Sept. 9 was National 401(k) Day. The name really makes a lot of sense because it has the potential to improve the savings rates of America’s working men and women, but it will require a national effort and a new partnership among public and private entities and our work force in America.
Government must create the safeguards and incentives for individuals to save. Businesses must make it easier for their employees to navigate the pension system. And American workers must make retirement saving a bigger priority in their lives. As I have said repeatedly, you can’t get rich on wages. The only way to create wealth is to work, save, invest, make a profit, then reinvest. This, Abraham Lincoln said, is the true American system.
The past 25 years have brought a dramatic shift in our nation’s pension system away from defined benefit plans and toward defined contribution accounts such as 401(k)s and Individual Retirement Accounts. As part of this shift, employers have grappled with how to get employees to sign up for the 401(k) and how to help them make sound investment options without resorting to a government "nanny" state.
Employers and their service providers have spent billions of dollars aimed at encouraging eligible employees to enroll and make constructive investment decisions. Despite these efforts, though, anywhere from one-fourth to one-third of eligible employees do not participate, and those who do often make suboptimal deferral and allocation decisions. A big reason is that the system is too complicated. Workers are busy with other priorities and don’t focus on the decisions.
The single best step we could take to address these challenges is to expand use of the automatic 401(k). Under these automatic plans, workers would be assured that if they did nothing, they would be saving in a sensible fashion. They would be in the 401(k) plan unless they opted out. Their contribution rates would automatically rise over time unless they decided against that, and their funds would be invested in a well-diversified, low-cost portfolio, again unless they wanted to spend the time and effort to opt out of that default investment.
In large part because of the demonstrated effectiveness of these steps and disappointment over the results from other attempts to boost participation, increase contributions and improve portfolio decisions, employers have increasingly adopted this type of automatic 401(k). But despite expanding support, only about 12 percent of 401(k) plans (and 30 percent of plans with at least 5,000 participants) have switched from the traditional "opt-in" to an "opt-out" arrangement.
Employers have been tentative in moving forward for several reasons. They had been worried about various legal risks, including the perception that several states’ laws would not permit employers to defer a percentage of an employee’s pay without express written consent by the employee; lack of clarity from the federal government on whether, in the absence of an explicit employee election, automatic investment would pose a fiduciary liability risk; and administrative issues relating to how contributions from employees who change their minds soon after being automatically enrolled would be handled.
The pension reform legislation, which President Bush recently signed into law, addresses many of these specific concerns. It pre-empts state laws to the extent that they preclude or restrict automatic enrollment. It provides a measure of protection against fiduciary liability for prudent default investments, with direction to the Department of Labor to issue regulations on the appropriateness of default investments. And it allows a penalty-free "unwind" period during which employees who opt out of the plan can recover their contributions without an early withdrawal tax penalty.
Congress has acted, and now it’s up to America’s employers to adopt the automatic 401(k). Then working men and women will be able to use inertia to boost saving rather than hinder it. Let’s get back to a pro-growth, pro-trade liberalization, pro-ownership society in which every child and family in America can own a share of the American dream and a stake in America’s future.