Defending the 401(k)

While attacks on defined contribution plans have ramped up significantly in the past year, advocates for workplace retirement plans are stepping up to counter their claims

The 401(k) is under attack on multiple fronts, with a range of scholars, economists, politicians and media lobbing criticisms at the private workplace retirement plan market.

It’s not working, they say. It has widened the wealth gap, disproportionately benefiting higher-income workers. There’s not enough access to defined contribution plans. As 401(k)s have replaced defined benefit pension plans, too many Americans have failed at taking responsibility for their own retirement saving.

These criticisms underscore a growing concern that the current 401(k) system, while beneficial in many ways, also contains significant flaws. But while the private workplace retirement plan industry has been working (and lobbying) diligently to address these flaws and close coverage gaps, some critics seem convinced the 401(k) is a failure and needs to go away.

Some (cough, Bernie Sanders) pine for a return to pension plans, which seems unlikely to gain much momentum despite IBM’s well-publicized move late last year to unfreeze its DB plan and UAW’s unmet demands for a return to pensions during last year’s strike negotiations. Corporate America lacks the appetite and there are many other reasons pensions aren’t coming back.

Some say the answer is a new federal program based on the Thrift Savings Plan model, in which savings accounts of eligible (lower-income) workers are supplemented with government matching funds. This proposal is the basis for proposed legislation called the “Retirement Savings for Americans Act,” which has bipartisan support (as well as the approval of AARP). It is strongly opposed by the American Retirement Association.

Some say the 401(k)’s tax incentives disproportionately benefit the wealthy and should be eliminated, with resulting government revenue increases steered toward propping up Social Security’s ailing finances.

This chorus of criticism has reached a crescendo in recent months, and it’s no doubt being heard by some lawmakers in Washington D.C. who may have the wherewithal to act in a way that could curtail the 401(k) system.

“This year and in the years to come, our clients’ income and assets, as well as our industry—which works day and night to serve those clients—will be a target for Washington,” NAPA President Keith Gredys said during the opening general session of the NAPA 401(k) Summit in April. Gredys stressed that NAPA members must work together to fend off challenges facing the 401(k) market.

“The folks in Washington are looking at qualified plan assets as a potential source of funds. Bottom line: the ability for plan advisors to assist our clients will be impacted if we sit and do nothing. Our livelihoods as trusted advisors will be impacted unless we do something,” he added. “Individually we can do only so much. Together, we are a powerful force.”

Indeed, the attacks have put the 401(k) industry on the defensive, forcing many industry advocates and stakeholders like Gredys and the American Retirement Association to speak out to counter what are seen as flaws in the logic or misinterpretations of data of various criticisms and proposals targeting 401(k)s.

Another staunch defender of the 401(k) is the Investment Company Institute, which plays a significant role in shaping the practices and policies affecting the asset management industry.

In an interview with 401(k) Specialist, ICI’s Senior Director, Retirement and Investor Research Sarah Holden and Senior Economic Advisor Peter Brady noted that part of the criticism, somewhat ironically, stems from the success of the system.

“We now see more than $7 trillion in assets in 401(k) plans and more than $24 trillion in all types of self-directed accounts (inclusive of IRAs and other defined contribution plans). That makes for a big target,” Holden and Brady said.

That’s across more than 700,000 plans and 70 million participants, as of September 2023, per ICI data. Rollovers from 401(k) plans to IRAs account for about half of the $12.6 trillion in IRA assets.

There’s also a lot of misplaced nostalgia for pensions, they add. “Many critics of today’s retirement plans overestimate what retirees got from DB plans in the past because they equate retirement plan coverage with retirement plan income. Although many workers were covered by DB plans, the combination of several factors—vesting rules, the timing of benefit accrual, and labor mobility—resulted in many of those workers getting little-to-no income from the plans in retirement,” Holden and Brady said. “The truth is that more retirees get more income today from the combination of DB plans, DC plans, and IRAs than they did in the so-called ‘good old days.’”

Holden and Brady said they don’t think the threats to the DC system should be taken lightly, but the facts and data are on the side of workplace retirement plans.

ICI points out the 401(k) plan is a powerful savings tool, providing millions of Americans access to: employer contributions (90% of 401(k) plan participants are in plans with employer contributions); a lineup of professionally managed and diversified investment options (28 options on average in large 401(k) plans); and cost-effective products available through ‘dollar-cost-averaging’ investing paycheck-by-paycheck.

NEXT PAGE: Rethinking Retirement

Rethinking Retirement

In his 2024 annual letter to investors, released in late March, BlackRock Chairman and CEO Larry Fink said it is time to rethink retirement.

“The retirement system in America needs modernizing, at the very least,” Fink wrote. “America needs an organized, high-level effort to ensure that future generations can live out their final years with dignity… As a society, we focus a tremendous amount of energy on helping people live longer lives. But not even a fraction of that effort is spent helping people afford those extra years.”

Fink noted factors putting the U.S. retirement system under strain, including changing demographics (and policy not keeping up), Social Security’s well-documented challenges, and the shift from defined benefit to defined contribution retirement plans.

“Put simply, the shift from defined benefit to defined contribution has been, for most people, a shift from financial certainty to financial uncertainty,” Fink wrote, noting that even people who know how to save for retirement still don’t know how to spend for it. “Today in America, the retirement message that the government and companies tell their workers is effectively: ‘You’re on your own.’ And before my generation fully disappears from positions of corporate and political leadership, we have an obligation to change that.”

In addition to introducing BlackRock’s LifePath Paycheck—allowing older workers to shift some of their 401(k) contributions into an annuity—which he called a “revolution in retirement” he believes “will one day be the most used investment strategy in defined contribution plans,” Fink also used that highly publicized letter to push for more automatic nudges to get more people enrolled and saving more in workplace retirement plans.

“As a nation, we should do everything we can to make retirement investing more automatic for workers. And there are already bright spots. Next year, a new federal law will kick in, requiring employers that set up new 401(k) plans to auto-enroll their new workers,” he wrote. “Plus, there are hundreds of major companies (including BlackRock) that have already taken this step voluntarily.”

NEXT PAGE: Putting Auto Features to Work

Putting Auto Features to Work

Ah yes—nudges like auto enrollment, one of the key reforms in SECURE 2.0 designed specifically to get more workers contributing to their 401(k)s. In the overwhelmingly bipartisan SECURE and SECURE 2.0 retirement-savings packages, Congress included many provisions intended expressly to further increase participation.

In his recent “blueprint for greater 401(k) success,” Empower President and CEO Edmund Murphy also stressed the importance of auto features that overcome bad behavior. Murphy penned the blueprint in light of criticism from those who wish to eliminate or significantly alter the 401(k), explaining it’s best to show how it is effective and offer some areas for needed improvement.

“The great innovation built into the 401(k) system is that it helps individuals overcome behavioral hurdles through the use of automatic savings features. Automatic paycheck deferrals, auto-enrollment and auto-escalation are features that have proven to work at keeping savers on track for retirement,” Murphy wrote.

He added that about 62% of businesses with a 401(k)-plan used automatic enrollment in 2020, up from 46% a decade ago, according to the Plan Sponsor Council of America. Another study found that 92% of new hires were still saving in the 401(k) plan three years after being automatically enrolled; in plans with voluntary enrollment, just 29% were still saving.

“Every retirement plan must have auto features,” Murphy said.

Add Ted Benna, the acknowledged “father of the 401(k),” to those believing mandates are needed to improve retirement saving habits. He said as much in a lengthy recent article in The New York Times titled, “Was the 401(k) a Mistake?” that falls into the category of attacks on defined contribution plans.

The article quotes Benna as saying that that the voluntary approach, in which companies decide whether they want to sponsor 401(k)s and employees decide whether they wish to participate, is leaving too many gaps. “He thinks all companies above a certain size should have to offer employees 401(k)s or alternative retirement-savings options,” the article says, adding that starting next year, employers that establish new 401(k) plans will be required to automatically enroll workers in those plans per SECURE 2.0 (and further adding there is still no obligation, however, to actually provide the plans themselves.)

Nevertheless, it must be noted that federal and state lawmakers have made great strides in their efforts to increase access to retirement plans at work, and that work is leading to an explosion of small plans through state mandates, tax credits and expanding access to pooled employer plans. And they are tackling the decumulation issue with SECURE and SECURE 2.0 provisions making it much easier for employers to offer high quality annuities as part of a 401(k) plan, which many are calling a game-changer.

And the incentives don’t stop there. ICI noted additional provisions such as small employers are provided enhanced tax credits to create a new ‘Starter’ 401(k) plans; the ability of employers to contribute matching funds to 401(k)s against student loan repayments, and the new “Saver’s Match” converting the Saver’s credit into a government matching program for lower- and middle-income Americans; increased savings opportunities for part-time employees; and allowing for new emergency savings accounts.

“The part of the system—the 401(k)s and IRAs people like to take sticks to—is the part that is working, and the improvements Congress passed recently will only help more Americans to save for a secure financial future,” ICI’s Holden and Brady said.

NEXT PAGE: Protecting 401(k) Tax Preferences

Protecting 401(k) Tax Preferences

This past January, Alicia Munnell, director of Boston College’s Center for Retirement Research, and Andrew Biggs, a senior fellow at the American Enterprise Institute, stirred a hornet’s nest with a paper proposing the elimination of the tax preferences for 401(k) plans to address the funding shortfall of Social Security.

They argue that these tax benefits primarily serve higher-income earners who are more likely to have access to and participate in these plans, contributing more substantially. The authors suggest that the government redirect the significant tax revenue lost through these preferences—estimated around $185 billion annually—toward bolstering Social Security, which, as has been widely reported, will be able to pay only 83% of the benefits promised to current and future beneficiaries by 2035 absent action by Congress—leaving beneficiaries facing a disastrous 17% cut in benefits.

“If you want to talk about the issue of whether it would be a good idea to get rid of the 401(k) tax incentive and use that money toward Social Security, it would be a preposterously bad idea,” ARA CEO Brian Graff said. He explained that Social Security does a really good job of providing replacement income for low-income individuals, but doesn’t do a good job of providing replacement income for middle-income individuals. “The only way middle income individuals are going to have adequate retirement savings is actually through private savings, primarily through retirement accounts,” Graff said.

If the 401(k)’s tax incentives were eliminated, middle income people would not have enough savings. “We’d actually create more of a retirement crisis,” Graff said. “What we really need to do is to make sure Social Security is adequately funded. The way to do that is not by undermining the middle-income people.”

ICI agrees, emphasizing that the current system works: most workers build up resources from retirement plans at some point during their working careers and most retirees get income from these plans.

“The tax benefits of retirement plans are not restricted to high earners. Most tax measures (in dollars) will be skewed to high earners, simply because both income and taxes paid are highly skewed. That’s just the math,” ICI’s Holden and Brady told 401(k) Specialist. “But if you express the tax benefits of 401(k) plans as a reduction in average tax rates—even using the estimates cited by the scholars making the proposal—the benefits are a similar share of income for the top 60% of the income distribution. That’s millions of middle-class Americans receiving a material benefit from the tax-advantaged nature of 401(k)s and IRAs.”

A recent study by ICI economists analyzing tax data showed that more than 70% of retirees received income from employer plans and IRAs. And research using matched household survey and tax data by Census Bureau and Social Security Administration economists found similar results.

The data also show that—through the combination of Social Security and retirement plan income—most retirees maintain a high share of the spendable income they had prior to retirement.

“So once you account for the math, it’s clear that everyday Americans from all walks of life benefit from the tax incentives they get from saving for retirement. That’s something our Representatives in Congress should protect,” Holden and Brady said.

There seems to be a consensus among retirement industry leaders—including ARA, ICI, Empower’s Ed Murphy, among others—that Social Security does need fixing sooner rather than later.

“The lack of serious attention to Social Security is a significant problem. Anyone who wants to claim we’re in a ‘retirement crisis’ and ignores the Social Security mess is being dishonest,” Murphy said in his blueprint. “The next Congress and the Executive Branch need to prioritize this. Social Security reform, combined with the 401(k) system, together offer the best chance to help more Americans create financial security.”

Aside from eliminating the tax-preferences of 401(k)s, numerous other proposals to shore up Social Security are floating around. Some suggestions involve raising the retirement age, eliminating taxes on Social Security benefits, and increasing Social Security taxes on high earners.

NEXT PAGE: Give Reforms a Chance

Give Reforms a Chance

Despite facing significant criticism, the 401(k) system remains a robust and essential component of the American retirement landscape. While its critics bring up some valid points about current shortcomings, these critiques often overlook the system’s strengths and the improvements already in progress or on the way that address those issues.

Just think about all the ways provisions in the SECURE Act of 2019 and SECURE 2.0 in 2022 are attacking holes in defined contribution world.

In-plan guaranteed income solutions are increasingly being offered in 401(k) plans to address the risk of running out of money in retirement. Continued movement toward automatic features in 401(k) plans, such as auto-enrollment and auto-escalation, has significantly increased participation and savings rates. To wit, Fidelity recently reported record-high contribution levels with a 401(k) plan savings rate reaching 14.2%, including employee and company contributions, as of March 31. That’s the closest the combined savings rate has ever been to Fidelity’s long-recommended 15% benchmark, and the recordkeeper gives credit to auto-escalation.

Multiple Employer Plans (MEPs) allow unrelated employers to join a pooled employer plan (PEP), reducing administrative costs and complexity, helping small businesses offer retirement plans more efficiently (and easily).

The Saver’s Match will transform the Saver’s Credit into a government matching contribution for lower- and middle-income earners who contribute to retirement accounts, enhancing the incentive to save. More part-time workers are now eligible to participate in 401(k) plans.

Emergency Savings Accounts allow employers to automatically enroll employees in these accounts within retirement plans, with contributions capped at $2,500, providing a safety net for unforeseen expenses without tapping into retirement savings.

Student loan payment matching permits employers to make matching contributions to 401(k) plans, 403(b) plans, or SIMPLE IRAs based on employees’ student loan repayments, helping employees save for retirement while paying off student loans.

Provisions like these collectively aim to broaden retirement plan access, encourage higher savings rates, and provide greater flexibility and security for retirement planning. 

“It’s important not to lose sight of the 401(k) plan’s ability to help workers of all ages, backgrounds, and incomes build retirement nest eggs,” ICI’s Holden and Brady conclude. “As American workers change jobs over their career, DC plans accrue benefits quickly and are inherently good and well-suited to the mobile workforce we see in 2024.”

No one is saying the 401(k) system is perfect, and it’s a big challenge to nudge more Americans into saving for retirement. But with many steps being taken right now to increase access to plans and encourage more people to save, the 401(k) remains the best plan for working Americans to secure their retirement.

EDITOR’S NOTE: This is the cover story of 401(k) Specialist Magazine Issue 2 2024, which can be read in its entirety via the digital edition here.

SEE ALSO:

• Podcast: Defending the 401(k) with ICI’s Sarah Holden

• AARP Endorses ‘Retirement Savings for Americans Act’ Opposed by ARA