Disparities For Women and Minorities in Retirement Saving

David C. John

General Summary

Good morning. I am David C. John, the senior research dellow for Retirement Security and Financial Institutions at the Heritage Foundation. I am also the deputy director of the Retirement Security Project (RSP), a joint effort of the Brookings Institution and Georgetown University supported by the Rockefeller Foundation and the Pew Charitable Trusts.

This morning, I am pleased to present parts of three papers written by former RSP colleagues and outside experts on specific retirement savings issues facing women, African-Americans and Latinos. In addition, I will present both some general solutions and some specific recommendations to help resolve these issues.

There are similarities in the reasons that all three groups under save, but it would be a serious mistake to assume that one solution will solve all problems. In addition to specific economic factors such a job type or tenure, there are also cultural causes of each group’s behavior that must be addressed to improve its retirement security. However, the cultural and economic situations differ from group to group, and even within groups. For instance, it is a mistake to assume that all Latinos fit the same behavior pattern and economic circumstances despite the fact that many are born here, while those who are not come from a number of specific countries. Clearly, the same is true for both African Americans and women.

For that reason, consideration of solutions should start with mass approaches such as automatic enrollment and similar features, which I will discuss in a moment, but then turn to specific educational outreach, mentoring, and financial literacy efforts aimed at specific populations. I strongly believe that automatic enrollment in a DC environment is an essential step, but it may not be sufficient to improve retirement security. Instead, it should be supplemented with additional efforts.

Let me also be clear that while most of my testimony will focus on the DC system, since it is the predominant retirement benefit offered by employers, I am by no means saying that it is perfect. For some populations, a DB plan may have distinct advantages, but to date there is no sign that the trend away from such plans is lessening.

Finally, while many discussions focus on the accumulation stage since no good outcome is possible in a DC plan without sufficient savings equal attention must be paid to what happens when an individual actually nears retirement. If this country is to continue to have a DC system and fails to increase the use of guaranteed lifetime income products, it runs the real risk of having hundreds of thousands of older retirees running out of money. This issue must receive equal weight in future reform efforts.

Retirement Savings Experience among Women1

Women have experienced substantial gains in the labor market over the last several decades. The share of women in the labor force has grown from under 38 percent in 1960 to almost 60 percent in 2000. Women have also made concomitant gains in educational attainment levels and wage rates. Today, a higher proportion of women than men graduate from college and women’s earnings are approaching the level of men’s. These gains made by women have been driven, in part, by institutional changes that created employment opportunities for women and, in part, by changes in social norms that transformed the perception of women’s work from a “job” to “career” and galvanized women’s participation in the labor force.

Despite the improvements in women’s employment outcomes, gender differences in employment persist in several key aspects. First, women are more likely to choose jobs that are part-time, have shorter careers in the paid job market, and experience shorter job tenure at any given point in time than men. Second, despite the fact that many women have entered highly-skilled and highly-paid occupations the majority of women still work in occupations or industries with lower earnings. Women continue to account for a higher proportion of workers in service and sales/office occupations, which tend to have lower earnings relative to other occupations. Even among professional workers, women are more likely to be employed in professions with lower relative earnings, such as education, training, and library occupations, rather than computer and mathematical occupations.

These gender differences in employment patterns partly explain women’s lower earnings relative to men. Women’s wages remain 20 percent lower than men even among full-time workers with comparable education attainment and age. Between 1979 and 2005, the difference between men and women’s hourly wages (gender wage gap) shrank by almost half. Most of the decline occurred during the 1980s. The shrinking wage gap in the 1980s is largely attributable to women’s increasing labor force attachment and market skills (from education and experience).

These gender differences in employment and wages lead to lower overall retirement saving for women compared to men. The last 30 years has seen a shift in employer provided retirement coverage from DB to DC plans. In a DC plan, which emphasizes accumulating assets, women are able to save less than men because they have shorter careers and lower wages.

Comparing retirement accounts of women and men, women near retirement are 5 percentage points less likely than men to have a pension or a retirement plan (such as a 401(k) and IRA). Women also have lower retirement assets than their male counterparts: the median female worker near retirement held $34,000 in a 401(k) plan or IRA whereas her male counterpart held $70,000.

Accounting for differences in employment patterns, removes much of the gender difference in men’s and women’s saving pattern. Not only do women have comparable participation and contribution rates to men, at each earnings level, female wage and salary workers are slightly more likely to participate in a pension or retirement plan than male workers and the difference is largest among workers in the middle- and lower income ranges. For instance, in 2005, 58.2 percent of female wage and salary workers participated in an employer plan compared to 55.4 percent of male wage and salary workers and among employed workers ages 18-62, women contributed 7.2 of their salary to a DC retirement plan while men contributed 7.5 percent.

Differences in retirement balance may also be due to differences between men and women in investment patterns. Participation in 401(k) plans requires management of investment accounts. If women are more likely to invest in less risky assets than men, they will experience lower returns on their 401(k) investments, which lead to lower 401(k) balances over time.

Although some studies have found gender differences in risk-taking behavior, the evidence is mixed and inconclusive. The shift away from DB plans to DC plans has affected more than just women’s retirement balance sheets, and these other changes have both helped and hurt prospects for women in retirement.

Compared to DB plans, 401(k) plans offer greater portability, faster vesting, and faster accrual of benefits, all of which are better suited to women’s interrupted work history and shorter job tenure. Pension benefits in a DB plan typically increase with earnings and years of service with a firm. As a result, they penalize those with short job tenure, since benefits at a particular job accrue at rates that are proportional to job tenure and since benefits “start over” in a new job. In addition, DB benefits vest more slowly than 401(k) balances. In a 401(k) plan, employees’ contributions are vested immediately and employers’ contributions under DC plans tend to be vested earlier than under DB plans.

The major disadvantage for women of the shift away from defined benefit plans and toward 401(k) plans is the loss of the automatic life annuity through an employer-based retirement plan. DB plans must offer (as a default) the option of benefits in the form of a life annuity, and often pay benefits in that form. In contrast, 401(k) plans generally provide a lump-sum distribution at retirement (in 2005, only 20 percent of employers with 401(k) plans offered an annuity payout option). Because women tend to live longer than men, a life annuity, which insures against outliving one’s resources, is more valuable to women than to men.

Although one could use the lump-sum distribution to purchase a private annuity, markets for individual annuities are poorly developed and feature high expenses, making such investments unattractive. Private annuity contracts are a particularly bad deal for women because they have longer life-spans than men and, consequently, face relatively higher prices for an annuity that pays a fixed amount per year for life. This type of disparity does not exist under a DB system where men and women would receive similar benefits over their lifetime if they have similar employment histories.

An additional disadvantage of DC plans for women is that generally spousal consent is not required when the retired worker makes distribution choices at the distribution date. Under traditional DB pension plans, benefits to married workers are automatically paid as a lifetime annuity with survivor benefits for the spouse unless the spouse consents to waive the survivor benefits. By contrast, under a DC plan, there is no default distribution option and a worker may choose to take distributions as a lump sum or in installments without the spouse’s consent. Men and women, however, will likely have different preferences regarding the form of the distribution because of differences in the length of their retirement period.

Requiring spousal consent when the worker makes distribution choices potentially could increase the proportion of workers taking distributions in the form of a life annuity with survivor protection. Evidence indicates that when the default option in DB plans for married couples was changed to a joint and 1/2 survivor annuity, unless the spouse consented to an alternative option, the selection of survivor annuities by married male pension plan participants increased from 48 to 64 percent.

On the other hand, 401(k) plans have become increasingly electronic, which has the potential to reduce administrative costs. Spousal consent proposals, by calling for a spouse’s signature that is notarized or witnessed by a plan representative, generally have been viewed as precluding electronic administration in this phase of 401(k) plan operations. Accordingly, plan sponsor representatives have expressed concerns that expanding 401(k) plan spousal consent requirements could increase administrative complexity and costs. This issue has been the subject of considerable discussion and controversy for years. It would be useful to continue this discussion and explore approaches that could balance the legitimate interests in protecting spouses, promoting lifetime guaranteed income and minimizing 401(k) costs and administrative requirements.

Marriage patterns and living arrangements have changed considerable over the last half century. Fewer adults are married, more are choosing to divorce or remain single, or live in cohabiting households. Marriage rates have fallen from 77 per 1,000 unmarried women in 1970 to 41 in 2005. In recent years, most of the decline in marriage rates has occurred among households with lower educational attainment. The rise in single motherhood is also notable. The percent of all births to unmarried women has increased dramatically, rising from 5 percent in 1960 to 37 percent in 2005.

Marital patterns vary by race. Among white women, the percent currently married declined from 67 percent in 1960 to 54 percent in 2006. Among African American women, the decline in the proportion currently married was even more sharp – falling by nearly half from 60 percent to 34 percent. There are also large racial differences in the percentage of non-marital births. In 2005, 69 percent of births to African American women and 48 percent of births to Latino women were outside of marriage whereas only 25 percent of births to white non-Hispanic women were outside of marriage.

The decline in marriage rates creates concerns for women’s retirement security because of the close link between marital status and economic status for women. Unmarried women, on average, have fewer economic resources than married women. Near or nearly retired unmarried women are three times more likely to be poor and have lower household income and net worth than similarly-aged married couples. Even compared to unmarried men in the same age group, unmarried women are financially worse off.

Unmarried women from minority groups have even lower economic resources: nearly 30 percent of unmarried African American and Latino women are living in poverty and they have between 10-25 percent the net worth of unmarried white women. Single mothers are particularly vulnerable to living in poverty than other types of households with children. In 2006, 37 percent of female-headed households with children under the age of 18 had income below the poverty-line compared with 18 percent of male-headed households and 6 percent of married couples.

The importance of marital patterns and living arrangements for economic welfare persists into the retirement years. Elderly widows are three times as likely to be poor as elderly married couples. This is partly because widowed households are more likely to have incurred large out-of-pocket medical expenses from their husband’s illness. Additionally, households in which a husband dies at a relatively young age may have lower resources even prior to widowhood than households in which both spouses survive. One study found that forty-four percent of the difference in economic status between widow(er)s and married elderly persons was due to disparities in economic status that existed prior to widowhood.

Retirement Savings Experience among African-Americans2

Many studies have documented that the average African American family has lower savings than the average U.S. family. The median net worth of African Americans is only around $28,000 compared to $140,000 for the median household nationwide. The difference in savings between black and other households is even larger if one excludes the value of housing equity. The value of non-housing assets for the median black family is one-twelfth that of the typical American family, compared to one-fifth when housing equity is counted.

Racial differences in retirement resources are also apparent among current retirees. The median African American family aged 70 and older has a net worth of $36,900, which is markedly lower than the net worth of the median U.S. household. In addition, sources of income also differ between black and white retirees.

Retired African American households are more likely to rely on income from pension plans and earnings than other retirees. Furthermore, income from assets represents a much smaller portion of total household income for African Americans than for other households (almost half as large).

To a large extent, observed racial differences in retirement resources. To a large extent, these differences are attributable to racial differences in labor market experience, such as a higher unemployment rate and more part-time work. These differences lead to lower average earnings than white persons and differential access to employer-sponsored retirement plans. Some of the differences in retirement resources, however, are also attributable to racial differences in saving decisions. For instance, 401(k) participation and contribution rates are lower among black workers than white workers, and investment choices are sometimes different. In most (although not all) instances, these differences in labor market experience and saving choices adversely affect African Americans’ retirement security.

A. Differences in labor market experience
African Americans are more likely to be unemployed than white persons. Unemployment rates are 50 percent higher among African Americans than white persons. In fact, higher unemployment rates among African Americans are apparent across all education groups, including among college graduates who, as a group, tend to have the lowest unemployment rate among all workers. Even among those who are employed, labor market outcomes between African American and white workers differ. A larger fraction of black workers are employed in low-wage occupations than other workers: 15 percent of low-wage workers are African Americans, yet African Americans comprise only 11 percent of the total workforce. In addition, among men, African Americans are more likely to work part-time than whites: 13.2 percent of black men work part-time compared to 12.3 percent of white men.

As a result of these labor market differences, black families tend to have lower earnings than white families. As a group, black men earn about 72 percent of what white men earn and black women earn 86 percent what white women earn.

Low-earning households save less (in levels) than high-earning households because they have a lower base from which to save. In addition, there is some empirical evidence that suggests that households with low incomes tend to save a smaller fraction of their incomes than high-income households. Thus, the combination of a lower base for saving and lower savings rate partly explains the racial gap in net worth. Differences in earnings also have implications for retirement resources because retirement balances and pension payments often are tied to earnings.

Under a DC retirement plan, such as a 401(k) plan, the employer’s contribution to the plan typically is a fixed percentage of the worker’s earnings. Consequently, African American workers with lower earnings would receive lower levels of employer contributions than other workers with higher earnings. Likewise, DB plans typically compute pension payments based on earnings and years on the job. Accordingly, workers with lower earnings accrue lower pension benefits than higher earning workers and, workers with shorter tenure on the job accrue lower pension benefits than those with longer tenure. On average, African American workers have lower earnings and they have shorter job tenure than other workers; which means they are more likely to accrue lower pension benefits in DB plans than other workers.

Racial differences in labor market experience also lead to differential access to employer sponsored retirement coverage. In the private sector, black workers are less likely to be offered retirement coverage than other workers because they are more likely to work in part-time and lower-wage jobs, which typically do not offer coverage. The private-sector coverage rate for African Americans is about 3 percentage points lower than the national average.

Compared to white workers, the gap is even greater: 50 percent of white workers in the private sector are covered by an employer-sponsored retirement plan compared to only 42 percent of African American workers. Furthermore, private-sector African American workers may become increasingly less likely to have coverage relative to other private-sector workers.

Between 1979 and 2004, coverage rates in private-sector employment fell by about 10 percentage points among workers with a high school education (to about 40 percent), but stayed stable at about 60 percent for college-educated workers. Since a higher proportion of African American workers have a high school education or less, to the extent that the trend continues, the gap in coverage rates between African American workers and white workers in the private sector may increase.

Black workers, however, are more likely to be employed in the public sector than other workers. This difference in public sector employment places black workers on a more favorable footing for retirement than other workers because most public sector employers offer pension coverage and the coverage is typically in the form of a DB plan. One of the advantages of DB plans over 401(k)-like plans is that workers generally are not responsible for making participation and contribution decisions: they are automatically enrolled in the plan if they are eligible, contribution rates are pre-determined and the assets are professionally managed. Generally, these features are beneficial to all workers (because inertia can prevent or delay a worker from participating) but they are particularly beneficial to low income African Americans who, as a group, tend to have less financial market experience and lower financial literacy than other workers.

The other advantage of DB coverage over DC coverage is that benefits from a DB plan are payable for life (that is, as an annuity); whereas, the majority of DC plans do not even offer the option to annuitize plan balances. Retirees in DC plans, therefore, must manage their assets to last their lifetime and face the possibility of outliving their resources should they live longer than expected. Thus, African American retirees who, on average, have greater access to DB pensions are better protected from the risk of outliving their resources than workers with DC-type retirement coverage.

B. Differences in saving decisions

While racial differences in earnings and access to employer-sponsored
retirement plans lead to racial differences in retirement account balances, the choices that black workers make regarding retirement saving may further amplify these differences. Even when black workers are offered employer-sponsored retirement coverage through 401(k)-type plans, they make choices about (i) whether to participate in 401(k) plans, (ii) how much to contribute, and (iii) how to invest their saving, that lead to lower relative savings in these retirement accounts.

For example, among workers who have access to 401(k)-type plans, black workers are less likely to participate in these plans than white workers. One study found that in 2004 only 50 percent of eligible black private sector workers participated in their employer’s retirement plan compared to over 59 percent of white workers. By not participating, workers are also losing any employer matching contributions they might have received had they contributed to their 401(k) plan and the tax advantages that come with saving in these employer sponsored retirement accounts.

There also is some evidence that 401(k) contribution rates among African Americans with DC plans are smaller than those of other households.23 Estimates suggest that among workers who participate in a401(k) plan, the average 401(k) contribution rate for African Americans is 4.2 percent, while it is 5.5 percent for whites and 5.4 percent across all DC plan participants regardless of race. This same study reveals that more than half of African Americans contribute 4 percent or less of their salary to their 401(k) account.

Additionally, African Americans appear to be less likely than white workers to invest in and hold high-yielding assets, such as stocks, than the average U.S. family. To the extent that investment returns are lower as a result, the accumulated savings over time for a black worker would be lower than that of a white worker, on average. This difference in investment choices may partly explain the difference in accumulated assets between retired African Americans and comparably-aged households. At the median, African American households age 70 or older hold about $300 in financial assets compared to $13,000 held by the median retired household nationwide.

C. Income-Adjusted Differences in Retirement Resources

It is important to note that the comparisons of net worth and other retirement resources discussed in the previous section have been between groups with potentially very different income. As noted earlier, the earnings of black and white workers differ. Moreover, Black families have lower income than other families, on average, and a disproportionately higher fraction of black families are in the nation’s lowest income group. The median income for African American families nationwide is about two-thirds that of the typical U.S. household ($32,000 for blacks compared to $48,000 for the typical U.S. household). In addition, 17 percent of African American families are poor compared to 7 percent of white families and the national average of 8 percent.

In order to assess the relative retirement preparedness of African American families, therefore, it is useful to juxtapose families with comparable incomes. The key question then becomes whether African American households will have comparable retirement resources as other households with similar income. In this section we examine wealth levels of households, controlling for income. This income adjusted comparison of wealth also would illuminate whether there are factors beyond income that differentially affect black and white households’ retirement security. A cursory comparison of income ratios (two-thirds) to wealth ratios (ranging from one-twelfth to one-quarter) suggest that other factors may play a role.

The wealth gap persists when comparisons are restricted to households with similar income. The gap is narrower for households in the highest income group (at the median, the wealth ratio is between one-half and two-thirds) but is wider for households in the lowest income group.

The typical (or median) poor African American household has virtually no savings (zero IRA/DC balances, financial assets, and net worth); whereas, the typical poor U.S. family has accumulated a small amount of wealth (primarily from equity in their home). Among middle-income households, the typical African American household still has lower savings than other households. The net worth of a typical pre-retired middle-class black family is only about half of the net worth of a typical pre-retired middle-class household in the population at-large ($47,000 compared to $95,000 respectively), indicating that even middle class blacks will be entering retirement with fewer resources than other Americans.

Similarly, black households in the top 10 percent of income have lower net worth than comparable households. While the typical rich household in the United States has accumulated about $50,000 in retirement savings in IRA/DC accounts and about $90,000 in financial assets, the typical African American household in the nation’s top income group has an IRA/DC balance of just $21,000 and financial asset holdings valued only at $13,000.33 Blacks therefore have a resource deficit even when one considers the most well-to-do Americans.

Few black households, however, have incomes that place them in the top 10 percent of all Americans. In fact, black households that are in the top 10 percent of income among other black households have substantially lower income and lower net worth than those in the 10 percent of the U.S. population ($257,500 compared to $708,000). Comparing liquid wealth, such as financial assets, the typical black household at the top of the African American income distribution has no more than one-eighth the assets of typical rich household. Accordingly, African Americans who may very well consider themselves rich relative to their peers still lag far behind many other U.S. households when entering retirement.

D. Retirement Adequacy

The analysis to this point has focused on household net worth primarily, which includes the value of home equity, financial assets, and savings in tax deferred retirement accounts, such as IRAs and 401(k)s. The measure of net worth, however, does not include expected claims to future benefits from Social Security and DB pensions. As was noted earlier, the importance of Social Security and pension benefits varies across households and, for some, these benefits can account for a substantial portion of retirement income.

Because Social Security benefits are progressive, in that benefits replace a higher portion of earnings for low income workers than for high-income workers, and because black households on average have lower income than other households, the omission of Social Security benefits from household resources would tend to overstate the differences in retirement preparedness between black and white households. Similarly, to the extent that black workers are more likely to receive DB benefits than white workers, the omission of DB payments would overstate racial differences in retirement resources.

A more appropriate comparison of relative preparedness of those not yet retired therefore would account for these expected sources of funding, in addition to accumulated assets. One common approach is to evaluate whether and to what extent a household’s expected retirement resources (including all saving, Social Security and DB benefits) are sufficient to maintain their pre-retirement standard of living throughout retirement. That is to say, what percentage of the household’s income before retirement can be replaced by accumulated savings and claims to benefits in retirement (the income replacement rate). It is generally thought that an income replacement rate of 75 to 80 percent would be needed to finance consumption during retirement and maintain pre-retirement standards of living.

Estimates of expected mean retirement income of African American and white families suggest that the average African American family could expect to have a replacement rate of 73 percent of preretirement income, whereas the average white family could expect to replace 83 percent of their pre-retirement income, when pension wealth and social security are included. Thus, even after accounting for expected Social Security and DB benefits, a gap still exists in the degree to which African Americans and white families are prepared for retirement: African Americans lie near the lower end of the range deemed adequate to maintain their living standards while whites are slightly above the top of the range.

Moreover, a recent study that examines families below the adequate range reveals that 40 percent of African Americans could expect to have a replacement rate that is lower than 50 percent; whereas only about one-quarter of white households had estimated replacement rates in that range. Thus, a significant minority of households will not be financially prepared for retirement and a disproportionate number of those households are expected to be African Americans.

E. Other Explanations for the Income-Adjusted Racial Wealth Gap

It is common to view household saving as a process governed solely by factors affecting the nuclear household however, there is increasing evidence to suggest that relationships with extended family members may affect the way that individuals prepare for retirement. Sharing resources, such as housing, may help older households meet some of their retirement needs and help some families accumulate wealth. At the same time, intra-family transfers to support poorer kin members also may depress younger generations’ ability to save for their own retirement. Furthermore, knowledge and skills about saving could be shared within the family, so young African Americans from lower-income families may not have the same learning opportunities as those from higher income families.

Family Networks
Economists have argued that families can do almost as well as insurance markets in protecting against adverse events if family members pool risks and resources. Choosing to pool risks and resources withi