AARP: Policy and Research Information for Professionals in Aging

Helping Americans Build More Retirement Assets

Private pensions and individual savings combined constitute, after Social Security, the second pillar of retirement security. At one time, the two were seen as distinct and separate components of retirement security. However, as typical pensions change from defined-benefit plans, which provide an annuity, to defined-contribution plans, which are basically tax-privileged savings plans, the situation changed. Since the advent of 401(k) plans, the most common defined-contribution plan—which shifts the responsibility for retirement security from the employer to the worker—pensions have become virtually indistinguishable from other individual savings. This is because 401(k) accounts are portable, immediately vested, and are plainly visible to the worker. In effect, pensions are the way Americans do most of their saving. Roughly half of all working Americans age 50 and older have current pension coverage, a percentage that has not changed in two decades. (Coverage rates are higher if we take into account coverage at any time in the past, or coverage through a spouse, or include only full-time workers.)

Since the advent of the 401(k) plan, which shifts the responsibility for retirement security to the worker, pensions have become virtually indistinguishable from other individual saving… In effect, pensions are the way Americans do most of their saving.

Three-quarters of eligible workers in firms that offer 401(k) plans actually enroll in them. Some employers have begun to experiment with automatic enrollment, in effect changing the general model from an "opt-in" system to an "opt-out" one. The results have been encouraging. One research team found a 30 percent higher participation rate after auto-enrollment. Encouraging or requiring other employers to follow this approach would be a significant step towards improving retirement security.69 Not surprisingly, employer-matching contributions also seem to encourage higher levels of participation.70

Another approach has shown that workers are willing to increase their savings rates, especially when they receive raises. This approach, labeled "save more tomorrow," allows workers to voluntarily allocate part of any compensation increase to their 401(k) plan while receiving the remainder in regular pay. Research shows that such innovations have raised worker savings remarkably.71

In addition to inadequate accumulations in 401(k) plans, plan assets often leak out when participants take lump-sum distributions when changing jobs or fail to annuitize benefits at retirement. Traditional defined-benefit plans used to offer a guaranteed income for life by annuitizing the entire pension, eliminating the leakage problem. In many 401(k) plans, however, there is no annuitization option available. Mandating retirement benefits to be paid as an annuity would help protect workers in retirement.

About half the population has no employment-based savings plan of any kind. For some of these individuals, one option is the saver’s credit, which was enacted as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) but is due to expire in 2006. It provides tax credits to low-income individuals and couples who set aside up to $2000 in savings. The sliding scale credit, which phases out at $25,000 for an individual and $50,000 for a couple, expires in 2006. It needs to be expanded to cover more middle-class taxpayers and be made permanent and refundable.

But the saver’s credit is only a modest beginning. Long experience shows that people find it very difficult to save without the carrot of an employer plan or a matching employer contribution, or the stick of a mandatory payroll deduction such as Social Security. One ambitious possibility would be to create a government-subsidized "universal 401(k)" plan for all workers, which could require employers to make available to each worker the option of a 401(k)-type retirement account with a narrow range of investment options that could not be accessed until retirement. Further, the plan would afford the great advantage of automatic payroll deduction by the employer. For low-income earners, a subsidized initial contribution, which could be in the form of a refundable tax credit, would enable people with very modest means, to "jump start" their savings for retirement.