Retirement Policy: Grounding The Dialogue In Facts
Is the 401(k) system a failure? Multiple media outlets and industry pundits would have you think so, but the US 401(k) system has led to millions of American workers voluntarily saving for retirement. We look at some of the arguments being made for upending the system and share why we instead advocate for a sustained focus on improvements to the existing system.
The central theme of recent articles is that the current 401(k) system has created a retirement crisis. Under the 401(k) system, a worker’s retirement security depends on an employer’s decision to have a plan and, if there is a plan, on the individual employee’s decision to participate. Workers not covered by a plan or who choose not to participate (such as those living paycheck-to-paycheck who feel unable to contribute any earnings to 401(k) savings) are left without the retirement savings needed to achieve a secure retirement. These articles admonish the 401(k) system for primarily benefiting the wealthy, who have the ability to save.
Some articles go on to suggest solutions, including: eliminating the tax incentives for 401(k) plans and investing the savings into Social Security, mandating employer or government contributions, or returning to “the good old days” of defined benefit pension plans wherein employees are automatically covered by the plan, contributions and investments are made by the plan sponsor and, at retirement, employees may receive an annuity/income for life.
Eliminating tax incentives isn’t the answer…
Many in the retirement savings community – who support the current system – have expressed concern that Congress could revisit the 401(k) plan tax incentives in 2025 in order to address criticisms of the system, or to raise tax revenue to cover the extension of some of the 2017 tax reform provisions that expire at the end of next year. Some have suggested eliminating tax incentives for 401(k) plans and investing the savings into Social Security – which is essentially robbing Peter to pay Paul. It may sound progressive, but could cost taxpayers much more in the end, which could significantly add to the already enormous government deficit. Yes, there needs to be a solution to the crisis facing the Social Security system, but de-incentivizing workers from saving into a 401(k) plan is counter-intuitive.
…nor is bringing back Defined Benefit plans
As for returning to the traditional defined benefit landscape: it was an excellent plan…for some companies and for some workers who stayed in one job for their entire career. The reality is that few workers do that anymore. As the Bureau of Labor Statistics has found, the average number of jobs a younger Boomer (born 1957-1964) will hold in their career is twelve. Millennials (born 1981-1996) are already averaging 9 jobs mid-career,* suggesting that by the time that generation retires, the average will be much higher than 12. What’s more, with an employer-controlled pension plan, employees have no say in their investment choices and their drawdown options are limited – 401(k) plans offer a level of flexibility and autonomy that are needed by many savers. For some workforces, defined benefit plans still provide an excellent source of retirement security, and we strongly support making such plans workable for those employers, but these plans are not the answer for everyone.
Today’s system
The reality is that no retirement system nor any of the solutions offered are perfect. So we must strive to improve today’s “three-legged stool” (Social Security, employer-sponsored plans, and individual savings) through changes that work.
Rather than upending our current retirement system (which in fact, has become a blueprint for retirement systems around the world), we should continue to build on the extensive improvements that have been made since 401(k) plans were first introduced in 1981. In particular, the latest provisions included in SECURE and SECURE 2.0 aims to ensure that many more workers are covered by plans, that they are saving sufficiently in those plans, and that they will have the resources available to ensure that they can manage their plan assets throughout their retirement, no matter how long that may last. Of particular note, SECURE 2.0 contained bold new initiatives to help low and middle-income individuals save, such as an expanded and reformed Saver’s Match, a requirement for most new plans to automatically enroll employees, and enhanced eligibility for part-time employees.
The central question in this debate is: Has the 401(k) system failed and caused a retirement security crisis? In a word, no. Retirement security is generally measured by determining the extent to which retirement income replaces pre-retirement income. An adequate replacement ratio is the goal of any retirement system. A 2023 study1 by the Investment Company Institute found that the overall replacement ratio – based on all sources, including Social Security – through age 72 was over 90% and was over 100% for those in the bottom 25% by income. This is excellent by any standard.
Obviously, these very favorable replacement ratios are heavily influenced by the progressive nature of Social Security, but we have seen dramatic improvements in the private retirement system too. For example, a 2022 Federal Reserve Board study2 found that the private retirement savings of the bottom 20% by income more than tripled from 1992 to 2022, based on real inflation-adjusted dollars. Moreover, none of the above figures take into account the improvements enacted in SECURE 2.0, such as the new Saver’s Match, which will dramatically improve retirement security for low and middle-income individuals.
But further improvement is needed
We support the enactment of state-sponsored automatic IRAs for employers that do not provide retirement plans for their workers. The initiative taken by these states is laudable. But we need to do more. First, we need a national solution that builds on the states’ success. Second, the objective of the state automatic IRAs is to establish a safety net for employers that cannot adopt their own plans, but the ultimate objective is plans, not IRAs, because state automatic IRAs are, for example, capped at IRA levels, and cannot allow for employer contributions. This makes the state automatic IRAs limited in terms of savings sufficiency.
These are the reasons we support a solution like the legislation introduced by Congressman Richard Neal, the Automatic IRA Act of 2024. That bill provides for a national solution, including both IRA and plan options. As we said in our own proposal in 2017, although automatic IRAs are an excellent first step, ultimately we want to achieve a plan-based solution: Federal law should require all employers, including those that currently do not sponsor a plan, to automatically enroll and automatically escalate all employees, including part-time workers, into a defined contribution plan.
The Bottom Line
Improving today’s 401(k) system is not the only viable path forward, but we caution against disregarding 30 years of great bipartisan work by Congress that has dramatically improved retirement security. We encourage continued active dialogue about ways to improve the current system, particularly as the debate about the expiration of the 2017 tax cuts (and the possibility of curtailing retirement tax incentives) continues into next year and beyond.
*Bureau of Labor Statistics, “Number of Jobs, Labor Market Experience, Marital Status, and Health for Those Born 1957-1964,” August 22, 2023, and “Labor Market Experience, Education, Partner Status, and Health for Those Born 1980-1984,” April 2, 2024.