Retirement in America — Individual Account Retirement Savings Plans ARE Good Enough!

By Jack Towarnicky • July 18, 2018 • 0 Comments

In Part 1 of this three-part series, I reviewed a recent Wall Street Journal (WSJ) article that suggested today’s retirees are less prepared than prior generations as well as other articles that suggested tens of millions of older Americans will soon live in poverty. The 401k was named as a culprit: “The decline of pensions and increase in 401(k) plans is one reason many seniors aren’t as ready for retirement as the previous generation,” and, “For many Americans facing a less secure retirement than their parents, the biggest reason is the shift from pensions to 401(k)-type plans.” This installment, Part 2, confirms:

  • The decline of defined benefit pension plans started well before the introduction of the 401(k), and
  • Individual account retirement savings plans, like the 401(k), 403(b) and IRAs are, when combined with Social Security, more than adequate tax-preferred tools workers can use to prepare for a financially successful retirement.
Pensions Were Eliminated in Favor of the 401(k) — Not!

First, yesterday’s defined benefit pension plans were not today’s lucrative pension plans. For example, my own DB pension plan had the following features before ERISA:

  • Eligibility age: 35
  • Vesting: 15 years of service, Rule of 45
  • Formula: Career average
  • Employee contributions: 2% of pay
  • Subsidized early retirement: No
  • Post-retirement COLA: No
Simply, before ERISA, many plans did not vest before separation and few plans were well funded.1

Declines in single employer pension plans corresponded with ERISA’s requirements that plans be funded and that benefits vest. As plan sponsors terminated underfunded plans, the unfunded liability that was shifted to the remaining pension plans (to fund PBGC liabilities with premiums) increased significantly.

While PBGC liabilities for single employer plans have moderated, multiemployer plan unfunded liabilities are at all-time highs.2 Academics in the WSJ article3 point to the fact that multiemployer plan funding was reduced due to factors such as ebbing union strength and a recession which was followed by deployments of the 401(k) to displace pensions. However, pension declines long preceded the 1980s and the 401(k). According to EBRI, before ERISA, 55% of all pensions were defined benefit and 45% were defined contribution. By 1983 (before introduction of all but the first 401(k)s), 59% were defined contribution and 41% were defined benefit. During 1976, the first full year in which all ERISA provisions were in force, 100% of the net new plans established were defined contribution. In fact, in 1976, the number of operating defined benefit plans decreased 1.7%.4

In other research, EBRI describes another facet of the ERISA experience is the notable shift toward defined contribution plans: “Before the passage of ERISA, the number of newly qualified and net growth in defined benefit plans consistently exceeded … net defined contribution plan growth. If the 1973 defined benefit plan creation rate had persisted, (we would have added) 190,000 net new plans … between 1975 and 1980. Actual net growth was 40,348. Based on the same criteria, however, only 144,000 defined contribution plans would have been created but actual growth was 157,175."

EBRI continued: "Elements of TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) may further increase the prevalence of defined contribution over defined benefit plans.”5 Since 401(k) regulations were not issued until late in 1981, the decline in defined benefit pension plans started long before the first 401k plan was created. Perhaps it would be more accurate to claim that the 401(k) came to our rescue.

Individual Account Retirement Savings Plans Are More Than 'Good Enough'

You can quote me: “Pension promises without funding are mere dreams.”

Immediate funding of individual account, retirement savings plans has significant value. When combined with Social Security, saving in an employer-sponsored plan (or an IRA for periods where a worker lacks access to an employer-sponsored plan) is a more than adequate retirement preparation tool.

If America has a retirement crisis today, it is smaller than the one we faced just two generations ago — for Baby Boomer’s grandparents. Few participated in an employer-sponsored plan. There were no IRAs. Personal savings were modest and “invested” in passbook savings accounts at local banks or S&Ls. Only a very small minority received the benefits of stock ownership. Work was much more physical/blue collar. Only a few workers could afford to retire before they were physically unable to continue working. The grandparents of Baby Boomers who survived to retirement age, often worked until they were physically spent, retiring to a few years of sedentary lifestyle in retirement.

And if America has a retirement crisis today, it is not because individual account retirement savings plans are inadequate. IRAs have been in place for every wage earner since 1982. For today’s median wage workers who was age 25 in 1982, even if she never had access to an employer sponsored defined benefit pension plan nor a retirement savings plan, had she saved the IRA maximum each year until reaching age 66 in 2023, earning only a 5% annual return, her monthly income (combined with Social Security) would be sufficient to replace 90+% of pay! Yes, every American Baby Boomer has had access to a more than adequate, tax preferred retirement savings plan.

The third and final part of this series will confirm that while all workers can use individual account retirement savings plans to successfully prepare for retirement, “can”? “Will.” However, because of yesterday’s 401(k) and tomorrow’s 401(k), retirement preparation for a majority of American workers will continue to improve.

Jack Towarnicky is the Executive Director of the Plan Sponsor Council of America.

Footnotes

1“ERISA: The Most Glorious Story of Failure in the Business: the Studebaker-Packard Corporation and the Origins of Erisa,” Buffalo Law Review, 11/13/01. “This is what happened in the Studebaker case … the union had to protect members from default risk. One option was for union negotiators to bargain for higher levels of funding. ... The union rejected this approach because it would require slower growth of pension benefits — which would lead older employees to be less willing to retire — or larger employer contributions — which would result in lower wages for active employees. Instead … union pension experts developed a proposal for a government-run insurance program that would guarantee the obligations of defined-benefit pension plans. … Termination insurance would shift default risk away from union members and make it unnecessary for the UAW to bargain for full funding. … The lack of vesting in UAW plans was not an oversight. Union bargainers appreciated the importance of vesting. … A more liberal vesting provision means that more employees will qualify for benefits. If the amount of funds available for pensions is limited, more liberal vesting and lower levels of forfeitures require lower levels of benefits to employees who do qualify. Conversely, a plan with limited resources can pay higher pensions if fewer employees qualify.” Accessed 6/25/18 at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=290812.

2Pension Benefit Guarantee Corporation Annual Report, 2017. “The single-employer program’s net position (is a) deficit (of) $10,914 million. … The multiemployer program’s net position (is a) deficit to $65,052 million, an all-time high.” Accessed 6/25/18 at: https://www.pbgc.gov/sites/default/files/pbgc-annual-report-2017.pdf.

3H. Gillers, A. Tergesen, L. Scism, "A Generation of Americans is Entering Old Age the Least Prepared in Decades," Wall Street Journal, 6/22/18. Accessed 6/25/18 at: https://www.wsj.com/articles/a-generation-of-americans-is-entering-old-age-the-least-prepared-in-decades-1529676033?mod=searchresults&page=1&pos=1.

4Employee Benefits Research Institute, "New Survey Findings on Pension Coverage and Benefit Entitlement," August 1984. Accessed 6/25/18 at: https://www.ebri.org/pdf/briefspdf/0884ib1.pdf. See also: EBRI Issue Brief #34, "The World of Pensions Ten Years After ERISA," September 1984. Accessed 6/25/18 at: https://www.ebri.org/pdf/briefspdf/0984ib1.pdf.

5S. Schieber, "A Statement on The Effect on Private Pension Plans of Pension Provisions In the Tax Equity and Fiscal Responsibility Act of 1982," 4/11/83. Accessed 6/25/18 at: https://www.ebri.org/pdf/publications/testimony/T-14.pdf.