Many right-of-center efforts to reform retirement savings rely on 401(k)-type retirement plans. Andrew Biggs of AEI, for example, has called for transforming Social Security into a universal flat benefit supplemented by universal retirement savings accounts, which he describes as follows:
Each worker would be enrolled automatically in an employer-sponsored retirement account such as a 401(k) or 403(b). Workers would contribute at least 1.5% of pay, matched dollar for dollar by their employers. Universal retirement savings accounts would allow Social Security to focus its efforts: If everyone saved as they should for retirement, Social Security could concentrate its resources on low earners who needed the program the most.
These universal accounts would take advantage of all that we have learned about how to structure retirement savings vehicles in recent decades. Enrollment would be automatic. While employees could withdraw if they chose, we know that auto-enrollment dramatically increases participation rates compared to plans that require affirmative choices by employees. All plans would have to offer a so-called life-cycle fund that automatically shifted from stocks to bonds as participants approached retirement. This life-cycle fund should itself be built upon low-cost index funds that track the stock and bond markets rather than make a costly and usually futile attempt to beat them. Finally, distributions from these accounts would be tax free (up to a limit) if converted to an annuity that provided a stable monthly income for life upon retirement.
But 401(k)-type retirement plans are not without downsides. Employers prefer defined contribution plans to defined benefit plans because they shift financial risk to beneficiaries. And as a general rule, they require that individuals make investment decisions that they’re not always equipped to make. With these downsides in mind, Rowland Davis and David Madland of the left-of-center Center for American Progress have called for what they call collective defined-contribution (CDC) plans. The CRFB summarized the concept as follows:
CAP’s SAFE Retirement Plan would instead pool contributions to spread risk around, in addition to having the plan be professionally managed so as to take advantage of better investment strategies than may be the case if individual investors were managing it. In addition, the fund would manage risk by having a flexible reserve fund; one added to when returns exceed a certain amount and depleted when returns are negative. The report’s actuarial analysis shows that the CDC plan would hypothetically have provided a much higher replacement rate for retirees than a “real-world” 401(k) and a slightly higher replacement rate than a theoretical perfectly managed 401(k). They also show that the CDC plan would be less risky, showing that it would have much better protected workers who retired during the Great Recession.
Smoothing investment returns is an attractive idea. What we don’t know is how expensive it will be in practice to maintain a flexible reserve fund. But if Davis and Madland are right and it is possible to create CDCs that offer greater income security than traditional 401(k)s, combining a right-of-center proposal (relying more heavily on private savings) and a left-of-center proposal (CDC plans that aim to mitigate risk) could make reforming retirement savings a more politically realistic prospect.