Why Are 401(k)/IRA Balances Substantially Below Potential?

For most workers, 401(k)/IRA assets represent the main source of retirement savings outside of Social Security. These accounts can generate significant wealth if workers contribute consistently from a young age, keep their money in their accounts, and minimize their investment fees. However, most workers have 401(k)/IRA balances at retirement that are substantially below their potential. For example, a 25-year-old median earner in 1981 who contributed regularly would have accumulated about $364,000 by age 60, but the typical 60-year-old with a 401(k) in 2016 had less than $100,000. This brief, which is based on a recent paper, explores the reasons for this gap between potential and actual balances. The discussion proceeds as follows. The first section identifies four factors – immaturity of the 401(k) system, lack of universal coverage, leakages, and fees – that might explain why 401(k)/IRA balances fall below their potential. The second section describes the data and the methodology used to estimate the role of each factor. The third section discusses the results, which show that the immaturity of the system and the lack of universal coverage are the main culprits, followed by leakages, and finally fees. The final section concludes that, without a significant effort to cover the uncovered, a large gap between potential and actual accumulations will persist even after the system matures.