Here at Via Meadia, we’ve long held that 401(k) style defined-contribution pension plans are a much better option for workers and employers than defined-benefit plans. They’re more stable, less susceptible to abuse by politicians, and less prone to collapse should an employer or municipality go broke. With more and more states struggling with their pension costs, this idea has been picking up steam in recent months.But not everyone is convinced. In a new report, the Economic Policy Institute—a left-leaning think tank with close ties to organized labor—argues that the shift toward 401(k) plans has has increased income inequality among retirees, and has left low-income savers extremely vulnerable to shocks in the stock market:
Retirement-income inequality has grown in part because most 401(k) participants are required to contribute to these plans in order to participate, whereas workers are automatically enrolled in defined-benefit pensions and, in the private sector, are not required to contribute to these plans. Thus, higher-income workers are much more likely to participate in defined-contribution plans. In addition, higher-income workers have more disposable income and a higher investment-risk tolerance, receive larger tax breaks, and are more likely to work for employers that provide generous matches (CBO 2013; Morrissey 2009). Thus, even if participation had not grown more unequal, disparities in retirement preparedness would have grown with the shift from defined-benefit to defined-contribution retirement plans.The shift to a retirement system based on individual savings also means that workers’ retirement prospects are increasingly affected by shocks to stock and housing markets and broader economic trends. Much of the 401(k) era coincided with a long bull market propping up household wealth measures even as traditional pensions became scarcer and the savings rate declined. This house of cards collapsed in 2001, and then again at the end of 2008. Though the share of households with any savings in retirement accounts has trended upward with the shift to defined-contribution plans and an aging population, it declined in the wake of the Great Recession (Figure 8). Nevertheless, aggregate savings in retirement accounts continued to grow faster than income even after the Great Recession (Figure 9), though median account balances declined (Figure 10) and retirement savings grew more unequal (Figure 11).
The EPI makes some good points, but fails to address the reasons to favor a (reformed) defined contribution system. Defined-benefit plans can reward lifers in jobs but also expose them to risk every time former employers struggle, go bust, or get merged. They work for large, stable institutions, but are particularly ill-suited for a job market in which small businesses, entrepreneurship and job-hopping are becoming the norm. Given that this is where the economy is headed, defined-contribution looks like a safer bet.To make those plans friendlier to lower income workers, we could consider federal matches of employee contributions, mandatory opt-in rules, or tough investment regulations to protect the vulnerable from Wall Street sharks. The old feudal employment system of lifetime jobs isn’t coming back anytime soon, and corporate life is getting wilder, not tamer.A good retirement security system should be a high priority for both parties, but it has to be grounded in the economic realities of the 21st century.