ICI: You Can Count on the Private Retirement System

In testimony submitted in response to the U.S. House Education and Labor Committee’s October 7 hearing on the impact of the financial crisis on retirement security (see Congress Considers Market Impact on Retirement Security), the ICI noted that an analysis of participants with account balances at the end of each year from 1999 through 2006 shows that between 1999 and 2002, the average account balance of this group fell 8%; but in 2003, the average account balance was up 30%, and that the average account balance almost doubled from the bottom (2002) through 2006.

Overall, the average account balance from 1999 to 2006 was up 79%, despite the multi-year bear market and even though U.S. equity prices had not recaptured all their losses during the 2000-2002 market downturn. If those participants had stopped contributing, left the 401(k) system, or moved their balances out of the stock market in 2002, they would have locked in their losses and missed out on the market rebound.

Not that they seem inclined to abandon the system. ICI notes that, “Our research finds that plan investors do not overreact to market downturns or panic, that they have a demonstrated commitment to long-term savings, and that consistent 401(k) contributors have seen their accounts rebound after bear markets.’ In fact, ICI cautioned that “It would be a grave mistake to use recent market events as an excuse to dismantle the current retirement system, as some suggested at the October 7 hearing.’

ICI noted that the 401(k) system is so new that no one has yet had a full career in the system. So, in order to evaluate the ability of that system to produce adequate income replacement rates at retirement, ICI has collaborated with the Employee Benefit Research Institute (EBRI) in development of the EBRI/ICI 401(k) Accumulation Projection Model. That model, according to the statement, looks at 401(k) participants of varying income levels and models future accumulations under a range of participant behaviors and scenarios–including modeling various long-term market returns that included significant historical market downturns.

According to ICI, that model “demonstrates that 401(k) can produce adequate replacement rates at retirement when combined with Social Security.’ It noted that, for example, among individuals who were in their late twenties in 2000, after a full career with 401(k) plans, the median individual in the lowest income quartile is projected to replace about 100% of his or her pre-retirement income using 401(k) accumulations and Social Security. “The model also demonstrates that when workers move into jobs that do not offer a 401(k) plan, median replacement rates fall significantly–by about half for workers in the lowest income quartile,’ according to the report. Other research demonstrates that, once Social Security, savings during employment, and taxes are accounted for, even moderate savings rates can lead to adequate replacement rates after retirement, according to ICI.

Future Recommendations

As for the future, ICI recommended two specific areas for reform in the current system: covering more workers and improving disclosure. Regarding the former, the ICI called for “realistic goals’, noting that recent ICI research shows that employers that do not offer plans tend to have workforces that are less likely to value and utilize retirement savings–such as younger workers whose savings is focused instead on education, home purchase, or building a savings cushion.

The ICI noted that lower-income workers are less likely to have, currently, the ability to save for retirement–and Social Security replaces a higher proportion of their working earnings. “In contrast, most workers who are likely to have the ability to save and to be focused primarily on saving for retirement are covered by an employer-provided retirement plan.’ As a result, ICI said, “Reform should recognize the differing savings needs of the American workforce.’

As for the second point, the ICI said that the committee “should focus on this issue and continue its oversight of the Department of Labor’s efforts.’

Then the ICI noted, “Some have suggested that the recent market downturn, which has been felt in all parts of the U.S. economy and throughout the world, shows that 401(k) plans are a failure. We strongly disagree. The employer-based retirement system plays a critical role in ensuring retirement security for millions of Americans, and the best evidence is the thousands of employers–including federal and state governments–and millions of workers who have entrusted trillions of dollars of their retirement savings to this system.’

The ICI statement went on to comment on testimony offered at the October 7 meeting of the Committee, where a proposal had been made to “replace 401(k) plans with a new government system funded with mandatory contributions to the Treasury (i.e. taxes).’ ICI noted that “this proposal would eliminate the tax incentive for employers to offer, and workers to participate in, a 401(k) plan’ – and that “the United States already has a system of guaranteed retirement income funded by taxes–Social Security–and one of the most crucial tasks in addressing retirement security in the future is ensuring that Social Security continues to provide adequate benefits to workers.’ The ICI described the plan in a footnote as something that would, in effect, be the world’s largest cash balance plan.

“The recent market turmoil highlights the need to continue the improvements started in the Pension Protection Act to make the 401(k) system stronger, more resilient and more transparent, to bring more employers into the system, and to continue to help workers make smart decisions–not to dismantle the current retirement system,’ said the ICI. “We applaud the Committee for examining this important topic and look forward to continuing to work with the Committee and its staff through this difficult time.’