Addressing racial disparities in defined contribution plans

Disparities exacerbated by the shift from defined benefit (DB) plans to defined contribution (DC) plans

In recent decades, there has been a significant shift away from traditional pension plans, which have served as a major force in building economic security for many African American workers with access. In the private sector, these DB plans have largely been replaced by DC plans – placing the responsibility of funding retirement income on the participant rather than the employer.

This change has had consequential implications for all retirees, but has presented significant challenges for Black Americans. While factors like wages and employment stability influence the amount of income received from a DB plan, generally, pension income is distributed more equitably by race and gender than other private financial assets including DC plans. According to a September 2023 report from the National Institute on Retirement Security, the typical Black pensioner received about the same annual benefit as the typical white pensioner ($15,180 vs $15,460).¹

That same report also found that the median net worth for older Black families was increased 86% by pensions, with public pensions providing more than half of this impact.¹ These examples illustrate the important role of pension income in narrowing racial retirement income gaps.

In contrast, DC plans place the burden of funding and figuring out how to take retirement income on the individual, oftentimes exacerbating long-standing inequalities concerning pay and employment as well as introducing new challenges including access to financial education and advice.

Pay disparities dampen retirement savings

Black workers, nationally, earn 76 cents for every dollar earned by white workers.² They are also significantly more likely to have low earnings, with 43% of Black workers earning below $25,000 compared to only 20% of white workers.³ Conversely, white Americans are more than twice as likely to earn over $100,000 annually.³

This presents notable disadvantages in a DC plan as lower wages means less to contribute. Further, low-wage workers struggling to cover current living expenses and/or debt may be less likely to put away money for the future. This could also mean missing out on valuable benefits like being able to take full advantage of an employer-match program.

The impact of employment instability

Pay inequality is not the only factor that negatively influences retirement savings. Significant racial disparities in unemployment have been observed at every education level for the past four decades. Black workers are not just twice as likely to be unemployed compared to similarly educated white workers, but they are also often more likely to be unemployed than white Americans with less education.⁴

Disruptions in the workforce or unemployment can have a sizable impact on how much someone is able to save for retirement. Interruptions in employment on top of lower lifetime earnings means fewer opportunities for money to compound and grow. For low-income workers with frequent job changes, there is also an increased likelihood that they “cash out.” This means that they withdraw their full balance before retirement – sacrificing long-term investment growth, and subjecting themselves to additional taxes if taken before age 59½.

Lack of access to financial advice

Further, within a DC structure, workers are more involved in decision-making and managing their retirement plan investments than in a traditional pension plan. This presents an advantage to those with greater access to outside financial education and advice.

Black workers are less likely to have access to outside professional advice due to a myriad of factors including a legacy of discrimination that has diminished opportunities for them to build wealth, save for retirement, and pass on financial legacies to future generations – the aftereffects of which are not purely economic. Among similar economic circumstances, only 36% of Black Americans report using financial advisors compared to nearly half of white Americans, according to a 2023 survey from Allianz Life.⁵

Continuing inequalities have eroded trust in the financial system – leaving many African Americans, particularly those in older generations, reluctant to seek professional advice. The task of finding reliable financial advice is made more difficult by the fact that African Americans are significantly underrepresented in the financial industry. Only 2% of Certified Financial Planners (CFPs) are African American.⁶ As such, finding a financial advisor who understands their unique financial needs and goals can be particularly challenging.

Promoting equity and inclusion in defined contribution plans

Knowledge of the unique challenges facing communities of color is paramount to addressing these inequalities and boosting retirement security for all. However, it is only a first step. Moving the needle forward requires advisors, consultants, and plan sponsors to take action and evaluate the effectiveness of their retirement benefits in addressing the needs of all employees.

Tracking plan demographics

Understanding the demographic makeup of a plan is another foundational step, as it can help identify gaps in coverage and efficacy, though it’s important to note that this shouldn’t come from a single point-in-time analysis, but rather an ongoing evaluation. This will help measure how your organization evolves and the effectiveness of particular interventions.

While this analysis can be done in-house, there are resources from industry organizations as well. For example, the Collaboration for Equitable Retirement Savings (CFERS) is a joint initiative from the Defined Contribution Institutional Investment Association (DCIIA), the Aspen Institute Financial Security Program, and Morningstar to analyze anonymized plan data to understand the differences in how different demographic groups use, experience, and benefit from their employer-sponsored plans. As part of this analysis, CFERS provides participating plan sponsors with customized plan analysis and consulting to help address disparities in their plans.

Access and auto-features

Ensuring more equitable retirement outcomes starts with ensuring equitable access. Tenure requirements and restrictions for part-time workers have long limited access for certain demographic groups to start saving. New provisions under SECURE 2.0 are poised to change this with the requirement that all new 401(k) and 403(b) plans established after the enactment of the legislation automatically enroll employees at an initial contribution between 3.0% and 10.0% beginning in 2025. This legislation also reduces the required years of service from three to two years for long-term, part-time workers to be able to contribute to employer-sponsored plans. These new requirements are poised to have a sizeable impact, but plan sponsors should also consider additional ways of expanding access as well as strategies for improving participation rates.

DC plans are highly dependent on engagement. They are primarily funded by employee contributions, which in turn usually influence employer contributions. For minority groups who may be more likely to be budget-constrained due to debt or other obligations, there may be economic as well as psychological barriers to starting or upping contributions.

To this end, auto-features can be a powerful tool, as they provide a point of entry for retirement savings. Black and Latino employees with access to an auto-enrollment retirement plan have a participation rate two to three times higher than their peers who do not have access to an auto-enrollment plan.⁷ Getting individuals in the door with savings early through auto-enrollment improves outcomes, as their money has more time to grow.

Further, for those not contributing to their employer-sponsored plan due to budget constraints, new provisions under SECURE 2.0 with regard to student loan and emergency saving may provide some reprieve. Beginning in 2024, employers can treat qualified student loan payments as elective deferrals for the purposes of employer-matching contributions to their defined contribution plan.

Employers will also be able to offer non-high income earners an emergency savings account as part of their retirement plan starting in 2024. Employee contributions to the emergency savings account must be eligible for the same matching contributions that apply for elective deferrals, with employer contributions directed to the retirement plan. These new provisions, which will soon be in effect, could have a significant impact on those who are putting off retirement savings to prioritize debt and emergency saving.

The power of personalization

Each individual’s retirement journey is unique, influenced by his or her specific financial circumstances, risk tolerance, and time horizon. However, many retirement savings strategies are one-size-fits-all. More personalized solutions, which take into account additional data points and survey information about their goals, can help participants develop a retirement income strategy tailored to the individual.

These solutions, known as Managed Accounts, provide a data-driven approach that helps cater to the diverse needs of and unique challenges faced by underrepresented populations to help get them on track. These solutions are also often professionally managed – providing a level of personalized financial advice to participants who may not have access outside their employer-sponsored plan.

Incorporating these strategies into equitable plan design can play an important role in addressing the racial retirement gap. Tailoring retirement plans to individual needs, simplifying savings through auto-features, taking advantage of new provisions under SECURE 2.0, and conducting robust plan analysis can help narrow gaps and achieve outcomes that are more equitable.

However, these plan interventions represent only a fraction of the work that needs to be done to fully address the racial retirement gap. Closing that gap will require a concentrated effort from government, businesses, and community organizations. It will also require comprehensive strategies that tackle the root causes of disparities including pay inequality and employment discrimination.