The Minority Report

Studies consistently show that black and Hispanic employees save less for retirement than other groups. What can HR do to address this?

Sunday, September 2, 2012
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First, the bad news: Americans still aren't amassing enough for retirement. Indeed, the U.S. household savings rate in recent years has been abysmal compared to other major industrialized countries.

Worse news: Some Americans, especially blacks and Hispanics, are confronting more savings challenges than others. Blacks and Hispanics are eroding their retirement nest eggs at an "alarming" rate compared to whites and Asian Americans, according to a study of defined-contribution plans conducted by Ariel Education Initiative, the nonprofit affiliate of Chicago-based Ariel Investments, and Lincolnshire, Ill.-based Aon Hewitt.

In particular, the year-end 2010 study involving 2.4 million workers at 60 large U.S. organizations reported that significantly fewer blacks and Hispanics participate in 401(k)s even when taking into account age and income level. Moreover, these two groups are far more likely to take hardship withdrawals, loans and cash-outs from their retirement plans.

"If you have employees who are worried about their financial security and retirement preparedness, who are not necessarily understanding the best way to maximize their retirement potential, that affects them at work," says Mellody Hobson, president of Ariel Investments. "It erodes their ability to be effective and productive."

Now for the good news: Many larger companies are offering features in their 401(k)s that compel all employees to salt away money for retirement. These features -- among them, automatic enrollment, automatic yearly contribution increases and auto-pilot funds that remove most ongoing investment decisions -- are being added to a burgeoning number of DC plans, says Dan Weeks, founder of BrightScope, a San Diego financial-information company that analyzes 401(k) plans.

Even better news: The features appear to be working. A prime example: When automatically enrolled, a much higher percentage of employees -- including blacks and Hispanics -- participate in a plan than those who proactively opt out, according to the Ariel/Aon Hewitt study. Furthermore, once workers enroll, relatively few drop out.

And yet, as revolutionary as these financial instruments seem, the jury is still out on them. It's too early to gauge their long-term effectiveness.

Differing Perspectives

Getting employees to participate in 401(k) plans has long been challenging for employers, many of whom promoted the retirement vehicles as they eased workers out of traditional pension plans. While tools such as automatic enrollment helped boost plan participation among all employees, the rate is still lower for Hispanics and blacks, according to the Ariel/Aon Hewitt study, titled 401(k) Plans in Living Color II. The study reports that just two-thirds of Hispanics and 68 percent of blacks contributed to a defined-contribution plan, compared to 79 percent for whites and 80 percent for Asian workers.

Moreover, while investments in 401(k)s declined for all workers from 2007 to 2010, contributions remained lower for blacks and Hispanics. The study found that these two groups contributed slightly less than 6 percent of their salaries, respectively, in 2010, compared to 7 percent for whites and 9 percent for Asians.

Many blacks and Hispanics contribute less in part because of different attitudes toward money and retirement, not to mention familial expectations, says Andres Tapia, president of Chicago-based consulting firm Diversity Best Practices.

Tapia, who previously served as chief diversity officer at Aon Hewitt and helped lay the groundwork for the study, says additional attitudinal and focus-group research reveals many blacks save first for a home, then college and only then for retirement. Among both blacks and Hispanics, there tends to be more of an expectation and reliance on family to help with retirement, he says.

Hobson, who is black, says many black workers are cautious about investing because they may be the first generation in their families to earn a middle-class or better income. Black households are also less likely to discuss investments, she adds.

"We don't have the same experience level, when it comes to investing, as some of our white counterparts," says Hobson.

Many blacks, in particular, may be more wary of investing in mainstream financial vehicles because of U.S. financial institutions' historical legacy of "redlining," which prevented black neighborhoods from receiving loans or credit, says Tapia. "There has been a deep and documented distrust of the financial system," he says. "They were disenfranchised and couldn't even participate. That led to a lack of multigenerational experience with long-term savings."

Beyond the disparity in participation and monthly contributions, the Ariel/Aon Hewitt study reveals other troubling findings. While workers of every stripe dipped into their retirement savings during the Great Recession, black 401(k) paticipants did so disproportionately. The study reports nearly 9 percent of black employees took withdrawals in 2010, compared to 3 percent of Hispanics, 2 percent of whites and 1 percent of Asians.

"The early withdrawals," especially among blacks, "have just skyrocketed and are truly problematic," says Hobson.

She partially attributes this trend to the pummeling blacks and Hispanics absorbed during the recession; the 2010 unemployment rate for blacks mushroomed to 16 percent (compared to 10 percent in 2007), while the rate for Hispanics jumped to nearly 13 percent (compared to 7.6 percent in 2007).

Even for those who retained their jobs, many companies decreased the number of hours for workers during the economic downturn, says Theodore Daniels, president of the Society for Financial Education and Professional Development in Arlington, Va. Combine that with the fact that blacks and Hispanics, in general, tend to have fewer assets than whites and are less likely to be homeowners, he says, and the result is less access to credit instruments such as home-equity loans to tide them over during a rough patch.

"One of the few places many blacks and Hispanics" could turn to for relief was their 401(k), says Tapia.

Not only were both groups more likely to withdraw money from their 401(k)s, they were also more apt to take loans from the plans. The study said half of all black employees and 40 percent of Hispanics had a loan on the books by year-end 2010, compared with 26 percent of whites and 22 percent of Asians.

Another recent study, this one from Valley Forge, Pa.-based Vanguard Group, also finds that blacks and Hispanics are more likely to take loans or hardship withdrawals from their DC plans than whites and Asians.

Furthermore, the vast majority of workers who leave their employers with an outstanding loan end up defaulting on it, the study says, with blacks and Hispanics slightly more likely to default than whites and Asians. The study notes that, since loans account for an average of 20 percent of a worker's retirement-savings balance, those who default suffer a major financial setback.

"When you're taking out a loan, you're generally not putting in new contributions," says Hobson. "Sometimes, there is a wait before you can contribute again. At any rate, [a loan] definitely slows down the savings process."

The Ariel/Aon Hewitt study also reports that blacks and Hispanics who left their employers in 2010 were more likely to cash out their retirement savings. Nearly two-thirds of blacks and 57 percent of Hispanics did so, compared to 39 percent of white employees and about one-third of Asians.

"Most employees who cash out their savings will never be able to rebuild their balances," says Hobson.

Higher "Stick" Rates 

As dispiriting as the retirement savings outlook appears for many Americans, especially blacks and Hispanics, there is reason for optimism. Thanks, in part, to the 2006 Pension Protection Act, features are being added to many 401(k)s that require employee-investors to opt out of the plans rather than opt in. Perhaps the key feature is automatic enrollment, which automatically places workers in a plan unless they notify employers otherwise. BrightScopes' Weeks says a companion feature, automatic escalation, typically increases contributions in tandem with pay raises unless employees opt out. Studies show both features boost 401(k) participation and savings among all groups, regardless of ethnicity.

"[Auto-enrollment and auto-escalation] are really tied to investor passivity" in 401(k) plans, says Weeks. "People generally don't spend near enough time thinking about their 401(k)s."

Whatever the reason, auto-enrollment has soared in popularity. Twenty-four percent of employers offered the feature in 2006, according to an Aon Hewitt survey. Four years later, the Ariel/Aon Hewitt study reports, 67 percent of all new hires were automatically enrolled.

"Auto-enrollment has absolutely been the key to higher employee participation" in Costco Wholesale's 401(k) plan, says Jay Tihinen, assistant vice president of benefits at the Issaquah, Wash.-based retailer, which has 116,000 U.S. employees. Prior to auto-enrollment, he says, Costco sported a 68-percent participation rate for eligible employees; it is now about 91 percent.

Once employees are enrolled in the plan, the "stick" rate is "very high," says Tihinen. That is true for both new hires and employees who were working before auto-enrollment was added at Costco about five years ago, he says.

Automatic enrollment is particularly valuable in boosting the plan participation rate for low-earning (annual incomes of less than $30,000) blacks and Hispanics compared to their low-earning white and Asian counterparts, according to a 2011 Vanguard study titled In Diversity and Defined Contribution Plans: The Role of Automatic Plan Features. The study finds that low-earning blacks and Hispanics are the least likely of the racial, ethnic and income groups examined to join 401(k)s.

However, the study also found that the black participation rate -- 57 percent under voluntary enrollment -- skyrocketed to 94 percent with automatic enrollment. For Hispanics, the 67-percent voluntary rate zoomed to 95 percent through auto-enrollment.

The study also finds that auto enrollment is responsible for substantially shrinking the racial and ethnicity gap in plan participation. When auto-enrolled, 82 percent of black and 83 percent of Hispanic employees participate in a DC plan, compared to 64 percent and 59 percent, respectively, who are not subject to auto enrollment.  

A Three-Legged Stool

While auto-enrollment has many backers, some caution that it alone is insufficient. That's because many companies start the default deferral rate too low, often between 1 percent and 3 percent of an employee's salary, according to the Ariel/Aon Hewitt study. Patti Bjork, Aon Hewitt's director of retirement research, says these low default rates hinder employees from saving enough for retirement.

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"We're seeing that many companies are defaulting at 3 percent," says Bjork. But, even when firms install a higher default rate, few employees go back and change it to a lower percentage, she says. "[A higher default rate] is a design feature we'd encourage more employers to make."

When the default rate is low, that magnifies the importance of marrying auto-enrollment to auto-escalation, says Hobson. However, the Ariel/Aon Hewitt study finds only 42 percent of employers offered auto-escalation.

At Costco, employees are auto-enrolled at 3 percent after 90 days of employment, in part because the majority of workers are part-time and a higher initial rate might prove unaffordable, says Tihinen. Unless Costco employees opt out, their contributions auto-escalate by 1 percent annually on their start-date anniversary, up to a maximum of 20 percent, he says.

Another popular automatic feature is target-date funding, a common type of default investment option, says Weeks. With this vehicle, investors are typically defaulted into an age-appropriate stocks-and-bonds fund that becomes more conservative as employees near retirement. Some have criticized TDFs for the significant losses many experienced during the Great Recession, but Weeks believes many of these funds recently responded by becoming more conservative.

"Think of a three-legged stool," says Weeks. "One leg is auto-enrollment. Another is auto-escalate and the third leg is a target-date fund. You're making it very palatable for a participant to put enough money into a plan and then you have a default investment that will do much of the work for you. That's a pretty good combination. They [employee-investors] are on auto-pilot and on a pretty darn good glide path."

At Costco, the company offers plan participants other funds, but an age-appropriate TDF is the default investment. Tihinen credits the TDF and other automatic features with playing a role in Costco's enviably low turnover -- about 5 percent -- for employees who've worked at the firm more than one year.

A Straightforward Approach 

Even with heartening developments like the automatic features, concern lingers that many Americans, especially blacks and Hispanics, won't save enough for retirement.

To obtain more buy-in to 401(k)s, especially among minorities, Hobson suggests offering seminars and other face-to-face communications. Something as simple as putting minorities' faces on retirement-plan brochures is an inviting gesture, she says.

The 2012 Vanguard study on loans and hardship withdrawals says limiting plan participants to one outstanding loan per time is among measures that appears to reduce borrowing levels for all employees. At Costco, Tihinen says, the company prohibits employees from taking out multiple loans at one time; they must first pay off one loan before becoming eligible for another. They are also forbidden from taking out loans on the company's annual contributions to employees.

About 30 percent of Costco employees take out loans at any one time during the year. And, while many workers like the borrowing feature, Tihinen says, he wants them to understand all the ins and outs of taking out a loan. That's why information about how a loan may impact employees' long-term savings is included in Costco's internal communication outlets, he says.

The Vanguard study offers suggestions on how to shrink 401(k) withdrawals and loans, which can seriously interrupt retirement savings. It recommends increasing the federal penalty for early withdrawal from 10 percent to 15 percent (for those under 59.5 years) for noncritical needs.

The study suggests easing loan- repayment terms to help stem loan defaults, which disproportionately occur with blacks and Hispanics. For example, employers should extend the time a terminating employee must pay back a loan from 60 days (a typical repayment period) to one year. The study further encourages a grace period for loan repayments while an individual collects unemployment benefits, allowing a loan to be repaid from personal financial accounts rather than payroll deductions, and enabling portability of loans to another employer.

While companies must be careful not to "profile" individuals within ethnic or racial groups, organizations can offer programs for all employees that just may be especially appealing to black and Hispanics, says Tapia. For example, HR could address the potential distrust of financial institutions by offering a seminar titled something along the lines of, "Can I Trust Financial Institutions with my Money?"

"Hit it head on," says Tapia. "From the get-go, you're attracting people who may have questions about trusting financial institutions."

HR leaders should also consider promoting a meeting on 401(k)s or retirement savings that is sponsored by the company's black or Hispanic affinity group, says Tapia. That might provide additional comfort for many blacks or Hispanics considering attending, not to mention safeguarding a company from charges that it is stereotyping behavior because attendees will "self-select" to attend the meeting, he says.

Another way to encourage greater participation is to send targeted information to all employees with low default-deferral rates, says Cynthia Pagliaro, senior research analyst at the Vanguard Center for Retirement Research.

"The key is to focus on the behavior, and not necessarily the group exhibiting the behavior," says Pagliaro.

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