In general, employers can sponsor two types of retirement plans for their employees: defined benefit plans and defined contribution plans. Defined benefit plans typically provide a set benefit whose size varies depending on job tenure and salary level. Defined contribution plans are tax-preferred savings accounts such as 401(k)s.
Employer-provided defined-benefit pension coverage in the private-sector labor force, which has never been much above 50 percent, has declined slightly in recent years. Private-sector defined-benefit pension payments to individuals are relatively small compared to their final salary, and are rarely indexed to price increases. Increasingly, few workers have this type of benefit.
As coverage by defined benefit plans has fallen, coverage by defined contribution plans has increased. Despite the growth of balances in such tax-preferred savings accounts, the income they will generate will not compensate fully for the loss of employer-provided traditional pensions.
Retirement plan coverage—the actual participation rate of workers in those plans—varies by demographic group and sector: Older, better-paid workers are more likely to be plan members than are younger, lower-wage workers, and men tend to have larger benefits than women. Racial and ethnic groups that have experienced discrimination, including nearly two-thirds of Latinos, are more likely than non-Hispanic whites to work for an employer that does not offer a retirement plan. Similarly, large employers are far more likely than smaller ones to offer a plan. Although Social Security provides lower-paid workers a higher wage-replacement rate than higher-wage workers, these disparities mean that retirement security may be an elusive goal for a sizeable share of the American workforce.
Apart from stagnation and disparities in coverage, the trend toward defined-contribution instead of defined-benefit plans has disquieting implications for retirement security. There are three risks to a secure retirement that any saving system should address: the risk of not saving enough, the risk of poor investment performance, and the risk of outliving one’s retirement nest egg. The decline in the number of workers covered by traditional defined-benefit pensions and the growing importance of defined-contribution plans such as 401(k)s have heightened all three types of risk. The 401(k) plan is voluntary for workers, unlike the traditional define- benefit or hybrid plans (for more on hybrid plans, see Replacing Traditional Defined-Benefit Plans with Hybrid Plans, below). Plan participants in many cases have no professional guidance in selecting investments, there is no strong encouragement to annuitize even part of a 401(k) plan’s balance, and cash-outs are common.
Extending the number of workers with retirement plan coverage substantially will be a challenge. Instruments already in place, like Savings Incentive Match Plans for Employees (SIMPLE) IRAs and the saver’s credit are not well known and have not substantially increased the numbers of workers who are saving for retirement. More recent innovations, discussed below, such as state-sponsored retirement savings plans and the Automatic IRA, may be more successful.
Over the past two decades Congress has enacted significant tax and employee benefit legislation. The Pension Protection Act of 2006 made major changes in the rules governing private retirement plans. Such statutory changes have, on balance, increased access to these benefits and made the plans fairer to low- and moderate-income workers. However some legislative and regulatory pension activity has been driven by a desire to find needed government revenue, particularly in the short term, by limiting the tax subsidies provided to retirement plans. As a general rule these reforms should be judged by their longer-term impact on the number of workers covered by plans and the size of benefits that they can provide, not by their impact on the federal budget.
A number of reforms supported by AARP have improved retirement benefits for millions of workers. Among the changes are shorter vesting periods, reduced plan integration (for more on this, see Established Employer-Provided Retirement Plans—Integration, below), improved coverage standards, and better disclosure requirements. These changes substantially increased both the number of people receiving retirement benefits and the income provided to retirees, although not necessarily the proportion of the workforce that is covered.
Notwithstanding recent reforms in retirement benefit law, a number of issues remain unaddressed. In particular the rights of spouses and survivors to the balances in defined-contribution plans need to be enhanced or protected. There is also substantial confusion among 401(k) plan participants about the fees they pay. In addition the investment standards of both defined-benefit and defined-contribution plans need to be strengthened.
Rules for employer-sponsored retirement savings plans have become extremely complex. Many of these rules are designed to protect participants, particularly lower-paid employees, and thus encourage more equitable pension plans. Over the past decade several efforts have been made to simplify the underlying laws. However, some proposals, characterized as simplification plans by their proponents, could actually weaken or even eliminate important pension protections.
The next sections of this chapter outline specific policies to improve the private retirement system so it will provide an adequate level of income to supplement Social Security. AARP recognizes that more general policies, like tax incentives, may also help achieve these objectives. (See the Tax Incentives section of this chapter for more information.) More generally, equity, fairness, and transparency constitute key principles of a retirement system. Their application ensures broad coverage and increases the financial security of plan participants and their dependents.