U.S. Looks At DC Reform
Delta Airlines recently announced it will request termination of its Defined Benefit pension plan for pilots. It joins GM, IBM, Verizon, Motorola, Hewlett-Packard, and Lockheed as major employers which are freezing or terminating DB plans and opting for the U.S. equivalent of the Defined Contribution pension plan, the 401(k) plan.
Coupled with this is the fact only about half of workers contribute to an employer-sponsored pension plan in any given year. Among workers with tax-preferred retirement saving plans, few make the maximum allowable contribution. The result is many households approach retirement with meager savings and with some 77 million baby boomers nearing retirement, these defects in the nationʼs DC plans are becoming obvious, says the National Center for Policy Analysis (NCPA).
In the past 25 years, the use of DC pension plans – such as 401(k)s – has soared. Created by the Revenue Act of 1978, the feeling was these plans are ideal for workers who change jobs frequently or experience gaps in employment since the funds that accumulate in their accounts are the employeesʼ property.
Today, more than 42 million workers participate in DC plans, with total assets exceeding $2 trillion. In 2001, however, the median balance in such accounts among all households headed by 55- to 59-year olds was only about $10,000, says the NCPA.
As well, participation in these plans is badly skewed towards income. A Congressional Budget Office review shows only 22 per cent of workers with incomes of less than $20,000 participate in taxdeferred plans. The participation rate is 56 per cent for workers between $20,000 and $40,000; 70 per cent for workers between $40,000 and $80,000; and almost 80 per cent of workers with incomes of more than $80,000 participate.
The NCPA says there are a number of other problems.
For example, most donʼt save enough. About a quarter of workers who are offered a 401(k) plan at work donʼt participate in it. Those who do participate rarely make the maximum contribution, even though employers often offer a matching contribution. Well under 10 per cent of participants contribute as much as is allowed by law.
Another problem is that those who do save typically invest in inappropriate portfolios. While thousands of Enron employees lost most of their retirement savings when the company stock price collapsed, this was not an unusual situation. A Hewitt Associates survey of 375 companies that offer 401(k) plans found that 55 per cent offered their own stock as an investment choice. Of employee plan assets, 30 per cent are invested in employer stock. Using company stock as the basis of retirement savings is twice as risky as if the company goes bankrupt, the employee faces not only the loss of their job, but seeing their retirement savings wiped out as well.
And while workers who invest their retirement funds in their own firm take an undue risk, other employees invest in overly conservative assets, which may be safe, but do not offer adequate returns for a comfortable retirement. Lower income workers, in particular, are prone to do this. Research shows that employees in the lowest income quintile have typically invested almost two-thirds of their account balances in lower-earning money market or bond funds, says the NCPA.
While Congress is currently deliberating reforms to 401(k) plans, including those proposed by the NCPA and the Brookings Institution, it is not going far enough, says John C. Goodman, president of the NCPA. “401(k) reforms proposed by the NCPA and Brookings Institution have been treated largely as an afterthought in the pension reform bill. But these provisions will have by far the largest impact on millions of Americans.”
Its proposals being debated by congress include suggestions to provide automatic enrolment of employees into company 401(k) plans and providing automatic contribution rate increases so that as workersʼ wages grow, so do their contributions.
Evidence strongly suggests that when workers are automatically enrolled in a 401(k), participation rates are significantly higher. Yet most employers require employees to specifically opt in.
Savings rates are also higher when 401(k)s commit workers to saving part of their future pay raises, rather than trying to encourage them to save at a higher rate immediately.
The NCPA/Brookings also wants an adequate minimum contribution rate and default investments in broadly diversified equity and bond index funds.
To encourage the adoption of plans with features proven to be effective in helping workers better prepare for retirement, policymakers should:
- Clarify that retirement savings plans with these features are permissible under state labor laws.
- Offer pension plans meeting the requirements outlined here targeted relief from class action complaints and special treatment under the non-discrimination standards.
- Require that, at least as a default, when employment ends, employeesʼ 401(k) accounts are automatically rolled over into another qualified plan or into an IRA, or remain in the previous employer ʼs plan, rather than requiring a terminated employee to take a potentially taxable (and penalized) distribution.
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