Study Asserts 401(k) Plans Can Be Enough

At a time when some complain that the 401(k) plan has lost its effectiveness as a retirement savings vehicle, a new academic study suggests many participants can actually do fine financially relying just on their workplace plan.

The study, by Investment Company Institute researcher Peter J. Brady for the Pension Research Council at The Wharton School at the University of Pennsylvania, concluded that “moderate 401(k) contribution rates can lead to adequate income replacement rates in retirement for many workers; that adequate asset accumulation can be achieved using only a 401(k) plan; and that these results do not rely on earning an investment premium on risky assets.”

Brady admits risky assets will make a difference. For example, with baseline assumptions, a single female with earnings comparable to median earnings for workers with a bachelor’s degree would replace 87% of pre-retirement net income in retirement. If she instead invested in risky assets, she would expect to increase her net income in retirement by nearly 20%, according to the report.

However, because Social Security provides the bulk of most individual’s retirement income and represents a floor beneath which retirement income cannot fall, the risk as a percentage of total retirement assets is not as large as would be suggested by examining the 401(k) plan distributions separately, Brady said in the report.

Studying Different Scenarios

According to a report about the study, “Can 401(k) Plans Provide Adequate Retirement Resources?”, Brady constructs representative earnings paths for individuals and married couples that roughly represent median earnings for workers with a high school degree, a bachelor’s degree, and a graduate degree; and a fourth earnings path is created that is one-third higher than median graduate degree earnings.

Depending on income, assumed total contributions rates to the 401(k) account, including employer contributions, range from 4% of income to 10% of income. Contributions to the accounts begin at age 32 for the highest earners and at age 52 for the lowest earners.

Income in retirement consists of Social Security benefits and income generated by the 401(k) plan account. According to the report, Brady’s baseline scenario has 401(k) participants investing in Treasury Inflation-Protected Securities (TIPS) securities that provide a real yield of 2.4% and, at the time of retirement, using accumulated assets to purchase an annuity in the private market.

Brady’s hypothetical risky portfolio has half large corporate stocks and one-half corporate bonds, with the portfolio rebalanced annually, the report says.

The report is available here.