Document Abstract
Published:
2009
Can 401(k) plans provide adequate retirement resources?
Are 401(k) pension plans really that unsuccessful?
Despite only having been in existence for 27 years – less than a typical working career – some analysts seem to have concluded that 401(k) plans are a failure.
401(k) plans were expected to be supplemental plans, used in conjunction with a defined benefit (DB) pension or a traditional defined contribution (DC) pension. Increasingly, employees are provided pension benefits solely through a 401(k) plan. This development has raised concerns that 401(k) plans alone do not provide adequate financial resources in retirement.
To assess these claims, this paper uses simulations to calculate the amount of retirement income that
could be generated by 401(k) participants with different levels of earnings using realistic assumptions of participant behavior, and to illustrate the amount of income that can be generated from both riskless and risky investments. Annuities are priced using actual market prices rather than assuming that actuarially fair annuities exist. Investment returns on risky assets account for investment fees, rather than assuming that the market return is available without any transaction costs. The simulations incorporate Social Security benefits and the replacement rate measures used to assess adequacy account for taxes and savings and are calculated for both renters and homeowners.
The author concludes that:
401(k) plans were expected to be supplemental plans, used in conjunction with a defined benefit (DB) pension or a traditional defined contribution (DC) pension. Increasingly, employees are provided pension benefits solely through a 401(k) plan. This development has raised concerns that 401(k) plans alone do not provide adequate financial resources in retirement.
To assess these claims, this paper uses simulations to calculate the amount of retirement income that
could be generated by 401(k) participants with different levels of earnings using realistic assumptions of participant behavior, and to illustrate the amount of income that can be generated from both riskless and risky investments. Annuities are priced using actual market prices rather than assuming that actuarially fair annuities exist. Investment returns on risky assets account for investment fees, rather than assuming that the market return is available without any transaction costs. The simulations incorporate Social Security benefits and the replacement rate measures used to assess adequacy account for taxes and savings and are calculated for both renters and homeowners.
The author concludes that:
- moderate 401(k) contribution rates can lead to adequate income replacement rates in retirement for many workers
- adequate asset accumulation can be achieved using only a 401(k) plan
- these results do not rely on earning an investment premium on risky assets
