NCPA - National Center for Policy Analysis

Reforming 401(k)s The Right Way

June 13, 2002

The post-Enron drive to reform pension laws has stalled in Congress over what regulations to impose on employers. Most of the reform plans run the risk of making 401(k)s too costly and burdensome for companies, especially small employers. Some companies may drop employee retirement savings plans altogether.

There is a better way.

A Watson Wyatt consulting firm survey covering the period 1990 to 1995 found traditional pension plans (defined benefit plans) averaged an annual return 1.9 percentage points higher than employee-directed 401(k) plans. The 401(k) plans performed poorly because unsophisticated investors make one or both of two poor decisions:

  • They invest in what they know -- thus 30 percent of 401(k) plan assets are invested in company stock.
  • They invest in what is safe -- almost two-thirds of funds invested by employees in the lowest-income quintile are in money market or bond funds, or both.

When employees don't choose an investment alternative, employers typically default them into money market funds to protect themselves from tort liability. The accounts can never decrease in value -- but they pay too low a rate of return for retirement investing. To address this problem, the NCPA proposes giving employers liability protection if they do the right thing:

  • Employers would actively encourage their employees to invest in diversified portfolios that broadly reflect the market as a whole.
  • Employees who do not exercise a choice would be defaulted into diversified portfolios unless employees specifically opt out.
  • Since the plan is purely voluntary, no employer would have to adopt it. The employer would be exempt from lawsuits.

By shielding companies that help their employees invest prudently, this would encourage employers to help their employees without burdensome new regulations.

Source: Matt Moore, policy analyst, National Center for Policy Analysis, June 13, 2002.

For NCPA "Reinventing Retirement" study


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