The Evolving 401(k) Plan

Posted on May 4, 2009

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Elephant in the rotunda of the National Museum of Natural History

I visited the National Museum of Natural History with two of my kids this past Sunday. We spent a lot of time exploring the museum’s mammal exhibits, where the major theme is adaptation and evolution. Adaptation and evolution are also the main themes in two recent articles about new developments in 401(k) plans.

InvestmentNews reports that “[s]ome top retirement gurus are in the process of developing proposals that could make annuity products a crucial part of millions of Americans’ retirement plans.”  The article goes on to discuss new ideas being generated through the Retirement Security Project, a collaboration between the Brookings Institution and the Public Policy Institute of Georgetown University. The basic idea is that creative uses of annuities within 401(k) plans would keep workers’ retirement savings on track, even in the face of severe downturns in the stock market.

It’s likely that the ideas being floated by the Retirement Security Project will at least get a serious hearing, as one of the project’s leaders, J. Mark Iwry, recently joined the Obama administration as the deputy assistant Treasury secretary for retirement and health policy.

A related article appeared in The Wall Street Journal on Monday which discusses products in the market today that provide plan participants with guaranteed income.

While the concept of providing guarantees to retirement savers holds obvious appeal, being able to make good on such guarantees may not be so easy. As the article notes:

For one thing, insurers can’t promise too much, or they risk damaging their own financial health. What’s more, insurers may have to work hard to gain the trust of big employers, who fear they will end up footing the bill for these plans if the insurers go under.

And that highlights a big irony. Last year’s market slide showed that there’s a great need for guaranteed 401(k) products. But it also showed the vulnerability of the insurers who craft these offerings. And it raised questions about just how well insurers understand the risk of dealing with complex financial instruments—such as the ones used to guarantee investments.

Both articles point out that it is likely that the federal government will need to be involved in one way or another to enable such products to gain a meaningful foothold in the 401(k) market.

While we can’t know today the precise ways in which workplace savings plans will evolve and adapt in the years to come, it’s clear that one result of the current financial crisis will be that significant changes to these plans will be put in place. As the WSJ article states:

Employees counting down to retirement need a guarantee because “people are not Monte Carlo simulations,” with many potential financial outcomes to choose from, says Mark Foley, an executive at Prudential Financial Inc. Instead, “they get one shot” at retirement.

And so we see another big irony: there’s a real chance that defined contribution plans will evolve into something that looks strikingly similar to the defined benefit system that the 401(k) and other DC plans largely replaced.