Abstract
The new Congress and the President will react swiftly to the economic recession and will be pressed to restructure the collapsing financial order. Unfortunately, there is no sign they will save the American pension system that relies on individual retirement plans, which are based on that very same deteriorating financial order.Changes in the nation’s pension system in the last two decades means that the upcoming generation of retirees will be worse off than their parents and grandparents. This forecast is assured for many because in the last three months of 2008 workers’ and retirees’ lives upside down as retirement accounts have lost a third of their income. Older workers and retirees are vulnerable and panicked and the stimulus package will do nothing to make their incomes more secure. The proposals to expand individual private retirement accounts put forth by Candidate Obama would make the nation’s retirement crises worse. Individual accounts do not deliver what Americans need or want, a safe source of retirement income.I propose a system of mandated retirement accounts that will supplement Social Security and whose rates of returns will be guaranteed by the government, the money will be locked up until retirement, and the distribution will be in the form of an annuity.
Candidate Obama proposed a pension reform system that is already outdated. He proposed “Automatic IRAs” employers with 10 or more employees, who do not already sponsor a retirement plan, would automatically deduct contributions from their workers’ paychecks and deposit them in an Individual Retirement Account (IRA). The employer chooses the financial service company to manage their accounts – just like in 401(k) plans or workers could choose their own. Workers could opt out if they choose. Automatic IRAs would make matters worse because it expands the system of individual retirement accounts that is riddled with major problems: because the contributions are voluntary workers don’t save enough in them and employers stop contributions when they want to and most workers withdraw funds before they retirement; rates of return for these accounts are low because workers are not professional investors and the fees are hidden and are high since they are charged on a retail basis; investing as individuals, workers take on financial risk, the risk the market does poorly when they reach old age (one person can’t insure against that risk); and, finally, even if the worker did everything right and has ten times earnings at the end of their work life they face the vexing problem of how to distribute it until their death, which fundamentally is unknown. Private annuities are unpopular because insurance companies charge voluntary purchasers as if they will be the longest lived members of the population.
Retirement Systems based on Individual Retirement Plans Fail
401(k) plans are named after the section of the tax code passed in 1978 intended to help high- income management save tax free, they have spread to the rest of the population but they are not suited for most workers. When many companies stopped their 401(k) contributions in late 2008s many people, for the first time, realized that employers were not required, beyond Social Security, to contribute anything towards a pension system. And for people with a pension plan at work, it was the first time they realized that only 50% of workers had any other pension system besides Social Security. (About 89% of union members have an employer pension, while less than 40% of non union workers have a pension at work.)
IRAs and 401(k) plans did not expand pension coverage past the 50 percent of the workforce covered since the 1970s, nor did they increase national savings rates. However 401(k) plans do add to the profits and growth of the financial sector and consumed ever-increasing tax expenditures from the U.S. Treasury.
I propose replacing 401(k) plans and IRAs with a much more valuable and efficient retirement program: the Guaranteed Retirement Accounts (GRAs).
Taxpayers Lose with 401(k)s and IRAs
401(k) plans are highly subsidized by the U.S. government with the intention of raising savings rates and helping people who need the help secure retirement security. Yet individual retirement accounts produce a lower level of savings compared the system of employer pensions they replaced.
What is unfortunate is that many Americans are not aware of the large amount of money the U.S. Government spends to subsidize this system that yields little social benefit. Taxpayers are not told clearly who gets the subsidies and whether or not the money spent is used wisely. This is because the U.S. government uses a back door method to subsidize certain activities. It uses “tax expenditures” – the value of the Tax Code’s exemption of income generated for certain activities – to encourage workers and the nation’s business owners to spend their income in socially approved ways.
In 2007, Social Security and Medicare cost $800 billion. Tax expenditures for retirement plans – traditional employer pensions (defined benefit plans), 401(k) plans, Individual Retirement Accounts, other savings vehicles dedicated for disbursement at older ages, and exemptions of Social Security and other federal pensions from tax – totaled over $156 billion in 2007.
In 2004, taxes not collected on pension contributions and earnings equal a fourth of annual Social Security contributions and, at over $114 billion, are perversely larger than household saving of over $102 billion. The tax breaks were supposed to expand pension coverage and increase retirement security.
Pension tax breaks are deductions from income. Therefore, high-income earners in higher tax brackets get a greater benefit from these deductions than low-income workers. If a lawyer earning $200,000 makes a $1,000 contribution to his 401(k) plan, he reduces his income tax by $350. If his receptionist, earning $20,000, makes the same $1,000 contribution (which is much less likely), she will save only $150 in taxes. The Brookings Institution and Urban Institute calculate that the three percent of taxpayers (i.e., those with incomes over $200,000 per year) get 20 percent of the tax subsidies. And, for all this effort, the nation gets no extra savings. At most, this complicated system creates economic activity when accountants happily transfer money between taxed accounts to tax-sheltered accounts and taxpayers foot the bill. The value of tax expenditures for 401(k) plans is projected to grow 49 percent while those for traditional plans are projected to fall by 2.1 percent between 2009 and 20013. (The estimated tax expenditures for 401(k) plans, Individual Retirement Accounts, and Keogh plans in 2009 is estimated to be $75.1 billion and for defined benefit plans $45.7 billion.)
Four trends moved in favor of Americans’ retirement savings rates being higher in the 1990s than they ever before: more tax breaks, an older and educated workforce, higher income workers getting the largest income increases, and the income effect. But the switch to individual accounts swamped these favorable factors.
First: Congress had relentlessly expanded tax breaks for retirement savings since the 1980s; the value of the tax expenditures for retirement savings is at an all-time high of $110 billion, while the effectiveness of such tax breaks is at an all-time low. (See the discussion below and EBRI’s analysis of the tax expenditures for pension and savings plans ). This alone should have boosted savings if taxpayers were getting their money’s worth. Secondly, retirement savings should have been higher just because the American workforce is more educated and older than ever before and people with more education save more than those with less education and middle-aged workers save more than any other age group. Third: High income people have higher savings rates and the richest Americans have gained the most income since the 1990s. And fourth, the income effect should have boosted national retirement savings. As national income grows, the demand for normal goods grow, because when people have money they buy more of what they want, from Ipods to better health and retirement “leisure.” This income effect was displayed in the 1960s and 1970s, when, as the economy grew richer, we garnered longer life spans and more leisure -- older people lived longer AND retired earlier.
To be clear, saving is hard for human beings that often lack foresight, discipline, and investing skills required to sustain a savings plan. Yet, humans in other nations have high savings rates... Our savings institutions, namely pension systems have changed which has caused the drop in retirement income.
Here is the evidence that it is the change in pension institutions that are to blame for the drop in savings rates, not human nature. The deep decline in national savings rates showed up in the 1990s, when employers started to reduce their contributions into defined benefit pension plans. These plans were a main driver of national savings whereas the expansion of 401(k)-type plans did not boost savings overall because they simply supplanted already existing defined benefit plans. Under traditional plans retirement savings companies did the savings automatically; defined benefit plans are institutionalized, contractual forms of saving that happen automatically. Also, in DB plans, all employees are covered. Workers have little discretion about whether to save or spend. Workers can’t opt out; decide how much to invest, or take out lump sum payments without difficulty. savings today is done by individuals.
One reason why savings rates increased when employers directly contributed to defined benefit pensions is because employees saved in other ways. When employers shrunk their role and workers were given the option to save in voluntary, tax-deferred accounts, many low and middle income workers just stopped having savings allocated to their accounts when they lost the DB plan. Higher-paid employees tended to switch their savings out of taxed accounts to the tax sheltered accounts. So what we see in real life may be a significant increase in savings by individuals in tax favored accounts; but we also see a decrease in other forms of net savings (taking into account the rise of credit card debt, home equity loans etc). This means that when you add up all these trends national savings rates plunged: the decrease in retirement savings done by companies on behalf of their employees, the transfer of savings from taxed to tax-favored accounts, and households taking on more debt.
In sum, the shift towards 401(k) plans increases tax expenditures, does little to expand retirement savings, and favors workers who need the help least. All told, the tax subsidies are not meeting a public purpose. The top heavy benefits for 401(k) plans create a sad paradox: since 1999, tax expenditures for retirement plans grew by 20 percent, while retirement plan coverage fell.
Employers are Winners in 401(k) Plans
If 401(k) plans are so bad, why are there so many of them? Though workers don’t gain much from 401(k) plans, some employers and Wall Street firms do. I followed 700 firms over 17 years and found that firms that adopted a 401(k) plan (whether or not they have adopted a pension plan) lowered pension expenses by 3.5 to 5 percent without sparking worker complaints. Since 401(k) plans are voluntary, many (about 20 percent) workers who can but don’t bother to contribute “leave money on the table” by not accepting the employer match. Employers’ contributions are 26 percent lower than they would be if everyone participated at the rate needed to obtain the maximum employer match. Employers could pay the match to every worker, comparably to what is done under defined benefit plans. However, because workers have to trigger the match by saving from their own pay and some don’t, 401(k) plans boost corporate profits by reducing employer contributions at the expense of retirement income security.
Employers find sponsoring a 401(k) plan is considerably less expensive than sponsoring a defined benefit plan. Defined contribution plans are less costly (since they do not even attempt to provide reasonable retirement benefits for all employees, less risky because the employer does not bear the risk of investment loss as they would in a defined benefit plan, and can be funded with the employer’s own stock, not with hard cash.
Investment Companies are 401(k) Beneficiaries
Wall Street firms collect over $40.5 billion annually in 401(k) fees. Yet, brokers and human resources professionals often tell workers that the fees paid by their accounts are zero. A good way to see what workers lose when they invest in a 401(k) plan rather than a group–based pension fund is to compare what each earns after fees are subtracted. A comprehensive study by Dutch and Canadian researchers Ron Bauer and Keith Ambachtsheer found that U.S defined benefit plans – where individuals do not direct the investment of their own accounts – earned a 2.66 percent higher return NET of fees on equities than did retail mutual funds. The superiority in returns is due to both the reduction in fees for large institutional investors and because the trustees of pension plans are better investors than the employees. In Canada, the skim was even higher; the retail mutual funds earned 3.16 percent less. (These shortfalls are the averages for the 25-year period between 1980 and 2004.) The gap makes sense – investing in retail funds means investors pay for advertising, shareholder profits, and glossy brochures.
Add to the fee realities the fact that workers with a lack of investment savvy tend to buy high and sell low – because people follow the leaders and buy stock as it is rising in value and sell when it is falling. As a result, self-directed accounts generally earn much less than professionally managed funds.
This isn’t just a leakage; it’s a levee break. Hidden from view, workers are unwittingly transferring huge sums of money to financial firms.
In summary: the reason 401(k) plans have failed as a retirement security delivery system is because the system is voluntary, commercially–based, and individually-directed. As a result:
• People do not save enough or consistently enough;
• The system depends on people having investment skill and luck (which they generally lack);
• The individual account-based commercial fees are high;
• People take out lump sums rather than annuities;
• Voluntary annuity markets are too expensive, discouraging individuals from taking annuities; and
• The government subsidy is based on a deduction system. People who get the tax deductions, for the most part, would have saved without the help.
401(k) plans are not successful at encouraging workplace savings for retirement savings, even if lower income earners save in them. Much of the balances are eaten up or distributed before retirement for many good reasons.
The sooner we admit that our 30-year experiment with 401(k) accounts is a failure, the sooner we can supplement everyone’s Social Security.
Guaranteed Retirement Accounts: Long Term Solution to the Retirement Crisis
Because there is a long-run retirement crisis -- not in Social Security, but in the heavily tax-subsidized, private, voluntary, and commercial tier of our nation’s pension system -- over half of workers under 50 will fail to have sufficient income after age 65 to replace the bare necessity of 70 percent of their pre-retirement income, according to Boston College’s Retirement Risk Index.
Think of retirement income as the food pyramid. Social Security is at the base, like grains and vegetables; the middle tier where the fruits and meat belong is the employer-based system; and up at the top with the whiskey and chocolate is the private and personal savings. The crisis is in the top two layers of the pyramid, as employer pensions erode and debt swamps personal wealth.
I propose Congress set up universal Guaranteed Retirement Accounts (GRAs) and rearrange the $80 billion of tax subsidies for individual retirement accounts -- 401(k)s and IRAs --- so that every worker contributes $600 to his or her GRA each year. All existing 401(k)s and IRA–like plans will retain their existing tax favored status. However, going forward, the incentives all workers will get from the government to save will be in the form of tax credits for their $600 contributions to the GRA.
The GRA will accumulate without additional taxation to the worker. Workers will pay taxes on the earnings when the money is withdrawn from the GRA at retirement. 401(k) plans and IRA plans may work for some people who have them. They will still exist, but they will have to compete with a guaranteed government system and they will not enjoy the large tax breaks they have now because the subsidies are inefficient and largely ineffective.
We have two options: the first one is expensive; but it keeps the 401(k) vendors happy. The second is more effective and cost effective. The first option keeps the existing 401(k)/IRAs system intact with all of its tax deductions that go to disproportionately to the top 6% of earners. The Guaranteed Retirement Account, with the GRA tax credits – the $600 (indexed) tax credit - just competes in the marketplace. The first option is expensive because the tax expenditures and the tax credit exist side by side. The second option uses the elimination of tax deductibility of new 401(k)/IRA to pay for the Guaranteed Retirement Account tax credits. In the second version the existing 401(k)/IRAs will be grand-parented-in; but, the money going in will not be tax advantaged.
Every worker who does not participate in an equivalent employer-sponsored DB plan will save five percent of compensation through contributions into a Guaranteed Retirement Account (in addition to the Social Security contributions). (Employers could elect to pay for all or a portion of the workers’ share of the Guaranteed Retirement Accounts, if desired.) Workers would earn pension credits based on the accumulation of these deposits, plus a generous rate of three percent investment return, adjusted for inflation. An unpublished report by a leading consulting firm confirmed that the three percent real rate of return proposed for the Guaranteed Retirement Accounts is a conservative long-run estimate under a range of plausible investment strategies that a government agency could undertake and not take any substantial risk of underperforming.)
The five percent contribution target is derived from basic math: an average earner saving five percent of pay over a lifetime of work (i.e., from his twenties to his sixties) with a guaranteed three percent rate of return plus inflation could supplement his or her Social Security to achieve a 70 percent replacement rate at retirement. If the GRA had been in effect, an average earner reaching 65 today would have accumulated enough to pay about one percent for every year of service (inflation indexed) from the GRA -- this is equivalent to some of the average employer-sponsored defined benefit (DB) pensions in the marketplace.
This basic math, though, comes up against the basic reality that many Americans cannot afford to save that much. Therefore, this proposal provides that workers’ contributions would be mitigated by a $600 a year contribution from the federal government, indexed for inflation, which would be paid for by scaling back substantially the tax breaks for 401(k) type accounts. The $600 defrays the expense for most lower- and middle-class workers (it pays for all the contribution for a minimum wage worker). Employers could make an additional contribution to provide for some of the GRA benefit, and, and workers could also elect to add their own contributions to increase their GRA pension.
Finally, workers could elect to have existing 401(k) accounts transferred into the GRA. Take a 55-year-old who had $50,000 in his 401(k) account in August and faces job loss and also, sadly, all hopes of retiring. Let him swap out the $50,000 for a Guaranteed Retirement Account, which means he will contribute 5% of pay until his normal retirement age at a guaranteed rate of interest of 3% real. This will yield something on the order of $500 per month beginning at his Social Security normal retirement age. Even though the economy is in downturn, a guaranteed income from his former 401(k) removes a significant source of the worker’s financial anxiety
Advantages of the Guaranteed Retirement Account
If we rearrange the current tax incentives for retirement savings by switching from tax deductions for contributions to credits that become contributions, then the proposal moves us to more efficiency and fairness. Both high income earners and lower income earners see a benefit from a tax credit, which is not true with a tax deduction structure. The GRA plan is also fiscally responsible because the credits are revenue-neutral. This is how it works. Because the current tax breaks are deductions from income, high-income earners get more breaks than low-income workers. The result is shocking. Six percent of taxpayers with incomes over $100,000 per year get 50 percent of the tax subsidies. [see the studies from the Urban and Brookings Institution] And, for all this effort, the nation gets no extra savings and workers no extra retirement security because studies show that people substitute taxed accounts for tax- favored accounts. The most economic activity this system creates are for accountants who happily transfer money between accounts. I propose that all workers accumulate savings with universal tax credits for savings, rather than tax deductions that go only to the well-off few who would have saved anyway.
Adding insult to injury is that this tax-incentive inefficiency is growing. The value of tax expenditures for defined contribution (DC) plans is projected to grow 49 percent while those for traditional DB plans are projected to fall by 2.1 percent between 2009 and 2013. [See EBRI on the analysis of the budget and the table below]
Tax Subsidies for Retirement Plans in 2009 (Billion of $)Type of plan- 401(k), Individual retirement plans and "Keogh Plans" $75. 7- Defined Benefit Plans $49.5
Tax Subsidies' Growth for Retirement Plans 2009-13 (estimated)
- 401(k), Individual retirement plans and "Keogh Plans" +49.5%
- Defined Benefit Plans -8.9%
[EBRI calculations Original data from Executive Office of the President, Office of Management and Budget, Analytical Perspectives, Budget of the Untied States Government, Fiscal Year 2009 www.whitehouse.gov/omb/budget/fy2009/]
In contrast to the voluntary nature of 401(k) plans, under which the most needy perceive an inability to save and therefore do not, Guaranteed Retirement Accounts require that people personally save for their own retirement. According to polls [see references], people want to save (even though they may not believe they can afford to do so). The GRA would permit people to save in a safe and secure way, as opposed to the fee-ridden, inefficient 401(k) self-directed account structure we have today. A government agency connected to the federal employees pension, the Thrift Savings Plan, and Social Security (for administration efficiency) and governed by a board of trustees representing workers, business, and the public, will invest GRA assets (workers’ contributions and the government subsidy) in a whole range of options. For example, the board of trustees could select any sovereign wealth funds like those in Alaska, Alabama, New Mexico, Wyoming, as well as many nations outside the US. The GRA funds will be invested across risky and non-risky assets for the long run to ensure the federal government can pay the three percent inflation-indexed rate of return to the GRA lifetime annuities.
Guaranteed Retirement Accounts are mandatory savings and thus universal, provide adequate income, the money is locked away from the participant’s access until retirement, the payout is for a person’s life, and the accounts are efficiently managed and invested. The GRAs would accumulate a working-lifetime of contributions and would guarantee a reasonable rate of return. Although Social Security also has annuity payouts, they have a strong redistribution element towards low income families with lots of dependents. This provides a basic floor of benefits for even the lowest income worker. The GRAs, on the other hand, would permit the accumulation of benefits through actual contributions, paying benefits out based on what was actually contributed.
GRAs are better than the automatic IRAs or 401(k) plans proposed by the part of President Obama’s economic team, because they are mandatory and bypass the commercial system and because they do not impose complicated requirements on small- and medium-sized employers. GRAs do not force workers to face the risks IRAs and 401(k) force workers to face: the risks they won’t save enough because of high fees, reluctant savings habits, and wrong investment choices; the risk that financial markets will tank; the risk that inflation will erode their retirement income; and the risk that retirees will out-live their money. Society will face unnecessary losses with Automatic IRAs because, net of fees, 401(k) and other individual retirement accounts are among the lowest earning in the financial asset universe. Add in preretirement withdrawals and adverse selection in annuity markets, and it is clear that, with automatic IRAs, the inefficiency would become more entrenched and a dollar of retirement income would be more expensive to obtain. In some ways the automatic IRAs plan would create more problems.
As I mentioned above, if we rearrange the tax deductions, the GRA plan is budget-neutral. If we allow tax breaks for the first $5,000 in voluntary 401(k) contributions, the plan will cost $25 billion per year.
Disadvantages of GRAs
Mutual funds and other commercial interests dependent on the 401(k) industry may perceive a disadvantage in GRAs because they will face pressure to lower fees, raise returns or both. Secondly, participants may want access to their savings before retirement, which they commonly have in the 401(k) or IRA structure. Therefore, Congress may consider subsidization of “precautionary” or “hardship” savings separate and apart from the GRA, but should assiduously avoid calling such accounts retirement savings.
The other disadvantage to GRAs is timing. We should not institute mandated savings in a recession unless fiscal policy provides a massive short term stimulus, which appears to be in our futures. In the long run, however, in order to have a true retirement system, we have to have disciplined savings throughout the business cycles. Whereas stimulus packages are often intended to encourage spending by the public, it should not be the job of households to increase their debt to get the country as a whole out of recessions.
A Political Opening for Mandatory Retirement Savings – Why Obama does not Go Far Enough
Even before the financial crisis of September 2008, workers were catching on to the disadvantages of 401(k) savings.
Surveys shows less than 50 percent of people think they will live comfortably in retirement, though most workers say they are personally responsible for their supplements to their Social Security benefits. Nonetheless, they want the government to help. Over 77 percent of people support mandating pensions. In 2006, HSBC bank asked 21,000 workers in 20 nations what the government should do about the expense of aging societies. On average, workers preferred compulsory savings to any other policy. A third of Americans responding to the survey wanted the government to force them to save more for retirement; far fewer, 16 percent, would support a tax increase; and, only nine percent wanted the government to reduce benefits. In October 2007, a whopping 91 percent of respondents told a Wall Street Journal poll that the government should do something to secure retirement and 41 percent said they were not hearing enough from the Presidential candidates about retirement income issues.
Conclusion
American workers know we have a short term and long term pension crisis, not with Social Security, but with the employer pension system. The persistent lack of coverage – over half of our working population has no employer plan -- the erosion of DB pensions, and the appalling failure of 401(k) system of self-directed, voluntary commercial accounts, is the reasons why workers in their mid-fifties and younger are facing less retirement income security than their parents and grandparents did.
This loss of retirement security is a reversal of fortune and the result of very specific flawed governmental policies that are biased toward 401(k) plans and against defined benefit plans, rather than the result of technological change or the logical consequences of global economic trends. The baby boomers’ parents were able to cobble together traditional pension plans and Social Security to replace a higher portion of their pre-retirement savings then most boomers will. That is the good news, oddly, because, in the past, we know that government policies eroded pensions, which means that new government polices can help secure workers’ retirement futures. If we make the changes suggested in this article, we can look back at the crisis and financial bailout and know we did some good.
References and Sources
1. Who is in a 401(k) plan? See the Center for Retirement Research Boston College. 2004. "Eligibility and Participation in 401(k) Plans by Age, 2001 and 2004" http://crr.bc.edu/frequently_requested_data/frequently_requested_data.html accessed October 4, 2009.
2. Polls that show people want a guaranteed pension: Madland, David. 2008. “Reforming Retirement: What the Public Thinks.” For the Georgetown University conference on “The Future of Retirement Security.” Held October 3, 2008. Department of History, HSBC Bank. “How should governments finance ageing populations” http://www.hsbc.com/1/PA_1_1_S5/content/assets/retirement/2006_for_news_release_final.pdf.) HSBC. 2007. “The Future of Retirement: What People Want.” http://a248.e.akamai.net/7/248/3622/7d1c0ed7aa1283/www.img.ghq.hsbc.com/public/groupsite/assets/ retirement_future/2006_for_what_people_want.pdf (accessed online February 2, 2007); Bright, WSJ.com November 2007 online Harris personal finance poll
3. Why DB plans help boost savings rates and 401(k)s do not. Bosworth, Barry, and Lisa Bell. 2005. The Decline in Saving: What Can We Learn from Survey Data?” Unpublished draft written for the 7th Annual Joint Conference of the Retirement Research Consortium, “Creating a Secure Retirement” (Washington, DC, August 11-12, 2005). . Tax breaks are higher than actual savings. See Bell, Elizabeth Adam Carasso and C. Eugene Steuerle, “Retirement Savings Incentives and Personal Savings,”Tax Notes, December 20, 2004.for this provocative insight. Also DC plans do not expand pension coverage. From 1999- 2005, the correlation between defined benefit coverage growth rates and pension coverage growth rates was 79%, while the correlation between defined contribution and pension coverage growth rates was a negative 10%. Ghilarducci. Teresa. 2006. “Future Retirement Income Security Needs Defined Benefit Pensions.” Center for American Progress. www.americanprogress.org/kf/defined_benefit_layout.pdf Back in 1981, Congress rejected President Carter’s Pension Commission’s call to reconsider the social value of these tax breaks and create a mandatory universal pension system (MUPS). Because they are designed to meet a social goal there were always conditions on these tax breaks. When the federal income tax was implemented in 1913, employer pension contributions were given special tax treatment only if the managerial plans included most of the rank and file. This is in direct acknowledgement that the tax breaks were targeted to the wealthy. The wrangling -- over how many tax breaks that higher income employees get in exchange for how many lower paid workers are in employer pension plans -- continues to this day and is part of a healthy process of assessing if the federal government tax breaks have the intended effects. Instead, in that same year, Congress satisfied the lobbyists for executives and made way for 401(k) plans by creating a section of the tax code which allowed workers to save, pre tax, in plans at work. After Wall Street firms and consultants successfully marketed 401(k) plans, the rest -- to use a shop-worn phrase -- is a history we all know: 401(k)-type plans replaced traditional defined benefit (DBs) pensions.-- over 63% of pensions are DC plans; whereas, in 1975, most pensions were DBs.
4. Definition of 401(k) – type plans are defined contribution plans include and include the following: 401(k) plans [about 80% of participants in defined contribution plans are in 401(k) plans]; profit sharing plans; money purchase plans; individual retirement accounts; and 403(b) plans which are 401(k) plans for employees in the public sector.
5. A good paper on the distributional effects of the tax expenditures for DC plans: Burman, Leonard E.,William G. Gale,Matthew Hall, and Peter R. Orszag. 2004. “Distributional Effects of Defined Contribution Plans and Individual Retirement Accounts.”Washington, D.C.: Urban-Brookings Tax Policy Center Comments on the tax subsidies: Because the tax subsidies come in the form of tax deductions and not credits they are regressive. For example, if a lawyer earning $200,000 makes a $1000 contribution to his 401(k) plan, he reduces his income tax by $350. If his receptionist, earning $20,000, makes the same $1000 contribution (which is much less likely), she will save only $150 in taxes.
6. Employers save money when they adopt DC plans: Ghilarducci and Sun 2006. How Defined Contribution Plans and 401(k)s Affect Employer Pension Costs: 1981-1998.” With Wei Sun. Journal of Pension Economics and Finance, 5(2): 175-196 Some of this is because when employees “leave money on the table” they leave it on the employer’s table. I used information from Munnell and Sundén. 2004. Munnell, Alicia, and Annika Sundén. 2004. Coming Up Short: The Challenge of 401(k) Plans. Washington, DC: Brookings Institution Press to get participation rates, average contribution levels by earnings, the distribution of employees by earnings (Calculated from the CPS (2003) to make the three billion dollar estimate of savings for the emplopyers from a voluntary plan. The average savings per worker is $156, calculated for their sample of over 800 employees in one firm that the employer saved over $250 per older worker who did not participate in the 40(k) even when they were eligible. Choi, James J., Laibson, David I. and Madrian, Brigitte C.,$100 Bills on the Sidewalk: Suboptimal Investment in 401(K) Plans(August 2005). NBER Working Paper No. W11554. Fidelity’s (2004) annual report documents employers’ match behavior.
7. References on Fees: There are $2.7 trillion in 401(k) assets Employee Benefit Research Institute. 2007. “401(k) Plan Asset Allocation, Account Balances, and Loan Activity” An Information Sheet from the Employee Benefit Research Institute (EBRI). www.ebri.org/pdf/InfSheet.QDIA.23Oct07.Final.pdf. The average fee is over $700 per year and average fees are 1.5% of assets which equals $40.5 billion. evidence that individual accounts have worse returns than DB plans: Ambachtsheer, Keith, Bauer, Rob. 2007. “Losing Ground.” Canadian Investment Review; Spring, Vol. 20 Issue 1, pp. 8-14
Teresa Ghilarducci
The New School for Social Research
