R ISKS A SSOCIATED WITH R ETIREMENT N EW R ETIREMENT M ECHANISMS Amanda Mason Jonathan Suttman Mateusz Rakowski Rosemary Gantt Kevin Scott Matthew Austin Mingfan Zhou Group 2

N EW R ETIREMENT M ECHANISMS 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. A UTO -E NROLLMENT

N EW R ETIREMENT M ECHANISMS 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 401( K ), 403( B ), AND 457 P LANS

N EW R ETIREMENT M ECHANISMS As opposed to a 401(k), Roth IRA is funded by post-tax dollars Money withdrawn from account at retirement won’t be taxed Allows investors to hedge the risk of future high tax rates by paying the taxes today, and not in the future Con: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 R OTH IRA P LANS

N EW R ETIREMENT M ECHANISMS 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!) C ATCH U P C ONTRIBUTIONS

N EW R ETIREMENT M ECHANISMS 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 S TEP U P C ONTRIBUTIONS

N EW R ETIREMENT M ECHANISMS 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 L IFE C YCLE F UNDS

N EW R ETIREMENT M ECHANISMS 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). R ISKS E LIMINATED BY THESE P LANS

N EW R ETIREMENT M ECHANISMS 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 R ISKS A SSOCIATED WITH THESE P LANS

N EW R ETIREMENT M ECHANISMS 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 R ISKS A SSOCIATED WITH THESE P LANS

N EW R ETIREMENT M ECHANISMS 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. C ONCLUSION