Facing America's Other Middle-Class Squeeze

Defined-contribution plans aren’t living up to their promise

President Obama said in an Oct. 2 speech at Northwestern University that the middle class is squeezed by stagnant wages, slow job growth, and ever-higher college tuition. A recent report shows that U.S. workers also are getting squeezed because they’re being pushed into inadequate retirement plans by the country’s largest employers.

A survey released last month by Towers Watson, the employee benefit consultant, illustrates how rapidly the defined-benefit plan—the traditional pension that guarantees workers an annual income after they retire—has moved from the norm at Fortune 500 companies to all but extinct. In 1998 just more than half offered new hires a defined-benefit plan; by 2013 that had fallen to 7 percent. That trend continues: According to Towers Watson, at least three of the 34 Fortune 500 companies that offered defined-benefit plans to new hires last year won’t do so this year.

Taking their place are defined-contribution plans—401(k)s and similar tax-deferred plans in which employees save for their own retirements, usually helped by matching contributions from their employers. In theory, employees can still save enough for a comfortable retirement, if they put enough away, invest wisely, and resist the temptation to tap the money early. But that’s not what usually happens—and, according to another Towers Watson survey of large companies, the employers know it.

In 2012, Towers Watson asked 371 companies about their retirement plans and how well their employees understand and manage those. The answer, in most cases, is not very well. A third of companies say their workers expect too much from defined-contribution plans, and 36 percent say those workers aren’t making informed decisions about their retirement.

Defined-contribution plans rely on the premise that workers are making rational retirement decisions. So the companies’ responses are an admission that the defined-contribution system is failing many of their employees. That raises the question: If employers don’t think their workers can manage the shift to defined-contribution retirement plans, why make it?

Here, the companies were remarkably candid. Asked what drove the design of their plan, 63 percent cited cost, while just 46 percent mentioned workers’ ability to retire with a reasonable level of benefits. (Only 9 percent said “employee preference.”) That cost-cutting approach may be shortsighted. “If you’ve got people who can’t leave you simply because they haven’t been able to save enough for retirement, that’s not a good dynamic for your productivity or for the people behind them that are stuck waiting for them to go,” says Alan Glickstein, a senior retirement consultant at Towers Watson.

The worst-case scenario is a return to the idea that old age is a time of deprivation for many. That option might be unappealing enough that a future Congress may decide to beef up Social Security payments. Those could be financed through higher payroll taxes on workers and companies. “Society always has a role to play here,” says Glickstein. If defined-contribution plans don’t deliver on their promise, “it means more Medicaid, more welfare.” Or Congress could look for a way to pass on the cost to companies alone, arguing that they’re the ones who put the labor force in this situation.

Another option would be for U.S. companies to find a way to help their workers make better decisions regarding their defined-contribution plans, probably through some combination of auto-enrollment, auto-escalation (in which default contributions increase with salary), and more generous matches. That may or may not require federal legislation to nudge companies along.

Obama promised in his speech that he “will not allow anyone to dismantle” the foundation of middle-class economic security. That pledge requires confronting the lightning-fast erosion of adequate retirement plans. The question for companies is, do they want to help? If not, government may need to.

    BOTTOM LINE -

    The bottom line: Only 7 percent of Fortune 500 companies offer traditional pensions to new hires, vs. about half in 1998.

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