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As the COVID-19 pandemic swept across the US in mid-March, the stock market, as measured by the Dow Jones Wilshire 5000, declined by 35% between its February peak and March trough. While the market has largely recovered, it remains volatile and exposes household savings to continued market risk, highlighting the fragility of the nation's retirement plans.
A recent report from the Center for Retirement Research details where the declines occurred and the extent to which retirement accounts are exposed to equity market risk.
In February and March, the value of equities in employer-sponsored retirement plans and household portfolios fell by $14.2 trillion. $4.4 trillion occurred in 401(k)s and Individual Retirement Accounts (IRAs), $1.8 trillion in public and private defined benefit plans, and $8.0 trillion in household non-retirement assets, according to the report.
"Individuals were sheltered from the immediate impact of the $1.8 trillion of losses in defined benefit plans. But they did experience a direct hit on the $4.4 trillion of losses in 401(k)s/IRAs," says the report. And, "as a result, a substantial portion of household financial assets were exposed in the recent market downturn."
Of the retirement plan losses, the lion's share, $4.4 trillion (71 percent) was through 401(k)s/IRAs. For households fortunate enough to have a retirement plan, 401(k)/IRA holdings usually account for the bulk of their financial assets. Furthermore, nearly three quarters of 401(k)/IRA assets are allocated to equities.
Household financial assets remain vulnerable to these fluctuations during the ongoing recession triggered by COVID-19, warns the report. And, "while allocations to equities are certainly higher at younger ages, many workers nearing retirement have over 60% of their 401(k) assets in equities."
The report speculates that initially some employees may have panicked and sold assets at depressed prices, and then may have been late getting back into the market to enjoy gains as the market has recovered, while other holders of 401(k)s/IRAs were certainly left feeling vulnerable, as their savings evaporated.
More than two-thirds of the drop in retirement plan equity holdings was in defined contribution plans, according to the report.
As defined benefit plans become rare, households increasingly bear the full brunt of market turmoil. Proposals to reform private sector retirement plans have focused on extending coverage.
However, the current financial downturn underscores the need to cushion retirement plan participants from the blows of full market risks.
The report suggests there are other models that can afford more protection, such as those in the Netherlands and elsewhere, where employers and employees share the risk of market declines in workplace retirement plans.
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