By Tom Eckert
Sponsored by CUNA Mutual Group
In 2011, the U.S. Government Accountability Office published a report that indicated 401(k) plans mostly benefit high wage earners and the wealthy. The report focused primarily on skewed tax benefits, which makes sense given the progressivity of the Federal tax code. Indeed, workers who earn more and pay taxes at a higher marginal rate will benefit most from tax deferral. Other studies have reached beyond tax benefits to explore differences in accumulated wealth in 401(k) plans among workers in various wage tiers. Again, accumulated wealth tilts toward high wage earners for self-evident reasons.
Retirement plan service providers reflexively defend 401(k) plans in spite of clear evidence that their benefits favor high wage earners. We will also defend 401(k) plans, but do so in the spirit of providing a remedy to wealth disparities rather than to simply protect our turf. We believe 401(k) plans can be an effective option for retirement savings, but they need to take on greater institutional characteristics to function effectively as a primary retirement funding program.
By definition, the success of a self-directed retirement plan depends on the behavior of its participants. Much has been spent on development of education programs designed to create optimal behaviors to fund a financially secure retirement. In spite of good intentions, it hasn’t worked, and retirement savings deficiencies exist at all income levels. In our opinion, suboptimal participant behavior explains most of the challenges described in the aforementioned studies that characterize 401(k) plans as "programs for the rich."
We embrace a new retirement savings model that seeks to address wealth accumulation disparities without scrapping the widely popular benefits of a 401(k) plan or transferring risk back to employers.
At their inception, 401(k) plans were savings programs designed to supplement a traditional pension and Social Security. Participants "put a little extra away" if they could. As such, 401(k) plans had retail characteristics, such as long menus of investments from well-branded mutual fund companies. Since then, 401(k) plans have replaced defined benefit plans as the primary source of retirement income, yet most retain their retail characteristics. A plan with institutional characteristics makes far more sense in the current environment. Such characteristics have been the hallmark of defined benefit plans that have historically outperformed 401(k) plans in all market environments.
It starts with discounting future liabilities--a retirement income stream--to the present value. Then current assets in a participant’s account are compared to the present value of the liabilities to determine a funding status. If there is a shortfall, it is communicated automatically, explicitly, and understandably along with a required increase in savings rate to participants. Changing the inadequate savings trajectory that led to the shortfall is as simple as a click of a mouse. Investment menus are short to eliminate paralysis caused by confusion, and the investments themselves are sensitive to the duration of the liabilities, i.e. how soon the participant will retire. Participants are guided to the correct investments, not just left on their own. The plan also enables conversion of accumulated assets into a sustainable income stream during retirement.
This ALM-based approach is how a defined benefit plan is managed. Its default nature will also work in a 401(k) plan, and it will benefit all wage tiers. If 401(k) plans automatically acted like “personal defined benefit plans,” most of the critics would be silenced.
Tom Eckert is VP/retirement plan products for CUES Supplier member CUNA Mutual Group, Madison, Wis.
