down debt and bills’ as the primary reason for redirecting income away from retirement accounts. Another 25% cited, ’needing money for day-to-day expenses,’ while 18% reduced salary deferrals to ‘finance a major life event’ and 16% did so to ‘address less income.’”  
2. John Beshears, James J. Choi, David Laibson, Bridget C. Madrian, William L. Skimmyhorn, “Borrowing to Save? The Impact of Automatic Enrollment on Debt,” December 6, 2017.  “Automatic enrollment causes no significant change in debt excluding auto loans and first mortgages.  …Automatic enrollment does significantly increase auto loan balances by 2.0% of income and first mortgage balances by 7.4% of income. These secured liabilities have muted immediate effects on net worth because they are used to acquire assets, but their increase could signal that automatic enrollment previously decreased non-TSP (Thrift Savings Plan) assets. Larger secured loans could also decrease long-run net worth through greater depreciation and financing costs.”   
3. Anne Tergesen, “Downside of Automatic 401(k) Savings: More Debt:  New research finds employees auto-enrolled in retirement plans borrow more than they otherwise would have, offsetting savings,” Wall Street Journal, January 5, 2018.  Ms. Tergesen reviewed the Beshears, et. al., study mentioned above: “Automatic enrollment has pushed millions of people who weren’t previously saving for retirement into 401(k)-style plans. But many of these workers appear to be offsetting those savings over the long term by taking on more auto and mortgage debt than they otherwise would have. ‘Our conclusion is that people who are auto-enrolled do eventually take on more debt,’ said co-author James Choi, a professor of finance at the Yale School of Management. ‘But they don’t take on more of the kind of debt that would be clearly worrisome,’ such as credit-card debt, second mortgages or installment loans, which often charge higher interest rates and are typically used to purchase consumer goods rather than assets.“   

While each headline offers a negative connotation, I was surprised by some of the conclusions drawn.  

With respect to John Manganaro’s article, the American Payroll Association annual study, Getting Paid In America, shows that 71% of Americans live payday-to-payday.  Despite that, of those survey participants who have access to an employer sponsored retirement savings plan, 86% confirm they are saving!  (See: http://www.nationalpayrollweek.com/documents/2017GettinngPaidInAmericaSurveyResults.pdf)  So, when “pressing financial needs” arise, is anyone really surprised to see workers adjust their contribution rates?  Who among us would recommend workers access monies through, say, a payday loan (with ~400% fees) in order to maintain their retirement savings rate?

I have more than ten years of plan sponsor experience working with plans using automatic features. In my experience, workers, on average,--and averages can be deceiving--experienced dramatic increases in accumulated savings with no significant change in plan loan activity. So, some of the Beshears, et. al. study results were a surprise:

• Non-participants normally have a much greater effect when comparing average account balances.  For example, in Vanguard’s annual study, How America Saves, voluntary enrollment systems experience a 63% rate of participation, automatic enrollment, 90+%.  (See:  https://pressroom.vanguard.com/nonindexed/How-America-Saves-2017.pdf) The study authors suggest the modest difference may have been the result of the modest design – a default of 3%, where each group received a 1% employer contributions, concluding:  “We would not expect automatic enrollment to be as powerful in this context.”
• Turnover may have played a role.  The same Vanguard survey shows significant differences in participation based on completed service – for those in the year of hire or with one year of service, 38% participate where enrollment is voluntary, 88% where enrollment is automatic.  For those with 2 – 3 years of completed service, the difference was 60% versus 94%. Since the study only compared those who completed a full four years, many who were least likely to participate may not have been part of the comparison.    
• Income factors may have played a role. The same Vanguard survey shows that, among those earning < $30,000 a year, only 32% participate where enrollment is voluntary, while 87% participate where enrollment is automatic.  And, income factors may be reinforced by turnover - my experience is that turnover declines as income rises.  So, as the Wall Street Journal article suggests, it is possible that the increased savings played a role in workers taking on more debt.    
• Finally, I wondered about second incomes, prior experience with retirement savings plans, the disposition of assets from prior retirement savings plans, household composition/size, accumulated household wealth, the proximity of the Great Recession, the rollout of automatic enrollment provisions and features, and many other factors that may not have been measured but might have affected the results - even though the authors did attempt to control for demographic differences via regression.  

I always encouraged workers to save up in the 401(k) for a purchase like a car or home – leveraging tax preferences, loan features, employer match and other valuable features not available elsewhere.  I have often encouraged workers to save up for needs other than retirement – what I call saving “along the way to retirement.” 

The question seems simple enough:  Are workers’ finances improved or impaired by automatic enrollment?  I have yet to see even one study that suggests automatic features lead to a decline in overall household net worth.