A Little Optimism on the Future of Retirement
Retirees may be forgiven for indulging in nostalgia, but all too often our thinking about retirement falls prey to that vice. Criticism of 401(k) plans is once again being voiced, and once again being read against the background assumption that in the good old days we had a better retirement system based on traditional defined-benefit pensions.
According to the critics, “the proliferation of 401(k) plans has exposed workers to big drops in the stock market and high fees from Wall Street money managers while making it easier for companies to shed guaranteed retiree payouts.” The alleged result is that a lot of Americans, maybe even most of them, are dangerously underprepared for their retirements. Some people want to scrap the 401(k) altogether.
As Megan McArdle of Bloomberg View notes, picking on 401(k)s obscures the major difficulty in funding retirement: Whatever type of plan is used, people have to restrain their consumption during their working years to be able to consume in retirement. But there’s also a positive story to be told. Whatever problems the U.S. pension system has, they are smaller than they ever were before.
For starters, our mix of 401(k)s, traditional pensions and Social Security is working relatively well for most current retirees. Roughly three-quarters of them say they’re living comfortably -- which is higher than the percentage of Americans of working age who say the same. Using data from the Federal Reserve’s Survey of Consumer Finances, my American Enterprise Institute colleague Andrew Biggs calculates that senior households in 2013 had annual incomes 34 percent higher than such households in 1989. Younger households in 2013 showed much less improvement over their predecessors.
Saving among today’s workers keeps rising. In 1970, people in the middle 40 percent of the income distribution had 33 percent of their annual incomes saved in retirement plans, Biggs estimates. Their equivalents today have 210 percent of their incomes socked away. And don’t assume young people are slacking off: Millennials are saving a higher proportion of their incomes in retirement plans than Generation X’ers did at the same age.
Criticism of 401(k)s frequently idealizes the defined-benefit plans they have largely replaced. It’s true that 401(k) participants have more responsibility for their retirements than defined-benefit plans involved, and they are also exposed to market risk. Andrew Samwick, a professor of economics at Dartmouth College, pointed out in an interview that defined-benefit plans had their own risks. The company sponsoring those plans could skimp on pension contributions, or allocate its investments poorly, or go bankrupt and leave plan participants short.
And the shift to 401(k)s has coincided with a large increase in the number of people with retirement plans: Most workers didn’t have those defined-benefit pensions. “People have a very distorted notion of how good things were under defined-benefit plans or how good they would be today if that system of defined-benefit plans had continued,” Samwick said.
None of this means that 401(k)s couldn’t be better, or that public policy concerning retirement couldn’t improve. But the improvements we should be considering would expand 401(k)-style plans to people who don’t have access to them. We could, for example, make it possible for small businesses to join together to offer their employees such plans. Our system, that is, has real strengths, and we should build on them rather than abandon it.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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