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ERISA at 45: Bolstering retirement security for the next 45 years

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In a recent post I outlined the key deficiencies in private pension plans that the passage of the Employee Retirement Income Security Act (ERISA) in 1974 was intended to address. But 45 years later, there are a different set of limitations with the private pension system with employers primarily sponsoring defined contribution programs for their workers’ retirement savings:

  • Insufficient funds: One 2019 study estimates over 40% of all U.S. households where the head of the household is now between 35-64 will run short of the retirement income needed to cover average expenses and healthcare costs.
  • High cost: Defined contribution (DC) plans sponsored by smaller companies don’t enjoy the economies of scale of larger plans and pay substantially more in total plan fees, usually at least 1% of assets. These costs often reduce employee returns as they are incorporated into the total expense ratios of plan investments.
  • Overly complicated: When you review the evolution of different DC programs issued under the tax code (e.g., 401(a), 401(k), 403(b), 457(b)), you quickly realize there has been no master plan in putting them together. Then consider personal retirement programs like IRAs, SEPs, Keoghs, etc. and it can boggle the mind. All these provisions add cost and complexity to the system without seeming to bolster retirement security.
  • Too centered on the Employer Plan: The current U.S. employer retirement plan system is partly an outgrowth of the wage-price controls imposed during World War II that encouraged employers to provide compensation increases through fringe benefit programs such as pension plans. But the regulatory regime imposed by ERISA to help secure these benefits (including non-discrimination testing, audits, legal documents, disclosures, etc.) substantially increased compliance costs and discouraged smaller employers from even offering programs. Furthermore, employees in the “gig economy” frequently aren’t eligible for an employer-sponsored plan and several state governments have begun to offer their own plans for this unserved group.
  • Decreased protection against longevity risk: U.S. life expectancy at 65 increased for men from age 78.5 in 1974 to age 83 in 2017, while during the same period women experienced an increase from age 82.5 to age 85.5. At the same time, the move from defined benefit (DB) to DC plans has meant that the average participant has less protection against outliving their assets as lump sum payments have replaced life annuities as their plan’s default form of distribution.

Rethinking retirement legislation for the 21st century

In aggregate, these issues suggest any overhaul of the current private pension system needs to deliver a simpler, less expensive system that encourages increased overall savings rates. It is hard to see how simply tweaking the existing ERISA legislation will produce that as it was built around forcing employers to secure their pension commitments through a series of regulatory requirements. But with the shift to defined contribution plans, perhaps we need to envision a system that recognizes individuals, rather than employers, as the key driver of retirement security.

One potential starting point would be to adapt the U.S. government’s Thrift Savings Plan for civil service and military employees. It is already a multi-employer plan, doesn’t have to file financial statements, has incredibly low administrative costs, is not subject to litigation, and allows employees to contribute to the same account across different jobs. Expanding this type of program to the private sector could even go further by allowing self-employed workers to establish accounts as well. The program could restrict any employer contributions to the use of certain safe harbor formulas, eliminating the need for non-discrimination testing. The U.S. government’s role could be limited to ensuring promised contributions are deposited, as occurs for Social Security contributions.

Addressing inadequate savings

The Thrift Savings Plan approach could lead to a much simpler, cheaper system. By pooling tens of millions of employee accounts together, even workers at smaller companies would enjoy low investment and administrative fees. Standardizing plan terms and options would make it easier for the average worker to understand.  And the plan could make available low cost life annuities or pooled longevity investments due to the population’s size.

What it wouldn’t do, of course, is address inadequate savings levels by employees or lack of employer contributions. However, savings could be encouraged by including automatic enrollment and default/escalating contributions as safe harbor options the employer could elect. And suppose the U.S. government would assume virtually all the administrative duties for this program in return for some level of minimum employer contribution (say 1% of pay, or a safe harbor matching formula) that would be required of participating plans. How many employers would turn down this trade?

Revamp instead of upgrading

ERISA was enacted when the average worker’s dream was spending their career with one company and retiring with a gold watch and a comfortable pension. Perhaps that is the best sign that a new system – whether based on the ideas above or something different – is needed to better reflect today’s economy rather than updating a system which has long outlived its original goals.

 

 

 

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