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EBRI Sees 401(k) Plans as Viable Retirement Savings Vehicles-If Used Faithfully

It is common to hear retirement industry professionals decry the failure of the 401(k) plan, in its current form, as a viable substitute for the once ubiquitous but rapidly disappearing traditional pension plan. The 401(k), after all, was designed to supplement, not supplant, a pension, and its successful performance depends on the voluntary participation of participants who, in most cases, know little or nothing about investment strategy or practice. It is also true that countless studies have shown that a sizeable percentage of 401(k) plan participants are not investing fast enough or smart enough to assure themselves a financially secure retirement-if they participate in their plan at all.

Still, the 401(k) might be taking a bit of a bad rap. Jack VanDerhei, a Fellow with the non-profit Employee Benefit Research Institute (EBRI), says research by that organization suggests that 401(k)s, when combined with participants' Social Security benefits, have the capability to provide adequate retirement income for post-baby boomers. To do so, however, they must participate in those plans from the beginning to the end of their careers.

Speaking at the SVIA's 2007 Spring Seminar in Charleston, South Carolina, VanDerhei said that his conclusion was based on EBRI's analysis of plan participants born between 1965 and 1974. He assumes that participants' savings and investment habits as they age should parallel the way the preceding generation of participants saved as they aged. Depending on income level, he said, the post-baby boomers should be able to replace anywhere from 83.9 percent to 106.4 percent of their pre-retirement income when they quit working at age 65 and start drawing on both Social Security and their 401(k) nest egg. Those in the lowest income quartile will have the highest replacement income, because their Social Security benefits will equate to a greater percentage of their pre-retirement incomes.

VanDerhei also discounted the gloomy statistic showing that the average 401(k) participant only has about $60,000 in his or her retirement account. That number is skewed by the accounts of young participants who have not had time to accumulate a significant balance and by accounts of older workers who did not have a chance to participate in a 401(k) prior to the launch of the first plan in 1981. Still, VanDerhei noted, workers in their sixties who are nearing retirement have, on average, about $180,000 in their accounts. That's not enough to sustain most people in retirement, but it's better than the broad averages would indicate.

The problem, of course, is that not all U.S. workers have access to a 401(k) plan, and those that do often do not take full advantage of them. Statistics compiled by EBRI from its database of 47,000 plans covering 17.5 million participants indicate that 15 percent of those participants allocate nothing at all to equities, including 18.5 percent of participants in their twenties and 13.3 percent of participants in their thirties. Most investment professionals agree that young investors should have a substantial allocation to stocks.

One reason for the disconnect may be that people do not have a realistic handle on how much they will need to sustain themselves in retirement-or they are simply unwilling to face up to that figure. In its Retirement Confidence Survey earlier this year, in which it polled more than 1,200 workers aged 25 and older, EBRI found that a significant number-18 percent-think they can get by on less than $100,000. On average, they project they'll need a nest egg equal only to about 6.5 times their current income. But VanDerhei said every EBRI simulation shows that people will truly need much more. Finally, while 17 percent of survey respondents said they worked for an employer that in the past two years had decreased their retirement benefits, almost 40 percent of that group said they would be doing nothing at all to offset that decrease.

Many retirement industry experts are hoping that by automating participation in 401(k) plans, as encouraged under the Pension Protection Act of 2006, more American workers will begin saving for their retirement. VanDerhei said EBRI's analysis shows that adding an automatic enrollment feature to 401(k) plans, in which all eligible workers are enrolled unless they take action to opt out, would dramatically improve the retirement security prospects for lower-income workers, even if plan participants are defaulted into saving just 3 percent of their paychecks. Automatic enrollment, however, has little, if any, positive impact on higher-income workers, he said, primarily since those workers would have been more likely to join their plans already, often at higher deferral rates. EBRI's findings suggest 401(k) plans can play an important role in providing financial security for retired Americans, but only if plan participants spend their entire working lives participating in them.

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