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The 401(K) Account: A Savings Carrot That Really Works

Economic Trends


It has long been a worry among economists and policymakers that special incentives do little to increase net new savings and simply cost the U.S. Treasury money. That concern prompted Congress to limit participation in individual retirement accounts in 1986. Now, the 401(k) account, a different tax-deferred vehicle, has displaced the IRA as the leading form of retirement savings by individuals. Do 401(k) accounts, annual contributions to which run about $50 billion, crowd out other saving?

No, categorically report three econo-mists who have studied growth in 401(k)s since the program began in the early 1980s. James M. Poterba of the Massachusetts Institute of Technology, Steven F. Venti of Dartmouth College, and David A. Wise of the John F. Kennedy School of Government at Harvard University looked at data from 1984, 1987, and 1991 comparing savings and wealth levels for 401(k) contributors and noncontributors.

Poterba, Venti, and Wise found that on average, 401(k) contributions did not substitute for other forms of private saving. If substitution was taking place, then the typical family eligible for a 401(k) in 1991, for example, should have less accumulated wealth in other financial assets than the typical family in the same income bracket not eligible for a 401(k). "This was not the case," say the study's authors.

Interestingly, the three economists found that participation in 401(k)s among those eligible exceeds 60% at all income levels. That's in sharp contrast to the experience with IRAs, which in the early 1980s showed that participation was greater at higher income levels. And it suggests that 401(k) accounts are not simply a carrot enjoyed by the rich.

Clearly, 401(k) plans provide a true incentive to save: Because they are easily funded through payroll deductions and because many employers provide a partial matching of employees' savings, 401(k)s encourage new savings, rather than simply prompting a shift of savings from one account to another.KAREN PENNAR

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