Put Your 401(k) to the Test
See if your retirement plan has the best and latest features
The debate continues to rage over which is better: a traditional (defined-benefit) pension plan or a defined-contribution plan, such as a 401(k) or 403(b).
Well, according to at least one firm, it's a bit of a mashup: the best of what a defined-benefit plan has combined with the best of what a defined-contribution should offer.
"If you design a defined-contribution plan that uses the same factors that make defined-benefit plans efficient, you get an efficient defined-contribution plan," said Donald Fuerst, a senior pension fellow at the American Academy of Actuaries.
According to a new report from the TIAA-CREF Institute, "Equivalent Cost for Equivalent Benefits: Primary DC Plans in the Public Sector," the following elements make up a "best-practice, risk-managed" 401(k)/defined contribution plan:
- Mandatory participation or automatic enrollment
- Adequate contribution rates
- A limited set of professionally managed, low-cost, pooled investments
- Mandatory or default investment in automatic asset allocation vehicles, such as target-date funds
- Limited or no borrowing from the plan
- Annuitized benefit payments; and
- Provision of objective education and advice for participants
These features — perhaps with the exception of annuitized benefit payments and limited or no borrowing — are in line with what other groups and plan sponsors say make up a great 401(k) plan. "They have it substantially right," said Fuerst.
(MORE: Fighting to Make 401(k)s Last a Lifetime)
While it's possible to design what the TIAA-CREF Institute views as an ideal 401(k) plan, Fuerst says he doesn't see many of them. "This is not the type of plan that (employers) or employees seem to want," he said. "(Employees) want investment control and lump sums."
Plan sponsors and plan providers are moving in the right direction, but it's still less than ideal.
At the moment, 47 percent of plans now have an automatic enrollment feature and employees who participate in plans with automatic enrollment generally begin contributing at 3 percent of pay.
Ron Gebhardtsbauer, a professor at Pennsylvania State University, said enrolling workers at just 3 percent of pay is a disservice to employees, especially if they get stuck at the very-inadequate 3 percent of pay and don't even get the full employer match. "If employers are concerned about the cost of a higher default contribution, they can stretch their match by going to, say, 30 percent or 40 percent of the first 10 percent of pay," he said.
Aggressive Auto-Escalation Is Needed
Others agree that workers need to save more than the default deferral.
"The single most important issue in retirement savings today is that participants are not saving enough," said Mike Alfred, the co-founder and CEO of BrightScope, a retirement plan analytical firm. "It isn't that they're not investing well, although that may be the case in a lot of plans. So, I think any feature that drives more participation and higher savings rates should be seriously considered."
What's an Adequate Savings Rate?
Meanwhile, here's what we know about the current state of affairs for default investments, education and advice, according to the PSCA:
- Roughly two-thirds of plans, some 64 percent, offer a target-date fund (it's the most popular default investment)
- 16 percent of plans offer a comprehensive financial wellness program, beyond a standard 401(k) education program
- 35 percent of plans offer investment advice
What's Needed: Advice on How Much to Contribute
"Education/advice is also important, but it needs to be on more than just on the investing side," said Gebhardtsbauer. "Employees need to know how much to contribute."
A great help for this is the Labor Department's push for employers to provide personal projections of what size annuity each employee will get at retirement. (You can find out more about that Lifetime Income Calculator on the Labor Department's website.)
That is not the case with defined-benefit plan participants. Those folks typically get a specified monthly benefit for life.
Others agree that getting 401(k) plans to offer annuitized benefits as a matter of course won't be easy. "It's an evolving issue that is fraught with potential risks for plan sponsors from a liability and regulatory perspective," said Alfred.
Government Agencies Propose Changes
"This is, I think, the essential tension," said Utkus. "For some the only valid form of 'retirement income' is a lifetime annuity stream and thus 'efficiency' requires 100 percent lifetime annuitized benefits. To me the question is not either/or, but finding the optimal combination of instruments providing lifetime income streams and instruments providing liquidity and flexible savings. Saying everything must be annuitized dodges the hard question: What fraction ought to be, and which not? And who decides? And for what reasons?"
"Basically the TIAA-CREF idea makes the defined-contribution plan as much like the defined-benefit plan as possible, which I like," said Gebhardtsbauer. "It can still have higher expenses than a large defined-benefit plan, because it has to maintain everyone's account. In addition, some employees will negatively elect out of enrollment, or out of the contribution escalations, or out of annuitization. But hopefully it will be better than current experience."
Robert Powell is a MarketWatch Retirement columnist. He has been a journalist covering personal finance issues for more than 20 years. Follow him on Twitter @RJPIII.