New research shows that defined contribution plans produce about the same level of asset accumulation as traditional pension plans, leading one prominent critic of 401(k) plans to slightly warm to the defined-contribution system.
Alicia Munnell, who's been the director of the Center for Retirement Research at Boston College for more than 15 years, has extensively researched and written about the shortfalls of 401(k) plans, covering such topics as inadequate savings, asset leakage from the DC system, insufficient plan coverage and racial and ethnic disparity in plan participation.
Now, a new paper Ms. Munnell co-authored with two colleagues indicates that people receive the same amount of retirement benefits in today's world of DC plans as in the days of defined-benefit plans, the former retirement-savings vehicle of choice among U.S. employers. That finding has caused her to do an about-face, at least in terms of DC plans' ability to generate equal savings as pensions.
“I, like others, have said people are saving less because of the shift from DB to DC plans, and that's one of the reasons why we're going to have a retirement income crisis as people just retire on 401(k)s,” said Ms. Munnell, who served on the President's Council of Economic Advisers during the Clinton administration prior to her work at Boston College. “Based on the exercise we just did, I'm never going to say people are saving less.”
The report, “
How Has Shift To Defined Contribution Plans Affected Saving?,” examines DB and DC wealth as a percentage of private wages and salaries. In 2012, the combination of DB and DC savings yielded a 14.1% figure, slightly higher than the 13.5% seen in 1984. That was the year tax-reform laws required testing to ensure 401(k) plans didn't discriminate in favor of highly compensated employees.
When investment returns are factored in along with plan contributions, the annual change in pension wealth remained fairly steady between 1984 and 2012, between a range of 13% and 15%, the report says.
“For me, it's a big deal,” Ms. Munnell said of the new research results. “I thought we were saving less in 401(k)s.”
An apples-to-apples comparison of DB and DC savings wasn't possible until recently, when the government changed the accounting method for DB plans, the study says. Since 2013, accounting is done on an accrual rather than a cash basis, so instead of reporting the amount an employer contributes to a DB plan, which can change from year to year, it accounts for how much a participant accrues in benefits.
401(k) plans took off in popularity during the early 1980s, and employers began favoring them over DB plans as the primary retirement savings vehicle for their employees. A
Towers Watson study of DB plan sponsorship among Fortune 500 companies puts the number of DB plans in 2013 at 118, down significantly from 299 in 1998. Over that same period, the number of DC plans rose from 195 to 382.
The transition from DB to DC plans coincides with a workforce that has become increasingly mobile, favoring 401(k) savings employees can take with them from job to job. The DB system works well in a world where employees stay with one employer throughout their lives, Ms. Munnell said.
Jim O'Shaughnessy, managing partner at Sheridan Road Financial, said it's good to see Ms. Munnell soften a bit on her 401(k) stance because she's been such a staunch critic, but said the report's findings weren't too surprising.
Retirement-plan advisers have placed strong emphasis on plan design features to drive better participant savings behavior over the past several years, Mr. O'Shaughnessy said, adding that he sees strong savings rates in most of the plans on which he advises. He aims for a total participant savings rate between 10% and 15%.
Michele Casey, corporate retirement director at The Casey Retirement Group, also said the report didn't come as a shock.
“If educated properly, I think the DC plan has a lot more opportunity from an asset accumulation standpoint” when compared to DB plans, Ms. Casey said. Some DC plans are
beginning to add retirement income options as well, making them resemble DB plans on the asset-drawdown end, Ms. Casey added.
Despite her reversal of opinion on asset accumulation, Ms. Munnell is still quick to point out plenty of other flaws in the DC system.
“I totally accept that the 401(k) system is here to stay, and it doesn't make any sense to throw it out and start brand new,” Ms. Munnell said. “But I think the 401(k) system could work much more effectively.”
For example, Ms. Munnell cited offloading of risk onto employees, lack of coverage in the private sector (something she contends pensions didn't fully address, either) and the problem of
leakage from plans when employees take loans and cash out upon new employment. She also said she suspects the distribution of 401(k) assets, unlike with DB plans, is skewed toward those with higher incomes; however, that's not something that could be ascertained from her research.
Full automation, or ensuring all DC plans include automatic enrollment and escalation in their design, would likely be the most effective improvement on the current system, Ms. Munnell said. According to a Plan Sponsor Council of America survey, 50.2% of 401(k) plans use automatic enrollment; 65.2% of those plans also include an automatic escalation feature.
