The 3% difference: What leads to higher retirement savings rates?Contributors Katherine Roy, Lori Lucas, Jack VanDerhei, Kelly Hahn, Je Oh, Livia Salonen
- Groundbreaking research from a collaboration of the Employee Benefit Research Institute and J.P. Morgan Asset Management is the first to use a unique set of data on actual spending and savings behavior to provide a holistic financial view of U.S. households.
- In our inaugural research, we ask: Why do some people save more than others, even when they have equivalent income? Despite having similar salaries, the middle 50% of our research populationA save about 3% more of their salary at all ages than the bottom 25% of savers. This 3% difference in savings behavior, if sustained over time, could ultimately explain some of the meaningful gap between the current retirement plan account balances of middle and low savers.
- For the very first time, we can point to the specific categories of current spending that appear to be constraining the ability to save more. Low savers generally spend more than middle savers as a percent of salary on housing, transportation and food and beverage, and less on travel. In future research, we will explore what factors might drive the increased spending.
- Defined contribution plans appear to be most households’ primary retirement savings vehicle, underscoring the importance of the employers’ role in savings.
It’s a difficult time in many ways. All of us are naturally focused on the near term, managing, as best we can, the profound disruptions caused by the COVID-19 shock to our lives at work and at home. With unemployment surging to alarming levels, the economic outlook remains uncertain. Many people, faced with financial hardship, may have no choice but to draw on their retirement savings for their immediate cash needs. But eventually the crisis will pass, and a long-term perspective on retirement must take into account both the arduous present and a more promising future.
That perspective, though, should be informed by a complete understanding of household behaviors through good times and bad—not just within but outside employer-sponsored plans, including debt, spending choices and other savings and investments. For example, defined contribution (DC) plan features such as automatic enrollment, automatic contribution escalation and target date funds have been shown to be beneficial for DC plans and their participants. But skeptics may ask if these features have definitively improved retirement outcomes when a household’s complete picture is taken into consideration. Armed with insights into plan participants’ financial picture, plan sponsors can make more-informed choices about adjusting their plan design decisions, gaining confidence that they are targeted to improve retirement as well as overall financial outcomes.
Until now, policymakers, plan sponsors and plan providers have had to rely primarily on analysis of relatively limited survey-based data to better understand these household dynamics. While leading academic research has taken the first steps toward understanding how plan features may affect broader household finances,1 a comprehensive, large-scale view of household behavior has proved elusive.
For the first time, groundbreaking research from a collaboration of the Employee Benefit Research Institute (EBRI) and J.P. Morgan Asset Management (JPMAM) draws on a unique set of data tracking actual spending and savings behaviors to lift those data limitations.
Joining an EBRI/Investment Company Institute database of 27 million 401(k) participants to JPMorgan Chase & Co.’s database of 22 million consumers,2 we seek a more holistic understanding of the critical issues in retirement and financial wellness by factoring in both the household balance sheet and cash flow behaviors. We believe the data can better inform decisions in policymaking, plan design and retirement investment—and help solve some persistent mysteries around Americans’ savings patterns.
We first tackle the conundrum of why some people save more than others, even when they have an equivalent salary. What spending behaviors do higher savers engage in that allow them to save more for retirement at all ages and accumulate considerably more over the long term? What might be inhibiting low savers from increasing their retirement plan contributions? Our analysis revealed that DC plans are likely to be most households’ primary retirement savings vehicle,3 underscoring the importance of the employers’ role in savings.
Past research has offered tentative explanations of savings disparities, including an inability to save due to:
- Low income making it harder to save enough for retirement
- Prioritization of current spending needs over savings (also known as hyperbolic discounting)
- Challenges in navigating the defined contribution system specifically and the overall savings system generally
In this paper, we focus on the first two themes. Among the highlights of our research findings:
- Despite having similar salaries, the middle 50% of our research population (based on employee contribution rate by age cohort) save about 3% more of their salary at all ages than the bottom 25% of savers.
- This 3% difference in savings behavior, if sustained over time, could ultimately explain the fact that the current retirement plan account balances of high tenured middle savers are almost two times larger than those of high tenured low savers.
- For the first time, we can point to the specific categories of current spending that are constraining the ability to save more. Low savers across most age groups spend more as a percent of salary on housing, transportation and food and beverage, and less on travel. All the other categories we looked at are similar across age cohorts.
METHODOLOGY: INSIDE THE EBRI/ICI-JPMORGAN CHASE DATA
First, a brief explanation of our methodology.
Using 2016 data, we compare information about 22 million Chase households and the records for 27 million 401(k) plan participants to isolate an overlapping population of 1.4 million households. We remove households with:
- de minimis employer plan balances4
- total spending less than 50% of salary
- likely more than one earner5
Examining the resulting population of 10,000 households, we look at behaviors by age cohort and try to find the links among salary, employee savings, spending and 401(k) balance. Any employer match is not included in our analysis.
We note two caveats. First, our research is a snapshot in time; we examine individual households’ concurrent financial picture instead of their behavioral trends over the years. Second, we use fairly broad definitions of spending categories. For example, the food and beverage category does not distinguish among spending subcategories such as eating at restaurants vs. eating at home. More granular analysis of the data will inform future reports.
SAVER PROFILES BY AGE COHORTS
What defines a high, middle or low saver? Using observed savings behaviors by age, we divide our population into three groups, based on their 401(k) contributions as a percent of salary by age cohort. We define middle savers as the middle 50% of our population, high savers as the top 25% and low savers as the bottom 25%, based on the employee contribution rate by age cohort (EXHIBIT 1).
At most ages, they save about 2% of their salary, slowly raising the amount to 3% as they approach retirement.
At younger ages, they save about 5% of their salary, slowly raising the amount to about 6% as they approach retirement.
At younger ages, they save about 9% of their salary, and they continue to increase their contribution as they get older. Notably, high savers save about twice as much as the middle savers throughout all age cohorts.
How should we think about the difference in the contribution rates of the three groups of savers, especially the gap between middle and low savers?
Middle savers save about 3% more of their salary at all ages than low savers
EXHIBIT 1: MEDIAN CONTRIBUTION RATE AS A PERCENT OF SALARY