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Small-Employer Retirement Plans Offer Big Challenges
How a reliance on employers has created a fractured retirement system
I find that Americans often take for granted two aspects of our
retirement system: it’s voluntary and employer-based. But, this is
mostly an accident. No country today would design their retirement
system with such a tight link to employers. Consider countries that have revamped their retirement systems in
the past few decades. Australia, Chile, and Singapore, just to name a
few, have much more centralized systems where employers' roles are
limited. For instance, employers ensure that money comes out of
workers’ paychecks and lands in a retirement account administered by
someone else. So, how did Americans come to rely on employers to offer retirement
benefits, particularly 401(k)s or other defined-contribution plans?
The most commonly cited explanation is that during World War II and
the Korean War, government-imposed wage controls forced employers to
lure workers with nonwage compensation. That pushed employers to
greatly expand the retirement system. This narrative seems correct, but I would add that the early
adopters of any social program always make mistakes, and the U.S. is
particularly burdened with legacy systems compared to other countries. As we all learned in high school civics, our bicameral system of
government with a strong, independent executive impedes making large
policy changes, particularly compared to a parliamentary system.
Shrewd observers of countries with “optimal” defined-contribution
systems (such as those listed above) might also note that two of the
three made changes during dictatorships. And perhaps a suboptimal retirement system is one price to
pay for a democracy. So, what’s the result of having this accidental employer-based
retirement system? The vast majority—more than 90 percent—of large companies offer a
401(k) plan. Here are some common features: The situation for workers at small employers is much worse. Here’s
what employees could expect: The gap in plan fees between large and small plans, shown in the
table below, can make a big difference in savings over time, with
investors in small plans about 20% worse off in retirement because of
differences in investment fees. In our paper, we examine how it’s the difference
between retiring with a plan balance of $600,000 and a plan balance of $470,040.
To us, the simple answer for addressing this two-tier system is to relieve some of the
burdens that small employers face in creating and running retirement
plans. One way is to let them combine assets with other plans to get
some benefits from economies of scale.Aron Szapiro
U.S. reliance on employer retirement plans
Workers at large companies are relatively well-served
Small-employer retirement plans are rarely offered and
typically aren’t great
Differences between large and small-employer retirement plans
add up
A reliance on employers has its limits
In next blog post,
we’ll discuss what we can learn from the United Kingdom. And we’ll
propose some policy changes that could preserve the well-functioning
parts of the U.S. retirement system while improving the small-plan market.Explore more differences between large- and
small-employer retirement plans in our research paper “Small
Employers, Big Responsibilities.”
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