You don’t have to spend much time scanning personal finance news to come across articles pointing out various flaws with the 401(k) system. Just recently, Slate.com told us the 401(k) world “sucks,” while Reuters published a more nuanced piece that asked, Are Employers with Auto-Enroll 401(k) Plans Less Generous?
I’m tempted to respond to the articles point by point. (The Slate piece in particular seems to reveal a lack of insight into how most companies enroll employees in their 401(k) plans.) But let me step back so I can make a more important point. Namely, that the 401(k) world does need to get better – and that some of its strongest critics come from inside the industry.
Consider the remarks made by BlackRock CEO Larry Fink in a recent speech at NYU. Larry said that Americans have not saved enough for retirement. He pointed out that our increasing longevity is putting stress on the retirement system. Among the potential solutions to consider, he called for greater employer contributions to 401(k) plans and raised the possibility of a mandatory retirement saving system.
By sounding the alarm on the current state of retirement funding, Larry hoped to spark a national debate on the issue. What he is not doing is saying, “Let’s just throw the whole thing out!” While the 401(k) system is not perfect, it has evolved tremendously over the last twenty years. It is worth taking a look at what’s right, what’s wrong, and what’s next for the system.
What’s Right: The irony is that the students Larry addressed have a system in place that will work for them – if they save. The sweeping changes of the Pension Protection Act of 2006 help ensure that most of them, once they graduate and find jobs, will be automatically enrolled in a diversified, professionally managed portfolio. That makes a big difference – plans that use auto enrollment have an 86% participation rate.
What’s Wrong: Major issues remain that will take some combination of behavioral and structural measures to solve. Here are two that are top of mind:
- Currently, we average about a 7% deferral rate into our 401(k) plans nationally. This needs to be higher, with 10% a reasonable goal. Auto-escalation, which gradually increases contributions each year, is one measure we’d like to see more broadly adopted.
- Because 401(k) was originally introduced as an optional supplemental plan, many people currently in their mid-50s did not take advantage of it. They assumed that their company pension and social security would meet their needs, leaving them with inadequate savings as a result. It’s important that solutions for this group do not throw out the improvements that will work for younger workers.
What’s Next: Under the old system of traditional, company-paid pensions, investment managers were able to pool payment obligations together and use mortality tables to predict income needs with a high degree of accuracy. That’s not a merely theoretical advantage. Without pooling mortality, individuals managing their retirement savings have to do the near impossible — guess how long they will need to make their 401(k) savings last. If we can somehow leverage mortality pools for individuals, we can do a better job of translating a lump sum savings into retirement income.
The Bottom Line: The 401(k) State of the Union message can be summed up fairly succinctly: it’s a relatively young system that has made dramatic improvements in the last two decades. Throwing up our hands and saying the whole thing “sucks” is wrong and counterproductive. But taking a clear-eyed view of the system and acknowledging its strengths and weaknesses can help keep it moving in the right direction.