401(k) Plans: Finding the Right Balance

Posted on May 19, 2009

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401(k) reform will be a challenge; finding the right balance might prove difficult.

Earlier this month, the SPARK Institute released a white paper entitled The Case for Employer-Sponsored Retirement Plans: Coverage, Participation and Retirement Security. It’s the second in a planned series of three white papers intended to contribute to the developing debate around reforms to the nation’s system of employer-sponsored retirement plans.

The white paper presents a well-reasoned defense of the current 401(k) system, and also makes various suggestions for strengthening that system. The white paper recommends that:

Employer-sponsored plans should be designed to help working Americans (1) save more, (2) avoid taking distributions of the money they have in their accounts before retirement, (3) appropriately diversify their savings through asset allocation, (4) protect their savings from market volatility, particularly as they get closer to retirement, (5) provide a steady stream of income throughout their retirement, and (6) minimize the risk of outliving their savings.

All perfectly reasonable ideas.

That being said, there are two elements of the white paper that I find problematic.

The first is that the word “saving” is thrown around rather loosely, as in the following example (emphasis is mine):

Over 90 Million Americans Save Through Employer-Sponsored Plans

The power of defined contribution plans as a vehicle for empowering American workers to save for their retirement years can be seen in the way millions of Americans have embraced these plans. The number of defined contribution plans sponsored by American employers has grown steadily over the past 25 years to over 700,000. These plans now provide savings accounts for nearly 92 million workers.

90 million Americans are, in fact, investing, not saving. As opposed to saving, investing entails risk, as most of those 90 million people have learned firsthand over the past 18 months or so. The contention that 401(k) plans are savings accounts is misleading and only serves to lend support to the arguments of 401(k) critics who are calling for more radical changes to the system.

The second problem is that the white paper declines to include as one of its recommendations that employers strive to maintain matching contributions. In fact, the recommendations lean heavily in the direction of ideas that revolve around restricting employees’ choices and options: advocating mandatory, automatic enrollment and escalation of employee contributions, for example, as well as arguing for regulations limiting participants’ ability to cash out their 401(k) plans before reaching retirement age. While there is much to be said in favor of both automatic enrollment as well as doing everything possible to encourage people to not cash out their retirement accounts early, it would be wise for those in the retirement services industry to lean a bit more heavily on employers and to work to discourage plan sponsors from suspending matching contributions. In the white paper, the SPARK Institute argues that “no proposal should give preferred status to the use of IRAs as a substitute for employer-sponsored retirement plans.”  That case would be strengthened by, at a minimum, having industry groups publicly call for employers to cut matching contributions only as a very last resort, as opposed to one of the first things to be considered when trying to determine the best way to shore up a balance sheet.