Replacing 401(k) Plans: Further Thoughts

Reader Reactions My two-part series on 401(k) plans attracted considerable attention. The first article, called "401(k) Plans Have Reached Their Expiration Date," argued:

1) Today's 401(k) plans are much better than previous versions. 2) However, the current approach is nearing its practical limit. 3) For significant further improvements, a new structure is required.

The second, modestly entitled "The New American Retirement Plan," presented my proposal:

1) A single national defined-contribution plan. 2) Offered by all employers, public and private. 3) No mandate for employer contributions. 4) Possibly a mandate for employee contributions (I hedged). 5) Tighter restrictions on early withdrawals.

Those are the basics. For more details on the New American Retirement Plan, or NARP, please see the column itself.

The series generated numerous responses. Some were complimentary, others puzzled, and still others skeptical. There's no need to address the first category ("That's right, John"), although such comments are certainly welcome, but the other two groups deserve replies. Thus, today's column.

Something Different Some wondered if the New American Retirement Plan was indeed new. Contended one reader, "Your successor to 401(k) plans sounds like … 401(k) plans." Others weren't certain how the proposal differed from Social Security. The confusion is understandable, because NARP contains some features of both. For example, it permits employee choice, as with 401(k)s, but operates identically across all companies, as with Social Security.

Per the American Benefits Council, there were 656,241 defined-contribution plans in 2019. Under NARP, that figure would drop to 1. Despite that huge number of plans, Pew Charitable Trusts reports that 35% of private-sector employees cannot access a work-based retirement plan. That percentage would drop to zero. Finally, NARP has no rollovers. The money always stays in the same plan; it is unaffected by job changes.

The contrast with Social Security is equally sharp. The Social Security Administration offers a defined benefit: a guaranteed stream of monthly income derived from investments that the recipient does not control. It is a pooled insurance program, with redistributive elements. NARP is something else entirely. It receives defined contributions; offers no guarantees; may be invested as its owner desires; is not a pooled account; and does not redistribute any assets.

In short, NARP is neither an enhancement of the the 401(k) system nor a reworking of Social Security. It is instead something old, something new, something borrowed, something blue.

Staying Aloft When designing an airplane, all that really mattered to the Wright Brothers was if the mechanism could fly. The ride might be unpleasant, the train might be faster, the landing might be rough. No worries. Those problems could wait. The Wright Flyer would not be the Dreamliner; its purpose was to demonstrate the concept.

At a far lower level of creativity, such is the current status of my proposal. The overriding concern is, could this contraption fly? The critical element--the fundamental basis of the proposal--is shifting defined-contribution plan ownership from companies to a federal government body. Everything else is negotiable, but that feature is not.

No respondent undermined NARP's central pillar. Indeed, while strongly critical of the endeavor, Nevin Adams of the trade organization American Retirement Association, echoes NARP's underlying principle. Writes Adams, "workers of relatively modest means (those earning $30,000 to $50,000/year) are 12 times as likely to save for retirement in a tax-advantaged account if they have access to a plan at work."

Spot on. The top of the income pyramid needs no retirement-planning nudges. Rank-and-file employees, however, generally do not become meaningful investors through retail investment accounts, regardless of tax incentives. Instead, they save at work, into accounts that are fed by their employers' payroll activities. That way, investment isn't a special event. It is instead an ongoing habit, one that is shared by the employee's co-workers.

In that Adams and I fully agree. He dissents by believing that my proposal would break that arrangement. Not so. The company would continue to serve as the hub for defined-contribution plans. Current 401(k) plan sponsors neither manage money, nor keep investment records, nor give advice. But they are crucial for employees, because they bring those activities together. Companies today are the face of defined-contribution plans. With my proposal, they will remain that way.

Two Concerns Readers' criticisms mostly followed two themes: 1) company matches and 2) account "leakage."

NARP contains no requirement for company matches. It's one thing to mandate that all companies join a national retirement-plan system; it's quite another to demand that they all pay money for the privilege. Several readers sharply disagreed. Effectively, that policy would relieve businesses of their substantial current financial obligations--Fidelity reports that the average plan-sponsor match of companies within its system is 4.7%--and increase the employee's load.

Is that fair? In addition, can that approach be successful? Or will employee contributions dwindle once the carrot of company matches is removed? Those are difficult questions, to which I have no replies whatsoever. The answers must come from subject-matter experts who have analyzed the necessary data. Happily, the issue does have a solution; unhappily, I cannot be the one to provide it.

On a similar note, many believe that I overstated the problem of 401(k) leakage--that is, withdrawals before retirement. Adams writes that my cited academic evidence is flawed, while others don't quarrel with the numbers but suspect that most withdrawals occur when investors face hardship. Also, once again surfaces the issue of employee participation. Will contributions drop if the rules are altered to make early withdrawals more difficult, as my proposal suggested?

These questions, too, are practical rather than theoretical. What's more, they apply equally to 401(k)s. Whether or not something like NARP ever occurs, the regulations governing early withdrawals from tax-sheltered accounts should be revisited, to ensure that best practices are being followed.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.