A lot can happen in a decade. Ten years ago, as air travelers tried to figure out if their water bottles violated the new 3.4-ounce rule and people added “tweet” to their lexicons, a 400-page piece of legislation called the Pension Protection Act (PPA) was signed into law and sparked a transformation of the U.S. retirement system.
This sweeping legislation established more transparency, stronger funding for pension plans, and new protections for defined contribution (DC) plans. While it worked its way through Congress, most of the debate and attention focused on the impact on defined benefit plans. However, looking back, it’s clear the resulting enhancements to DC plans were the true catalyst in creating a new era of retirement planning.
Prior to the PPA, DC plans operated under the assumption that employees would take the needed steps to build their retirement savings. Employees had to decide when to enroll in their plan, how much to save, and which investments were right for them. Some employees actively made good choices. Many did not. And the research of behavioral economists explained why.
For example, good intentions don’t always lead to action. As much as we may want to be better savers, we procrastinate. We get overwhelmed by too much information. We revert to the status quo. This is human nature, which is hard to fight. Policymakers applied these behavioral lessons to the PPA to make it easier for employees to join, save, and invest in their retirement plans.
With its endorsement of automatic plan features and qualified default investments, the PPA shifted the decisions of retirement planning from employees to employers. Companies were encouraged to automatically enroll employees at a predetermined savings rate and to invest their savings in a balanced, diversified fund. Although employees could adjust the employer-set defaults, their retirement vehicles were now more or less on autopilot.
Almost overnight, the retirement landscape began to change. First, enrollment numbers started to climb. In 2006, two-thirds of employees voluntarily joined their plan. Today, plans that use automatic enrollment have participation rates close to 90%.1 The biggest beneficiaries have been younger and low-income workers whose participation rates have more than doubled when their employers use automatic enrollment.
Second, employees’ investment portfolios became healthier thanks to the growing use of target-date funds. Before the PPA designated these all-in-one funds as qualified defaults, companies would steer employees to conservative investments—money market funds and stable value funds—that did little to help investors’ nest eggs grow. Target-date funds offered employees a new way to invest, with a portfolio of stocks and bonds that adjusts over time based on when they plan to retire. These funds are now available in almost every retirement plan, and as a result, the portion of participants holding balanced portfolios has grown from 42% to 70% over the last decade.¹
It’s time to build on this success
The retirement industry has come far in a very short period of time, but our work is not done. It’s time to build on the success of the past decade and address important challenges.
Let’s start by giving more Americans access to the benefits DC plans afford. Too many people are on their own when it comes to retirement. This is a national issue that requires federal action.
We need a PPA 2.0 that reaches underserved workers—small-business employees and contract, mobile, and part-time workers. Options such as open, multiple-employer plans can bridge the access gap, but we need to act now to move these promising ideas forward. Some states are trying to address retirement plan access in their own proposals, but this fragmented approach produces inconsistencies in quality and implementation. A federal solution is needed.
Further effort is also needed in helping Americans save more for retirement. One of the unintended consequences of the PPA was that default savings rates are often set too low. The law created a safe harbor for employers who deferred participants into their plans at a 3% savings rate with a 10% cap. With investment returns expected to be lower and people living longer, employees will need to accumulate more to sustain their standard of living in retirement. Retirement plans can help generate more savings by setting higher default rates—a minimum of 6% for example—and by enacting features that automatically raise that rate each year until employees are saving enough.
The 10-year anniversary of the PPA may not garner headlines like other world events, but it certainly is worth celebrating. Millions of Americans are headed toward a more secure retirement because their employers have taken the guesswork out of retirement planning. Looking ahead, let’s take the lessons learned over the last decade and make sure all Americans have the same chance to reach their retirement goals.
¹How America Saves 2016: Vanguard 2015 defined contribution plan data. Valley Forge, PA: The Vanguard Group.
- All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
- Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in the target-date fund is not guaranteed at any time, including on or after the target date.