Auto enrollment and other automatic savings features have also worked wonders in boosting plan
participation. In 2004, for example, when automatic enrollment was not widely used, the average plan participation rate was 74%, far below today’s average participation of 85%, according to Vanguard’s latest edition of its “How America Saves” report.
The emergence of target-date funds and their use as the default investment option have also helped millions of retirement savers who might not have been able to decide where to hold their assets.
“It seems sensible to make sure that people are not putting themselves into some fixed-income type of investment,” said Alicia Munnell, 25-year director and founder of the Center for Retirement Research at Boston College, adding that default investment options and other automatic features have been important in improving the effectiveness of DC plans.
Yet for all the advances in design, defined contribution plans may have reached a limit in terms of what they can accomplish, according to industry experts.
“Everything that can be done to make these plans work better has been done,” Munnell said, bemoaning the fact that despite the industry’s hard work and innovation, defined contribution plans are still not widely available to workers.
“If you take a snapshot of the private-sector workforce at any moment of time, you’ll see only half the working population is covered,” she said.
The lack of coverage disproportionately impacts low- and middle-income Americans who typically work for employers that do not offer workplace retirement plans, Munnell and other experts said.
The defined contribution system has worked well for the top third of wage earners who “built up big piles” because they’re in the system all the time, unlike those who haven’t been in the system in a steady way or have never had access to it, Munnell said.
Munnell explained that the industry initially produced Excel spreadsheets showing people that if they saved continuously at a set rate of return, they’d “have this much money,” but the calculation from the “synthetic” rather than the actual work history fell short because people move in and out of jobs that don’t always offer workplace plans.
“It’s only worked well for a subset of the population, and now I think the challenge is to figure out something that will work well for the rest of the population,” she said.
Teresa Ghilarducci, a professor of economics and policy analysis at the New School for Social Research, was more critical, denouncing the system as an outright failure. If she were to give the system a report card on its outcomes for an entire generation of workers over the past 40 years, she would give it an “F,” she said.
Ghilarducci noted that only 54% of people between the ages of 55 and 64 have any kind of retirement savings, with the median amount saved a modest $134,000.
“I am shuddering when I look at these numbers,” she said. “I don’t know how people are going to do it.”
Experts agree that the coverage issue shouldn’t fall squarely on employers, noting that they shouldn’t have to shoulder the burden of offering plans if they don’t have the money or resources to offer them, as is often the case with small employers.
“This isn’t to throw employers under the bus,” said John Scott, project director of retirement savings at The Pew Charitable Trusts. “Sometimes they don’t have the administrative capacity or bandwidth to take on the sponsorship of a retirement plan.”
Experts are skeptical that provisions in the SECURE 2.0 Act to spur employers to offer workplace plans, including more generous tax credits, will make much of a difference.
“A tax credit for small employers might seem generous, but if the employer has to pay an upfront fee for starting a plan but cannot get the tax credit for several months due to the time it takes to file the tax return and then processing the return, the credit might be less appealing,” Scott said, adding that he’s in the “wait-and-see” camp.
One bright spot in fixing the coverage gap are state-run retirement savings programs, which have been popping up across the country as “auto IRAs.” These programs typically require employers to make the programs available to their workers if they don’t offer a workplace retirement savings program themselves. They also typically automatically enroll workers in a payroll-deduction individual retirement account unless they opt out.
Munnell, a “big fan of auto IRAs,” is heartened by the fact that the programs are “moving in the right direction,” though she concedes that they’re “gaining employers and participants more slowly than most people would have anticipated.”
To date, 19 states have established—or enacted legislation to establish—state-run retirement plans, 15 of which are structured as auto-IRA programs. As of Aug. 31, the three largest programs — those in Oregon, Illinois and California — along with more recent programs in Connecticut, Maryland and Colorado, had $991.2 million in assets, covered more than 752,000 savers and worked with more than 177,000 employers, according to the Georgetown University Center for Retirement Initiatives.
While industry observers applaud the state programs, they’re rooting for a federal auto-IRA program that Congress has been considering since 2006 but hasn’t yet been able to pass. A federal program would achieve the broad national coverage that has long eluded the industry and drive greater administrative and cost efficiencies than the current state-run programs provide, sources said.
“We’re letting a thousand flowers bloom, but all the flowers are tulips and all the tulips are red,” Munnell said of state auto-IRA programs. “All these plans look exactly the same, and it would seem like there’d be economies of scale and a lot of benefits by having a national program rather than state by state.”
Nevertheless, for some industry experts, the current defined contribution system — despite its shortcomings — still beats the old defined benefit or traditional pension system that once dominated the workplace.
Olivia S. Mitchell, a professor at the Wharton School at the University of Pennsylvania, notes that under the old system workers had to have a full career at a single employer to receive reasonable benefits, a model that simply doesn’t suit most workers in the labor market today.
“In my view, the DC system is better for more people than the old DB system, since traditional DB plans only paid benefits to workers who never changed jobs and never quit,” she said.
In addition, Mitchell points out that pension plans were — and still often are — underfunded, meaning that retiree benefits can be slashed in the event of a company bankruptcy.
Yet, Mitchell still sees room for improvement in the world of defined contribution plans.
“If I had one wish, it would be to integrate a deferred annuity into DC plans so that some of the benefits are paid as lifetime income,” she said, adding that SECURE 2.0 enhanced employers’ ability to do this.
Boston College’s Munnell would also like to see annuities added to DC plans to help workers draw down their savings.
Workers “clearly are not in the mood of going to an insurance company and buying annuities,” she said. “There has to be some mechanism that they can get annuitized income in some semiautomatic way.”
Munnell is also a proponent of having employers adopt a Social Security “bridge” strategy within their 401(k) plans that would allow their retired workers to delay claiming Social Security benefits and thereby increase their monthly payment when they do eventually claim.
Under the bridge proposal, employers would distribute payments to retirees from their 401(k) equal to the Social Security benefits those retirees would get if they claimed. This stream of payments would continue as long as the funds set aside for it lasted, or until age 70.
The proposal envisions allocating 20% to 40% of a worker’s 401(k) assets to the bridge.
“Social Security is the cheapest annuity around and also the best in the sense that it’s fully indexed for inflation,” Munnell said.
The New School’s Ghilarducci would take the proposal one step further. She supports allowing people to roll over their retirement savings into the Social Security system so they can receive an equivalent benefit until they can claim for a higher benefit.
Workers with the median savings of $134,000 may not know how to make the money last the additional years needed to bridge them over to a higher Social Security benefit, Ghilarducci said.
Let the Social Security system help people “manage the little bit of money that they have because $134,000 isn’t chopped liver,” she said.
Ghilarducci points out that most people don’t have access to financial advisers who can tell them how best to manage the funds.
“If Social Security is so efficient, why can’t I just put more money into it and get a higher benefit?” she asked.