NCPA - National Center for Policy Analysis

Shoring Up Retiment with 401(K) Plans

January 22, 2004

President Bush has renewed his call to introduce 401(k)-style personal savings accounts into Social Security, to help more Americans save for their retirement.

Under these "defined contribution" plans, a worker saves for his own retirement. For example: A worker who contributes steadily and retires at 62 with a $52,650 salary could have 8 percent a year more in retirement, or $4,200 a year, than one with a typical defined-benefit pension, figures Alicia Munnell, a Boston College economist and co-author of a forthcoming book on 401(k)s, "Coming Up Short."

But that isn't typical. People make mistakes at every step along the way, she says. Here are the rubs:

  • One out of every four eligible workers does not sign up for 401(k) plans; of those who do, too many don't diversify wisely (more than half of 401(k) participants either put no money into the stock market or put all their money there).
  • About 55 percent of workers cash out when switching jobs instead of rolling the money into new retirement plans.
  • Too many workers don't appreciate the risk of outliving their savings; many would be better off turning their savings into low-cost annuities at retirement instead of taking a lump sum.
  • Let people do what they want, but don't make it easy for them to do the wrong thing.
  • Make use of human inertia: automatically enroll eligible workers; set worker contributions at a level to take full advantage of employers' matching contributions.
  • Put 60 percent of money in stocks and 40 percent in bonds, and give workers a low-cost annuity at retirement; anyone could opt out of these choices, but no one would end up with a stupid choice by default.

Source: David Wessel, "Private Lessons: Bush And the 401(k) Test," Wall Street Journal, January 22, 2004.

 

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