401(k)s Now Leading Retirement Savings Vehicle

A new study from the Investment Company Institute (ICI) shows that 401(k) plans, originally perceived as a supplement to worker pensions, now have more than twice as many participants as private-sector defined benefit plans.

According to an ICI summary of the study findings, 401(k) plans now have 47 million active participants, compared to 21 million who participate in private-sector defined benefit pensions. And 401(k) plans held $2.4 trillion in assets in 2005, compared to $1.9 trillion in assets in all private-sector defined benefit pensions.

The study also points out that the latest data show 90% of 401(k) plans are the only retirement plan offered by that employer. In 2002, some 350,000 employers offered 401(k) plans as their sole retirement plans, ICI said.

Other findings of the study included:

• The growth in 401(k) plans generally has been fueled by changes in the economy and the workforce, not by companies dropping traditional pensions in favor of 401(k)s. In particular, newer firms have tended to adopt 401(k) plans. Because traditional pensions generally favor employees with long service with one company, younger workers tend to place more value on defined contribution pension benefits.

• Mutual funds account for roughly half of the assets in 401(k) plans. Mutual funds have been instrumental in opening securities markets for workers participating in 401(k) plans, offering diversified investments, professional management, and innovative plan services.

• 401(k) plans offer a powerful savings tool that can provide significant income in retirement. In research with the Employee Benefit Research Institute, ICI has found that more than half of today’s young 401(k) participants can expect to retire with enough 401(k) assets to replace more than half of their pre-retirement income.

• The Pension Protection Act, passed in August, offers the potential to sharply increase 401(k) participation and retirement income. The PPA makes permanent the updated 401(k) (and IRA) contribution limits; preserves catch-up contributions for workers age 50 or older; and encourages employers to offer automatic enrollment and better default investments in 401(k) plans.

• If companies fully implement the PPA’s provisions, eligible workers can accumulate significant retirement income. In the lowest income group, the median eligible worker could replace 52% of pre-retirement income if companies implemented automatic enrollment with a default contribution of 6% of pay, invested in a lifecycle fund. That’s up from a 23% replacement rate for the median worker without those reforms.

The full study, entitled 401(k) Plans: A 25-Year Retrospective, is at http://www.ici.org/pdf/per12-02.pdf.