From appearances, it looks like defined contribution plans are displacing traditional defined benefit plans. But if one looks at the facts behind the figures, an entirely different story unfolds.
While it is true the number of defined contribution plans is on the upswing, the demise of defined benefit plans can be viewed as a statistical misrepresentation that is drawing undue attention and, for many, apprehension.
The number of primary defined benefit plans decreased by 36,823 between 1985 and 1989, according to a recent study conducted by the Employee Benefit Research Institute, Washington. At face value, the trend is alarming. Yet, the overwhelming majority of these plans - 28,158 - had nine or fewer participants.
As a result, a relatively small number of plan participants have been affected by the reduction in defined benefit plans. What's more, the number of large defined benefit plans (between 2,500 and 9,999 participants) remained fairly stable during the period, while the number of very large plans (more than 10,000 participants) actually increased slightly.
So, the sky is not falling. Indeed, it is fair to say defined benefit plans continue to be a key component of the retirement system. At the same time, the rapid growth of defined contribution plans has afforded millions of Americans an additional opportunity to save for retirement.
Importantly, most defined contribution plans do not represent the sole retirement provision for most participants. For example, within my company's own broad-based client group, two-thirds represent companies with both a defined benefit and a defined contribution plan, while only one-third rely exclusively on a defined contribution arrangement. These statistics are in line with national averages.
Other concerns regarding the rise of defined contribution plans, also when examined more closely, show such worry is unfounded.
Among the concerns:
Employee participation rates in defined contribution plans are low.
Not true. Participation levels in defined contribution plans continue to increase, indicating more of the work force understands the benefits of saving for retirement on their own. Current surveys identify overall participation of about 70%, compared with 50% to 60% levels as reported in earlier surveys during the late 1980s. Active and effective employee communications have boosted the participation rate at some companies to nearly 80%.
Savings rates among participants are insufficient.
I'm not convinced. In general, participants are saving at what appears to be reasonable levels when both employee and employer contributions are counted. Among sponsors with which our firm works, cash flow averages about $2,000 annually per participant. This figure represents an estimated 6% to 8% of average compensation. These contributions, when combined with market appreciation, dividends and interest, have pushed the average participant balance to more than $26,000, compared to $13,500 only four years ago.
Defined contribution plan savings are being used for current purchasing needs.
You couldn't prove it by us. Most plan participants look at defined contribution plans as a long-term savings tool, not a short-term savings device. While it is true that, among our clients, 15% to 20% of those participants eligible for loans do have loan balances outstanding, the percentage of assets represented by plan loans constitutes only 3% to 4% of total plan account balances.
Further, active participants are repaying their plan loans at reasonable interest rates. So, even when participants are using plan loan features, their retirement assets are not being significantly depleted.
Participants are spending lump-sum distributions upon separation from services.
Not so. When tenured participants with large plan balances change jobs, they are typically maintaining their defined contribution assets in long-term, tax-deferred vehicles, rather than spending them for current compensation. During the first three-quarters of 1993, about 80% of all dollar distributions resulting from terminations at our clients were retained in some form in a tax-deferred status. Those opting to roll over had balances in excess of $30,000, while those receiving payment directly had average balances of only $5,000. This leads us to presume that those receiving checks were younger, shorter-termed participants.
*Participants are not adequately diversifying their savings.
Maybe - maybe not. What we can see is that in well-constructed and well-communicated defined contribution plans, participants are likely to take advantage of opportunities for diversifying their investments. The asset mix for those plans with no company stock available is 45% equity and 55% fixed income, among our clients. For those plans offering company stock, the percentage of equities (including company stock) is even higher, at 60%.
Whether these percentages are "right" in all cases is, of course, open to question. However, one way to encourage added diversification would be for the ERISA Advisory Council to encourage employers to adopt a diversified portfolio as the default option for participants who do not make investment selections, as opposed to money market or guaranteed investment contract accounts that are used almost exclusively for the purpose currently. Indeed, is investing a participant's entire account designed for long-term retirement savings in a money market or investment contract account a "prudent" investment strategy for plan fiduciaries to follow?
Defined contribution plans can be very complicated and, therefore, expensive to administer. As a result, regulations should be kept to a minimum and existing requirements simplified.
A prime example of a worthwhile simplification measure would be to streamline non-discrimination testing for 401(k) plans by implementing "safe harbor" choices, thereby minimizing (or even eliminating) the need for complex and costly testing procures. This kind of simplification would be beneficial to 401(k) plan sponsors and participants alike.
The growth of defined contribution plans during the last 10 years or so has resulted in a major new source of retirement savings throughout the country, and when well run, the benefits of these plans continue to accrue to a broad cross-section of the work force.
James H. Gately is senior vice president-institutional at the Vanguard Group of Investment Cos., Valley Forge, Pa. His commentary is based on his testimony before the Department of Labor's ERISA Advisory Council.