401(k) Rollovers
and
Financial Literacy
Prepared for the U.S. Government Accountability Office
Chicago Field Office
By:
McKinney Austin
Byron DeLuke
Karen Walsh
Peter Whalen
Dominique Williams
Background
● The retirement savings landscape has
changed with increasing prevalence of
defined contribution plans.
● U.S. workers have greater responsibility
to prepare for retirement via savings and
investments.
1
Background
● Increasingly, defined contribution plan
accumulations are rolled into Individual
Retirement Accounts (IRAs)
● Potentially higher IRA fees can lead to
reduced accumulation, standard of living
● Broad cross section of U.S. population is
impacted
2
Research Questions
● To what extent do U.S. workers own IRAs and what are the
demographic characteristics of IRA holders?
● Are rollovers a significant source of IRA assets and who rolls
over?
● Are individuals who roll over aware of the option to leave
assets in 401(k)s?
● Are they aware of fees when rolling over? Are the fees
transparent?
● What is the relationship between financial literacy and the
rollover decision?
3
Research Methods
● Reviewed available literature
● Interviewed industry professionals
● Analyzed Health and Retirement Study
(HRS) data
4
To What Extent Do
U.S. workers Own IRAs?
● An increasing proportion of retirement
savings are held in IRAs
● Both IRA ownership and rollover activity
span many demographic groups
● Share of IRA assets increases with age
5
IRA Ownership:
Percentage of U.S.-based
Financial Retirement Assets in IRAs, 1985-2009
Year
1985 1990 1999 2005 2006 2007 2008 2009
Percent in IRA 10%
18
29
33
34
34
35
36
Actual amount
$0.2
(trillions of
2009 dollars)
0.6
2.7
3.7
4.2
4.8
3.6
4.3
Note: All values are nominal. Retirement assets include IRAs, annuities, and
employee-sponsored DB and DC plans
Source: ICI, 2010.
6
Share of IRA Assets Increase to Age 70
50
Percent
40
30
20
10
0
25-29
30-39
Traditional IRA Investors
40-49
50-59
Age Groups
60-69
70-74
Traditional IRA Assets held by Investors
Source: ICI, 2010
7
What are the Demographic Characteristics
of IRA Holders?
● IRA ownership increases with:
● Family income
● Educational attainment of the head of household
● Family net worth
● Ownership rates are highest for middle-age
individuals
● Individuals age 60-69 account for the largest share
of IRA assets
● Have worked for a long time; have not yet
reached retirement age
8
Are Rollovers a Significant Source of
IRA Assets and Who Rolls Over?
● U.S. workers change jobs with increasing frequency
(Bureau of Labor Statistics)
● Vast majority of assets in traditional IRAs are from
rollovers
● 2007: approximately 5% from contributions
● Rollovers
● Almost even across age groups
● Like IRA ownership, spread across demographic
groups
● Unlike IRA ownership, no strong correlation with
income
9
Employee Options
upon Separation
● Keep account assets in the employer’s plan
● Rollover account assets to an IRA
● Invest the account assets in the new
employer’s 401(k)
● Withdraw the account assets
● Annuitize the account assets
10
Option Selection
● According to Charles Schwab data, of the
distributed 401(k) assets under their management:
● 80% were rolled over into an IRA
● 10% were taken as cash
● 8% were moved into a new employer’s 401(k)
● 2% were taken in other “forms of
distribution”
11
Are Individuals Aware of
Options at Separation?
● Are 401(k) participants aware of their options
upon separation from the employer?
● The plan must provide participants with
information about their rights and benefits,
including rollover options
● Do participants read the provided
information?
● Our interviews suggest the answer is “no”
12
Factors Affecting the
Rollover Decision
● Are individuals aware of IRA and 401(k)
fees?
● What other factors might individuals
consider when facing the rollover
decision?
13
Are Individuals Aware of
401(k) and IRA Fees?
● Research suggests that about half of
employed persons cannot identify their
type of pension or plan
● An even higher portion are unaware of
any associated fees
● This is critical because higher fees relate
directly to lower returns
14
Are 401(k) and IRA Fees Transparent?
● Many 401(k) participants mistakenly believe
the employer pays the fees
● Factors affecting fees paid:
● Amount invested in the account
● Terms negotiated between sponsor and
provider
● Many providers bundle funds and/or
administrative fees and fund expenses
15
New 401(k) Disclosure Rule
● New DOL rule goes into effect November 1, 2011
● Under new rule, annual statement must including:
● Administrative and individual services fees
● Performance after fees are subtracted
● Amount and description of investment fees
● Total annual operating expenses
● Statement about cumulative effect of fees on
account growth
16
Relative Importance of Fees in the
Rollover Decision
● Other considerations:
● Investment options within plans
● 10% premature distribution penalty
● Tax treatment: employer stock
● Disposition at death
● Interviews suggest that investment options
and customizability are primary rollover factor
17
What is the Relationship Between
Financial Literacy and Rollovers?
● Does financial literacy affect rollover
decision?
● Financial literacy
● Knowledge and capacity required to
effectively manage one’s long-term
financial health
● Evidence suggests ambiguous
relationship
18
Data:
Health and Retirement Study (HRS)
● HRS is a national, longitudinal dataset
managed by the University of Michigan
● Captures information from biennial
interviews of over 22,000 Americans ages
50 and older
● Provides information about rollovers
into IRAs
19
HRS Financial Literacy Questions
● If the chance of getting a disease is 10%, how
many people out of 1,000 would be expected to
get the disease?
● If 5 people all have the winning number in the
lottery and the prize is 2 million dollars, how
much will each of them get?
● Let’s say you have 200 dollars in a savings
account. The account earns 10% interest per
year. How much would you have in the account
at the end of two years?
20
Defining the Sample
● Use respondent-level core data from 2006
● Include information from respondents who:
● Left an employer since 2004
● Had a DC plan
● Took only one action on their primary DC plan
● Rolled over to IRA, left assets in DC account, or
withdrew
● Total sample size of 375 respondents
21
Sample Breakdown
89
respondents
withdrew
154
respondents
left in
account
132
respondents
rolled over
22
Demographic Characteristics of the Sample
Mean age
Female (percent)
Married (percent)
Household income below the poverty line
(percent)
Race
White/Caucasian (percent)
Black/African American (percent)
Hispanic (percent)
Left in
account
60
53
66
Rolled
over
61
52
74
6
3
9
81
12
6
87
7
5
67
15
12
Withdrew
60
58
60
23
Methods for Analysis
● Compared correct response rates to
financial literacy questions and education
levels of those who rollover to:
● Those who left assets in DC plans, and
● Those who withdrew assets altogether
● T-tests used to test whether groups are
significantly different
24
Limitations
● Small sample size
● Analysis does not control for other
factors
● Results specific to sample population
● Financial literacy measures may not
reflect knowledge required for rollover
decision
25
Results
● Financial literacy and education levels are not
significantly different between respondents who
rolled assets into IRAs and respondents who left
assets in their DC accounts
● Financial literacy and education levels are
significantly higher for respondents who rolled
assets into IRAs than respondents who withdrew
assets
26
Correct response rate
Correct response rates not statistically different between
respondents who rolled over or left assets in DC accounts
100
90
80
70
60
50
40
30
20
10
0
85.8
Rolled over
Left in account
81.0
57.9 59.9
17.1 19.4
Q1 (disease)
Q2 (lottery)
Q3 (interest)
Financial literacy question
27
Education levels not statistically different between
respondents who rolled over or left assets in DC accounts
Average years of
education
16
14
14.1
14.0
Rolled over
Left in account
12
10
8
6
4
2
0
28
Correct response rate
Correct response rates significantly higher for
respondents who rolled over assets than respondents
who withdrew assets
100
90
80
70
60
50
40
30
20
10
0
85.8
Rolled over
69.3
Withdrew
57.9
43.7
17.1
Q1*** (disease)
Q2** (lottery)
11.9
Q3 (interest)
Financial literacy question
Significance levels: *** = 1 percent; ** = 5 percent
29
Average years of
education
Education levels significantly higher for respondents who
rolled over assets than respondents who withdrew assets
16
14
12
10
8
6
4
2
0
14.1
Rolled over
12.2
Withdrew
Significance level = 1 percent
30
Discussion
Financial literacy measures capture useful
information
Results consistent with literature and interviews
● Individuals may be:
● Unaware of fees
● Considering factors other than fees
● Ambiguous relationship between financial
literacy and investment decisions
31
Conclusion
● IRAs are an important, growing source of
retirement wealth. This issue applies to a
significant number of individuals in the U.S. and
cuts across demographic sectors.
● Basic measures of financial literacy (education
levels, arithmetic skills) are not able to
differentiate people who roll assets into IRAs
rather than leave them in their DC accounts.
32
Recommendations
● Conduct further research on the outcomes of
rollovers from a total wealth perspective
● Evaluate new financial disclosure requirements
● Address potential conflicts of interest among
financial service providers offering rollovers to IRAs
● Determine whether withdrawal behavior warrants
further study
33
Thank you!
To access the full report,
please visit:
http://www.lafollette.wisc.edu/publications
/workshops.html
Appendix
Correct response rates and education levels not
statistically different between respondents who rolled
over or left assets in DC accounts
Variables
Rollover to IRA
p-value
Financial literacy
Q1
% Correct Obs.
85.8
127
(3.1)
Assets left in
account
% Correct Obs.
81.0
147
(3.2)
Financial literacy
Q2
57.9
(4.4)
126
59.9
(4.1)
147
0.374
Financial literacy
Q3
17.1
(3.6)
111
19.4
(3.5)
129
0.327
Years of education
Mean
14.1
(0.2)
Obs.
131
Mean
14.0
(0.2)
Obs.
154
0.347
0.142
Standard deviations in parentheses.
P-values provided for one-tailed tests.
Correct response rates and education levels significantly
higher for respondents who rolled over assets than
respondents who withdrew assets
Variables
Financial literacy
Q1
Rollover to IRA
% Correct Obs.
85.8
127
(3.1)
Assets withdrawn p-value
% Correct Obs.
69.3
88
0.002
(4.9)
Financial literacy
Q2
57.9
(4.4)
126
43.7
(5.3)
87
0.020
Financial literacy
Q3
17.1
(3.6)
111
11.9
(4.0)
67
0.177
Years of education
Mean
14.1
(0.2)
Obs.
131
Mean
12.2
(0.4)
Obs.
89
0.000
Standard deviations in parentheses.
P-values provided for one-tailed tests.