401(k) Plans Raise Total Saving

The combined employer and employee contribution per active participant to 401(k) plans has been about twice as large as the employer contribution per participant to DB plans.

In The Transition to Personal Accounts and Increasing Retirement Wealth: Macro and Micro Evidence (NBER Working Paper No. 8610), authors James Poterba, Steven Venti, and David Wise explore the evolution of U.S. retirement savings over the 1980s and 1990s. In 1980, 92 percent of private retirement saving contributions were to employer-based plans and 60 percent of all contributions were to defined benefit (DB) plans. Today, defined contribution (DC) savings plans -- 401(K)s and similar employee-controlled retirement plans -- account for about 85 percent of private retirement saving contributions. The shift from defined benefit to defined contribution plans reflects several factors, including changing regulations on DB plans and greater worker demand for pensions that are portable from one job to another.

The authors argue that the growth of 401(k) plans has raised national saving. On average, the combined employer and employee contribution per active participant to 401(k) plans has been about twice as large as the employer contribution per participant to DB plans. This suggests greater wealth accumulation under DC plans. The researchers estimate that between 1984 and 1997, total contributions to all pension plans of people with a 401(k) plan were three times as great as they would have been in the absence of the 401(k) program.

Poterba, Venti, and Wise find no evidence of strong substitution between 401(k) participation and participation in other retirement plans. They point out that the growth in defined contribution assets has been so large that it is unlikely that all of this asset growth has come at the expense of what would otherwise have been defined benefit plans.

There are potentially important differences between accumulating retirement assets in defined contribution and defined benefit plans. Saving in a 401(k) plan is transparent and the individual largely decides how much to contribute, how to invest, and how and when to withdraw the money. This contrasts with far more opaque DB plans in which the employer makes these decisions, and in which the employee may not understand the accruing value of retirement assets. Individuals with 401(k)s are also likely to work longer and contribute for more years than those who rely on DB pensions, since many DB plans include provisions that make it financially attractive to retire early.

Assuming that current defined contribution pension coverage rates persist for the next three decades, the average 401(k) balances of people who will reach retirement age in 2035 will be roughly as large as the present value of their Social Security benefits. The precise value of DC plan balances will of course depend on asset market returns over the next thirty years.

The retirement plan contribution rate is much greater than the personal saving rate reported in the National Income and Product Accounts (NIPA) in recent years. The treatment of retirement plan contributions and retirement payouts in the national income accounts contributes to the very low measured personal saving rate.

-- Andrew Balls