Younger Adults Face Financial Headwinds

Long-term social and demographic trends have caused the gap in household wealth between younger and older adults to widen during the past quarter century. More recently, significant events, including the collapse of home values, the recent recession and continued high unemployment, have created additional financial challenges for adults under 35 years old.

Defined contribution plan sponsors must operate against this backdrop as they work to help their younger employees properly prepare for retirement.

To get a sense of the financial situation facing younger adults, Jim Danaher, managing director of the Defined Contribution Solutions Group at Northern Trust, recently spoke with Richard Fry, senior economist at Pew Research Center, Washington, D.C. Dr. Fry also is co-author of Pew's recent report, “The Rising Age Gap in Economic Well Being.” What follows is an edited transcript of that conversation.

Jim Danaher: In your report, you identified several significant financial headwinds for younger adults. Would you elaborate on these challenges and the impact they're having on younger adults?

Richard Fry: An important driver of wealth building is household income growth. A couple of factors specifically have limited income growth for households under 35. It's usually thought to be an effect of the Great Recession, but actually, as the Pew report shows, adjusted household income for households under 35 basically peaked in 2002 at about $55,000. Since 2002, it's been below $55,000. This is not simply due to the Great Recession, but income growth for younger households has been lagging for the whole decade. Associated with that, if you look at how many of them have jobs, young adults never recovered from the recession of 2001 and 2002. Job holding among young adults was at its highest level in 1999.

Now there is a silver lining to this. One of the reasons, especially for 18- to 24-year-olds, that they're employed less is because there has been a significant increase in college enrollment. But even once you account for what's going on with college, basically employer demand for young, inexperienced workers has been soft for the last 10 years. Given both the lack of income growth and the soft employer demand for young workers, it is not surprising that wealth building is down for younger households.

We compared the most recent wealth numbers for 2009 to the earliest comparable wealth numbers, which were back in 1984 and collected by the Census Bureau. Young households never have had big nest eggs, but back in 1984, the typical median net worth was about $12,000. By 2009, the typical young household had two-thirds less than that (about $4,000), a 68% percent decline.

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Given both the lack of income growth and the soft employer demand for young workers, it is not surprising that wealth building is down for younger households.

Jim Danaher: Your research noted the current discrepancy in household wealth between older and younger adults is the widest it has been in 25 years. This timeframe coincides with the general shift in retirement assets from defined benefit plans to defined contribution plans. What are your thoughts on the relationship between these two trends?

Richard Fry: This is an important question because of the data sets that we have to measure net worth. In the Pew study, we used one collected by the Census Bureau. Another one, which actually probably is better known, is wealth data collected by the Federal Reserve Board. But, neither of these major data sets include in their measure the net worth of defined benefit plans. So that kind of wealth is not captured in conventional wealth data sets. It's very difficult to put a value on these future streams, so that's why both the Fed and the Census Bureau don't try to value them.

That raises the possibility that some of the growing wealth that the Pew study observes might be, basically, artificial. It's capturing the growth in defined contribution plans, but not capturing the less availability of defined benefit plans. If that's true, then you'd expect older households over time to see a larger proportion of their wealth in the financial assets that are captured in 401(k)s and thrift accounts. Interestingly, when you look at older households back in 1984, 42% of their mean wealth was in financial assets. In 2009, 40% of their mean wealth was in financial assets. So I don't see a rising share in these sorts of financial assets, which are included in the data. That is one piece of evidence that might suggest that there's not a lot of artificial shifting. Having said that, in terms of the gap between older households and younger households, the report points out that a lot of the reason for the gap is indeed what's happening to the value of homes, home equity, and the fact that for older households, many of them took less of a hit in the Great Recession.

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Jim Danaher: What long-term impact do you think the collapse of the housing market, the recent recession and ensuing jobless recovery will have on younger households in terms of their overall financial planning and, more specifically, their beliefs about investing for retirement?

Richard Fry: We're primarily a survey research organization, and we look at the attitudes of American adults — including a particular focus on younger American adults. While we have not recently done a detailed survey looking at Americans' attitudes toward financial investments and preparing for retirement, we have had recent surveys looking at home ownership, how many adults say that they are under water and owe more than they own, and whether they would do it over again. What's perhaps a little bit surprising is that in spite of the very severe downturn in housing prices since 2006, many homeowners and many adults still have a pretty favorable attitude toward their homes. In terms of attitudes toward home ownership by age, we asked, “Do you believe that a home is the best long-term investment a person can make?” And 37% of American adults, nationally representative, said, “I strongly agree that a home is the best long-term investment a person can make.” Interestingly, young adults are perhaps a little bit more sanguine about the investment potential of a home compared to older adults. Among 18- to 29-year-olds, only 35% strongly agreed; 30 to 49, 32% strongly agreed. But, when you look at those 65 and older, almost half strongly agreed.

So, clearly, young households have a bit more pessimism, a bit more caution about the investment merits of home ownership. And I would suspect that going forward, they may be a bit more cautious than other adults in terms of thinking of a home as a great investment. I think in terms of their portfolio, it looks like younger adults may not see homes as quite the great part of their portfolio that older adults do.

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What's perhaps a little bit surprising is that in spite of the very severe downturn in housing prices since 2006, many homeowners and many adults still have a pretty favorable attitude toward their homes.

Jim Danaher: Are there any encouraging signs either from your research or that you might see elsewhere for younger adults in terms of their ability to accumulate wealth?

Richard Fry: I think there are some favorable tailwinds that in the long run should positively affect them. In the short term, the only obvious one that I want to point out is, for those young adults who did not over the past six, seven, eight years make the step toward home ownership, they potentially may be buying American homes at substantially reduced prices. Who knows how long the U.S. housing market nationally will remain depressed, but they have an opportunity to buy homes at fairly cheap prices compared to what they once were.

Getting away from homes and housing though, there is one aspect about the characteristics of young adults that the data is pretty clear about. This generation of young Americans is the most educated generation we've ever had. Using 25- to 29-year olds, 85% of them will have finished high school. Almost a third of them will have completed at least a four-year college degree. In terms of wealth building, that has two clear implications. One, on average those with college degrees get paid significantly more than those with high school degrees. The typical household income for a woman who is a high-school graduate is a little under $50,000, but if she is a college graduate it's closer to $96,000. For men, if he is a high-school graduate, the household income is about $57,000; if he is a college graduate, it's about $103,000. It's much easier for higher-income households to build wealth and to save, so that education hopefully should produce some income growth and lead to wealth building.

This generation of young Americans is the most educated generation we've ever had. Using 25- to 29-year olds, 85% of them will have finished high school. Almost a third of them will have completed at least a four-year college degree.

Another direct effect: There's a clear association between education and financial literacy. In terms of retirement preparation, home ownership, how to build wealth, all those sorts of complicated financial literacy issues, the research is pretty clear that there's an association between financial sophistication and education.

Jim Danaher: As the focus shifts from the Baby Boom generation to the approximately 61.5 million employees under the age of 35, defined contribution plan sponsors need to realize younger adults face unique challenges and a radically different financial landscape than older age cohorts. With this context in mind, plan sponsors can enhance DC plan design features to successfully engage younger participants and help to ensure their retirement readiness.

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