8 Ways Americans Are Using 401(k) Accounts More Wisely

Americans appear to be getting a little wiser about building wealth.

In fact, the nation has gone on an “unprecedented saving spree,” according to the Federal Reserve Bank of Kansas City.

From 2019 to April 2020, the savings rate nearly quadrupled, from 7.2% of disposable income to a record high of 33.7%. In a press release, A. Lee Smith, a research and policy adviser at the Kansas City Fed, said:

“That means that for every $100 of disposable income, consumers saved $7 in December, and by April consumers were saving almost $34 of every $100 of disposable income.”

Our collective retirement savings IQ also is on the rise. Rather than frittering away money on unwise investments, workers recently have shown a shrewder understanding about where to put their hard-earned cash, a study by Vanguard Investments finds.

Vanguard’s “How America Saves 2021” report — which examines the retirement plan data from 4.7 million plan participants — has revealed some surprising but welcome signs of improvement in terms of how people save for their golden years.

Following are some key ways Americans are getting smarter about saving for retirement.

1. We are saving more

Americans are putting more money into their 401(k) plans. Vanguard says the average deferral rate in its plans was 7.2% in 2020, up from 6.9% in 2011.

To be sure, the gain is small. But it is inching in the right direction.

2. We are using target-date funds more often

Target-date funds — which automatically shift your investment strategy from higher risk to lower risk as you near retirement — are a great “set it and forget it” approach to investing. And more 401(k) plan participants appear to be warming to the idea.

Nearly all Vanguard participants (99%) have access to target-date funds in their plan, and a whopping 80% of participants are using them. In fact, two-thirds of participants who invest in these funds have their entire account in a single target-date fund.

3. We are taking out fewer 401(k) loans

Many experts strongly discourage retirement plan participants from taking loans from their 401(k) plans. Doing so can rob you of the power of compounding wealth, putting a large and possibly unfixable crack in your nest egg.

Workers appear to be heeding the expert advice in growing numbers. During last year, the use of such loans declined by more than 20%. Participants borrowed just 1% of aggregate plan assets.

4. We are making fewer hardship withdrawals

Some retirement plans allow employees to make hardship withdrawals, which allow you to take money from your account early because of an “immediate and heavy financial need,” as the IRS describes it.

This can have a devastating impact on the size of your nest egg, as you are taxed on the amount of the hardship withdrawal and have no obligation to pay it back to your account.

However, despite the economic downturn amid the coronavirus pandemic, hardship withdrawal activity plunged 29% in 2020, and other nonhardship withdrawal activity slid 16% year over year.

The decline in the number of people raiding their 401(k) plans is even more remarkable because last year, the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 included a provision that allowed people who were adversely financially affected by the coronavirus pandemic to withdraw up to $100,000 from their retirement plan penalty-free last year.

5. We are trading less

Timing the market — trying to guess where it’s headed, and buying and selling based on those hunches — is a fool’s errand. A growing percentage of plan participants appear to recognize the folly of this tactic.

Vanguard says it has seen a decline in participant trading over the past decade, a trend that the firm attributes to the increased use of target-date funds.

In 2020, despite more market volatility, only 10% of plan participants traded in their retirement accounts.

6. We are improving our asset allocation

The right asset mix is key to long-term success in building wealth. Fortunately, Vanguard says this mix “has improved dramatically” among plan participants during the past 15 years.

In 2020, 76% of participants had a balanced strategy, which included more equities like stocks and bonds and less company stock. That compares with 39% of participants in 2005.

7. We are buying lower amounts of our own employer’s stock

Using your 401(k) plan as a place to hold large amounts of your employer’s stock is generally thought to be an unwise strategy. Does anyone remember Enron’s 2001 collapse?

Fortunately, a shift away from such investing that began in 2006 continued last year. Among plans that offer company stock, the percentage of participants holding more than 20% of their account balance in company stock has tumbled from 30% in 2011 to 12% in 2020.

8. We are using automatic investing programs

The adoption of automatic enrollment — in which a workplace retirement plan automatically enrolls new employees into the plan — has more than tripled since the end of 2007. And that effort appears to be paying big dividends.

Plans that feature automatic enrollment have a 92% participation rate, compared with 62% for plans with voluntary enrollment.

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