Risks Associated with Retirement New Retirement Mechanisms

1. Risks Associated with RetirementNew Retirement Mechanisms Group 2 Amanda Mason Jonathan Suttman Mateusz Rakowski Rosemary Gantt Kevin Scott Matthew Austin Mingfan Zhou

2. New Retirement Mechanisms Auto-Enrollment • Responsibility for retirement saving shifting from employer to employee • Auto-enrollment into 401(k), 403(b), and 457 plans • Employee has to manually opt out, as opposed to manually opt into a retirement plan • Mechanism greatly increases the number of employees who invest into 401k plans • Only 20% of low wage workers will manually enroll into a 401k plan • Under auto-enrollment, only 20% of people manually opt out of a 401k plan! • Argument: To much company control over personal finances.

3. New Retirement Mechanisms 401(k), 403(b), and 457 Plans • Allow employee to save for retirement • Defer income taxes on the savings and earnings until withdrawal • Employee chooses portion of wages to invest • Employer may elect to match the employee’s contribution up to a certain limit • 401(k): Popular plan for businesses of all sizes • 403(b): Plan established by public school, college or university or tax-exempt charitable entity • 457: Plan available to certain state and local governments and certain tax exempt non-governmental entities

4. New Retirement Mechanisms Roth IRA Plans • As opposed to a 401(k), Roth IRA is funded by post-tax dollars • Money withdrawn from account at retirement won’t be taxed • Allows investors to hedge the risk of future high tax rates by paying the taxes today, and not in the future • Con: Amount one is able to deposit per year is about 1/3 of the limit one can deposit into a 401(k) plan

5. New Retirement Mechanisms Catch Up Contributions • Savings tool offered for people 50 years of age or older • Gives these employees an opportunity to “catch up” on their retirement savings • Allows employees to put a higher amount of money into their 401(k) plan than is normally allowed • For people under 50, the 2009 limit is $16,500 • For people 50 or older, the limit is $22,000 • Ability to put more into savings, even at a late age, provides more cushion for retirement • Con: Increase may seem substantial, but doesn’t compensate for early savings • Con: Doesn’t compensate for advantage of the compounding effect of interest. • Con: Compounding effect often yields to much higher savings (even if the contributions amount to more money!)

6. New Retirement Mechanisms Step Up Contributions • Savings tool convenient for individuals living paycheck to paycheck. • Mechanism defined by a series of increases in employee’s contributions into their 401(k) plan over time • Employee starts out making a minimum contribution from earnings at a level that they are comfortable with • Employer increases contribution in small increments • Increases are virtually unnoticeable to employee over time • Eventually contribution amount will reach and remain at the desired level • Con: Accrues savings much more slowly • Con: Over time employee must remember to adjust to receiving less income each year unless they receive substantial raises in pay

7. New Retirement Mechanisms Life Cycle Funds • Powerful tool for the ignorant investor • Funds essentially set up to mimic how an investor would handle one’s portfolio as he/she ages • Portfolio starts risky and automatically becomes more conservative over time • Little effort from investor’s point of view. • A person with relatively little knowledge of how to invest can still have investments in stocks, picked by someone with expertise • Con:Still does not eliminate the uncertainty of the stock market, even with wise investment choices

8. New Retirement Mechanisms Risks Eliminated by these Plans • Business Risks • Under defined benefit plan, if employer experiences financial problems, retirement plan faces risk too • Though plan is insured, it can only pay up to a certain limit • Plan also faces risk of insurance company providing annuities becoming insolvent. • Portability • Employee that works for company with defined benefits plan risks loss of retirement benefits should they choose to leave • Defined contribution plans are portable with change of job • Employee able to choose to roll over investment to new company’s plan or an Individual Retirement Account (IRA).

9. New Retirement Mechanisms Risks Associated with these Plans • Inflation • Unexpected rise in inflation can considerably erode buying power of the retirement income • Unpredictable inflation and increase in life expectancy, increase risk of inadequate projection of required retirement funds • Individuals who cannot afford to hire professionals to manage their retirement may not be able to appropriately account for rates of inflation • Stock Market Risk • A stock market crash can cause even a well-diversified portfolio to lose large percentage of worth • If a stock market crash happens close to retirement, individuals heavily invested in market may need to postpone retirement until market recovers

10. New Retirement Mechanisms Risks Associated with these Plans • Life Expectancy and Morbidity Risks • Risk of outliving savings due to increased lifespan • With rising medical expense, illnesses can seriously affect the financial security of retiree • Difficulty predicting these factors • If retirement age remains at 65, people will need to start increasing savings to compensate for longer period of life they will have to support • Interest Rates • Employees with defined contribution plans face risk of interest rate fluctuation • Low interest rate lowers retirement income

11. New Retirement Mechanisms Conclusion • From 1950 to early 1980s savings rate was between 8-10%, today rate is around 3%, after being below 1% for past 4 years • Easy mortgage refinancing wasn’t common, so part of savings came from paying off mortgage • Credit cards weren’t common, so people had to save before making purchases • Under old-fashioned retirement systems, employees were automatically enrolled into pension plan with defined benefits • Today, defined benefit plans are less common and employee needs to make decisions of where and how to invest • With the introduction of plans that required will power in order to maintain savings, the rates fell drastically. • New innovative mechanisms make it possible for people who lack will power, or don’t necessarily understand the importance of retirement, to easily start investing for their future. • New innovative mechanisms make it possible for people who lack will power, or who don’t necessarily understand the importance of retirement, easy options to start investing for their future. • With the investment responsibilities falling on the employee’s shoulders, it is imperative that the employee obtains the necessary investment tools to alleviate some of the related risks.