For nearly 40 years now, we've been hearing that 401(k) plans are the key to a comfortable retirement. By giving a tax break to workers contributing part of their paychecks to their retirement nest eggs, the plans were designed to supplement Social Security benefits and employer pensions.
Instead, they've become substitutes, not supplements, for employer pensions and bulwarks against continuous attacks on Social Security benefits. A new survey from Boston College's Center for Retirement Research demonstrates, however, that 401(k) plans are destined to fail millions of Americans. They're not offered by enough employers, they're not taken up by enough workers, and for most people, their balances aren't large enough to provide for a decent retirement.
All these factors weigh most heavily on middle- and lower-income workers, the segment in which the participation rate and balance accumulation are disproportionately low.
The survey authors, Alicia Munnell and Anqi Chen, point to an important difference between 401(k)-type defined contribution plans on the one hand and traditional defined-benefit pensions and Social Security on the other. The latter provide lifetime benefits; the former provide steady retirement income only if they're managed carefully by their owners during retirement.
"They face the risk of either spending too quickly and outliving their resources or spending too conservatively and depriving themselves of necessities," Munnell and Chen write. "Individuals are on their own."
This is an important issue, because it goes to the heart of the retirement crisis facing millions of Americans. Conservatives never tire of claiming that the retirement crisis is a myth, based on their assertion that retired Americans have consistently under-reported their income and in fact are doing just fine. The subtext of their argument is that Social Security benefits can be cut without causing much pain. That's a faulty conclusion, as we'll see.
The rise of the 401(k) would not be much of a problem if these accounts provided an effective way to husband assets for retirement periods that are growing longer, or if Social Security and employer pensions were as secure as they used to be. Munnell and Chen observe, however, that Social Security's full retirement age is increasing to as high as 67 (for those born in 1960 or later) from the traditional 65. The change means that those subject to the maximum retirement age who nevertheless retire at 65 will receive 86.7% of their full benefits. In other words, most new retirees are facing a benefit cut, one way or another.
The 401(k) model has its virtues. The plans are portable, so they don't tie workers to a single employer over a lifetime. They're not quite as back-loaded as defined-benefit plans, which provide exponentially higher rewards to workers with high longevity. In an age when traditional defined-benefit plans are an endangered species in the private sector, at least they're something.
But how good are they at providing retirement security? Not too good at all.
Let's examine their record, with the help of a series of charts accompanying the analysis by Munnell and Chen.
First, the rise of defined-contribution retirement plans hasn't compensated for the disappearance of defined-benefit pensions. Since 1999, Munnell and Chen observe, the percentage of private-sector workers offered any retirement plan at all by their employers has plummeted, from 64% to 43%. The level is lower today even than in 1979, just at the inception of the 401(k) era, when 59% of workers were offered one type or another, or both.
The last three or four decades has seen an almost complete disappearance of defined-benefit pensions in the private sector. In 1983, 88% of workers were covered by defined-benefit plans, including 26% who also had access to defined-contribution plans. In 2016, 17% are covered by defined-benefit plans alone and an additional 10% have both plans. The share of workers with 401(k) defined-contribution plans only has risen from 12% in 1983 to 73% today.
Can the 401(k) reliably provide income for a full retirement?
In the 401(k) model, employees are responsible for deciding how much of their income to defer into their retirement nest egg. The maximum contribution is $18,000 a year, which is exempt from taxes the year it's contributed (with those approaching retirement eligible to contribute an additional $6,000 in "catch-up" contributions). Typically, employers will match some portion of the employees' contribution.
Figures from Vanguard, the largest manager of 401(k) accounts, indicate that the vast majority of workers don't maximize their contributions. Vanguard says that only 10% of its account holders do so; Munnell and Chen speculate that because Vanguard's universe encompasses relatively large accounts belonging to wealthier employees, the overall percentage may be lower.
The average employee contribution rate has been declining gradually since 2007; Munnell and Chen think that may be the unintended consequence of a 2006 change in the law that encouraged employers to make 401(k) enrollments automatic, with workers permitted to opt out if they chose. The idea was to increase the participation rate and it appears to have worked.
The downside is that "many of those who are enrolled at low contribution rates remain at those rates," the authors say, without updating how much to invest as their needs change and their careers evolve.
A modest rise in employer contributions has made up for this decline, but hasn't helped to advance the nest egg — employee and employer contributions combined were about 10.9% last year, not far from the average level dating back to 2007. But employer contributions are volatile — in the post-recession year of 2009 they fell so much the combined contribution rate dropped to only 9.8%, the lowest in a decade.
Put all these factors together, and you end up with a nation of meager retirement savers. Working households nearing retirement age have nowhere near enough saved up to provide for a lifestyle commensurate with that of their working years. The median among households in the 55-64 age range is $135,000. At today's prices, that's enough to buy a joint-and-survivor annuity (one that continues to cover a spouse after the principal beneficiary's death) of $600 per month, without inflation protection.
Moreover, Munnell and Chen point out, that's likely to be all they'll get outside of Social Security, "because the typical household holds virtually no financial assets outside of its 401(k)."
The plight is especially dire for lower-income workers. This is the dirty little secret of the 401(k) revolution — it mostly benefits the affluent. Among the lowest-earning 20% of workers age 55-64, only about one in four has a 401(k), and their median balance is $26,700. Among the highest-earning 20%, about 70% have a 401(k), with a median balance of $780,000.
These figures haven't dissuaded conservative policymakers looking for rationales to cut Social Security.
They seemed to get some grist for their argument that retirees are in clover from an analysis published this summer by Adam Bee and Joshua Mitchell of the Census Bureau, which documented that median household income for retirees was as much as 30% higher than previously calculated. The paper inspired headlines like this, from Andrew Biggs of the American Enterprise Institute: "New Research Confirms: No Crisis for Today's Retirees."
That may have been true as far as it went, but it didn't go nearly far enough. For one thing, talk of the "retirement crisis" seldom refers to today's retirees; it's almost always about what lurks over the horizon for today's workers.
Bee and Mitchell made clear that their analysis didn't address that. Because their study covered people already in retirement in 2012, they said, "we emphasize that our results cannot easily be extrapolated to future cohorts."
And there can be little doubt that those future retirees face tougher conditions. The next generation of retirees will lack some of the resources of their forerunners, such as home equity. As Dean Baker of the Center for Economic and Policy Research pointed out last month, middle-income homeowners in the 55-64 age group had an average equity stake in the homes of 54.6% of its value. In 1989, that figure was 81%.
Today's workers, moreover, have spent much of their working lives struggling with rising debt and stagnating incomes, producing a middle-class squeeze with tremendous social and political consequences. What makes the "no-crisis" crowd think that once these households enter retirement, their economic condition suddenly will turn sunny?
No, the fact is that the retirement crisis is real, and it's coming at us full speed ahead. Pensions are vanishing and 401(k)'s won't save us. The assault on Social Security would result in millions of Americans in retirement having almost nothing at all.