Will the 401(k) Allow for Retirement?
Will the 401(k) Allow for Retirement? | Human Resource Executive Online
The trend away from defined-benefit plans toward defined-contribution plans makes it harder for workers to have adequate retirement income. And even with default enrollment and other provisions in the pension-reform act, it's likely that many workers will not be able to stop working.
By Dallas Salisbury
Defined-contribution plan design features have dominated the world of private pension plans for more than three decades. That is, pension plans as defined by the Employee Retirement Income Security Act of 1974: any defined-benefit or defined-contribution plan that builds value towards a "retirement" benefit after a worker has met the coverage, participation and vesting requirements of the plan.
Prior to ERISA introducing requirements for 10-year and 15-year vesting, defined-benefit plans were generally designed to "reward" longer service workers.
Since median job tenure has hovered around four years since the early 1950s, and median tenure for workers between 55 and 64 is less than 10 years, pre-ERISA defined-benefit plans concentrated benefits on 20 percent or less of a company's workers. Now, with five-year vesting, as many as half of those who go to work for a firm receive benefits.
By the late 1970s, many defined-benefit plans were adopting defined-contribution features such as single-sum distributions regardless of age upon termination of employment. This feature also increased the cost of the defined-benefit plan. Maintaining adequate benefit formulas thus required higher contributions, and many employers found such higher costs unacceptable.
By the early 1980s, "hybrid" designs began to include a cash-account balance in addition to an annuity value, and credited the balance with an interest rate that frequently bore little resemblance to the actual investment return in the plan. Such plan designs generally delivered less than half the benefit value for long-service workers as the traditional plans they replaced.
As a result, these "cash-balance" and "pension-equity" plans became the subject of legislative and regulatory controversy, as well as numerous lawsuits.
Hybrids grew to represent more than 25 percent of participants in private single-employer defined-benefit plans before some employers began to freeze and terminate these new designs -- as they moved to total reliance on defined-contribution plans.
Today, the percentage of all workers actively participating in private defined-benefit plans has fallen below 20 percent, from what once approached 50 percent. And legislators, employers, consultants, planners and individuals now worry that defined-contribution plans will not provide adequate retirement benefits. They have accepted that defined-benefit plans will not be available to most workers and retirees and are no longer thinking of 401(k) plans as simply supplemental.
These concerns led to the Pension Protection Act provisions on default enrollment, contribution escalation, balanced-investment allocations and discussions of including annuity options in defined-contribution plans.
Surveys indicate that about one-third of plans have adopted the default enrollment provision; far fewer, the contribution-escalation approach; and many more, the default to a diversified-investment option.
But, the data also show that participants and their employers are contributing far too little to achieve adequate retirement-income levels.
Some large plan-administration firms report average combined contributions of less than 5 percent, others as high as 8 percent. Matching the benefit levels delivered by the average traditional defined-benefit retirement plan, for a continuously contributing 35-year career worker, requires annual contributions of at least 12 percent, and investment rates of return equal to the professionally managed defined-benefit plan.
Some large employers that seek to achieve adequacy with a defined-contribution plan contribute 15 percent of salary or more in employer dollars, while workers can contribute as well. Higher-education organizations that have relied on defined-contribution plans for decades have generally included a 12-percent employer contribution plus added contributions by the employee.
In general, however, the vast majority of workers now reliant on 401(k) plans will not build balances sufficient to adequately supplement Social Security -- even if they contribute for 40 years -- unless they and/or their employer significantly increase the amounts they contribute to 401(k) plans.
The current financial crisis, and resulting investment losses in 401(k) plans, have brought with them statements of concern from the president, the candidates, the media and employers, about the sufficiency of 401(k) plans. These concerns do not touch the most important issue in 401(k) plans: insufficient contributions.
HR executives who have moved their employers to rely on 401(k) plans and care about any notion of accumulation adequacy that allows for retirement, will either need to dramatically increase employer contributions -- or convince workers to contribute far more.
Should the low average equity returns of the past decade be made worse by an extended recession, contributions will have to be even higher to achieve reasonable account balances.
HR executives will also need to become defenders of Social Security, as inevitable reform debates take place in the years ahead. Social Security is the only reason that most workers are able to retire already, and this will be the case for growing numbers of retirees in the years ahead. An elderly population without income or assets would carry with it dire consequences for both the nation's economy and the nation's families.
So, to answer the question that is the title of this column, very few workers with 401(k) or similar plans today are contributing -- in combination with their employer -- anywhere near enough to accumulate adequate assets, and nearly two-thirds of all workers are contributing nothing, because they are not participating in a defined-contribution plan.
A 401(k) plan can deliver -- along with Social Security -- retirement-income adequacy. These plans may well be the nation's best hope. But, that will only occur on a voluntary basis if HR executives begin taking the initiative now to get more plans in place, more workers participating and more workers and employers contributing far higher percentages of income than is generally the case today.
In the end, the U.S. economy may depend upon it.
Dallas Salisbury, an expert on economic-security issues, is president and CEO of the nonpartisan
Employee Benefit Research Institute
in Washington.
September 29, 2008 Copyright 2008© LRP Publications
|
Print
Email
Write to the Editor
Reprints
