What’s Right: The irony is that the students Larry addressed have a system in place that will work for them – if they save. The sweeping changes of the Pension Protection Act of 2006 help ensure that most of them, once they graduate and find jobs, will be automatically enrolled in a diversified, professionally managed portfolio. That makes a big difference – plans that use auto enrollment have an 86% participation rate.
What’s Wrong: Major issues remain that will take some combination of behavioral and structural measures to solve. Here are two that are top of mind:
- Currently, we average about a 7% deferral rate into our 401(k) plans nationally. This needs to be higher, with 10% a reasonable goal. Auto-escalation, which gradually increases contributions each year, is one measure we’d like to see more broadly adopted.
- Because 401(k) was originally introduced as an optional supplemental plan, many people currently in their mid-50s did not take advantage of it. They assumed that their company pension and social security would meet their needs, leaving them with inadequate savings as a result. It’s important that solutions for this group do not throw out the improvements that will work for younger workers.
What’s Next: Under the old system of traditional, company-paid pensions, investment managers were able to pool payment obligations together and use mortality tables to predict income needs with a high degree of accuracy. That’s not a merely theoretical advantage. Without pooling mortality, individuals managing their retirement savings have to do the near impossible — guess how long they will need to make their 401(k) savings last. If we can somehow leverage mortality pools for individuals, we can do a better job of translating a lump sum savings into retirement income.
The Bottom Line: The 401(k) State of the Union message can be summed up fairly succinctly: it’s a relatively young system that has made dramatic improvements in the last two decades. Throwing up our hands and saying the whole thing “sucks” is wrong and counterproductive. But taking a clear-eyed view of the system and acknowledging its strengths and weaknesses can help keep it moving in the right direction.
Chip Castille, Managing Director, is head of BlackRock’s US & Canada Defined Contribution Group.