Employer-sponsored pensions fall into two major categories: defined benefit (DB) and defined contribution (DC) plans. In DB, or traditional, plans, benefits are typically set by formula, with workers receiving benefits upon retirement based on the number of years worked for a firm and earnings in years prior to retirement. In DC plans, workers accumulate savings through contributions to an individual account. These accounts are tax-advantaged in that contributions are typically excluded from current income, and earnings on balances grow tax-deferred until they are withdrawn. An employer may also make contributions, either by matching employee’s contributions up to plan or legal limits, or on a non- contingent basis. Like DB plans, DC plans operate in a voluntary system with tax incentives for employers to offer a plan and for employees to participate. Contributions to and earnings on DC plan accounts are not taxed until the participant withdraws the money, although participants making withdrawals prior to age 59 ½ may incur an additional 10 percent tax. In 2006, the pension tax expenditure for DC plans amounted to $54 billion. In addition, a nonrefundable tax credit to qualifying low-and middle-income workers who make contributions, the saver’s credit, accounted for less than 2 percent of the 2006 tax expenditure on account-based retirement plans. DC plans offer workers more control over their retirement asset management, but also shift some of the responsibility and certain risks onto workers. Workers generally must elect to participate in a plan and make regular contributions into their plans over their careers. Participants typically choose how to invest plan assets from a range of options provided under their plan, and accordingly face investment risk. Savings in DC plans are portable in the sense that a participant may keep plan balances in a tax-protected account upon leaving a job, either by rolling over plan balances into a new plan or an IRA, or in some cases leaving money in an old plan. Workers may have access to plan savings prior to retirement, either through loans or withdrawals; participants may find such features desirable, but pre-retirement access may also lead to lower retirement savings (sometimes referred to as leakage) and possible tax penalties. Workers who receive DC distributions in lump-sum form must manage account withdrawals such that their savings last throughout retirement. In contrast, a formula, often based on preretirement average pay and years of service, determines DB plan benefits, and workers are usually automatically enrolled in a plan. The employer has the responsibility to ensure that the plan has sufficient funding to pay promised benefits, although the sponsor can choose to terminate the plan. DB plans also typically offer the option to take benefits as a lifetime annuity, or periodic benefits until death. An annuity provides longevity insurance against outliving one’s savings, but may lose purchasing power if benefits do not rise with inflation. Table 1 summarizes some of the primary differences between DC and DB plans. Over the past 25 years, DC plans have become the dominant type of private sector employee pension. In 1980, private DB plans had 38 million participants, while DC plans had 20 million. As of 2004, 64.6 million participants had DC plans, while 41.7 million had DB plans. Further, over 80 percent of private sector DC participants in 2004 were active participants (in a plan with their current employer), while about half of DB participants had separated from their sponsoring employer or retired. According to the Employee Benefit Research Institute (EBRI), while overall pension coverage among families remained around 40 percent between 1992 and 2001, 38 percent of families with a pension relied exclusively on a DC plan for retirement coverage in 1992, while 62 percent had a DB plan. In 2001, 58 percent of pension-participating families had only a DC plan, while 42 percent had a DB plan. Assets in all DB plans exceeded total DC assets as recently as 1995. As of 2006, DC plans had almost $3.3 trillion in assets while DB plans had almost $2.3 trillion. In addition, assets in IRAs, accounts that are also tax protected and include assets from rolled-over balances from employer-sponsored plans, measured over $4.2 trillion in 2006. There are several different categories of DC plans. Most of these plans are types of cash or deferred arrangements (CODA), in which employees can direct pre-tax dollars, along with any employer contributions, into an account, with assets growing tax deferred until withdrawal. The 401(k) plan is the most common, covering over 85 percent of active DC participants. Certain types of tax-exempt employers may offer plans, such as 403(b) or 457 plans, which have many features similar to 401(k) plans. Many employers match employee contributions, generally based on a specified percentage of the employee’s salary and the rate at which the participant contributes. Small business owners may offer employees a Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) or a Simplified Employee Pension Plan (SEP), two types of DC plans that have reduced regulatory requirements for sponsors. Other types of DC plans keep the basic individual account structure of the 401(k), but with different requirements and employer practices. Some are designed primarily for employer contributions. These include money purchase plans, which specify fixed annual employer contributions; profit sharing plans, in which the employer decides annual contributions, perhaps based on profits, into the plan, and allocations of these to each participant; and employee stock ownership plans (ESOPs), in which contributions are primarily invested in company stock. Building up retirement savings in DC plans rests on factors that are, to some degree, outside of the control of the individual worker, as well as behaviors an individual does control (see fig. 1). Factors outside the individual’s direct control include the following: Plan sponsorship—the employer’s decision to sponsor a plan, as well as participation eligibility rules. Employer contributions—whether the sponsor makes matching or noncontingent contributions. Investment options—the plan sponsor’s decisions about investment options to offer to participants under the plan. Market returns on plan assets—market performance of plan assets. Key individual decisions and behaviors that may affect retirement savings include the following: Employee contributions—deposits into the plan account, typically out of current wages. Investment decisions—how to invest plan assets given investment options offered under the plan. balances, which usually incur a tax penalty. Similarly, taking out a loan from a plan, if allowed, may reduce future balances if the loan is not repaid in full and treated as a withdrawal, or by lowering investment returns. Rollover—upon separation from a job, a participant may transfer the plan account balance to an IRA, which maintains most of the same tax preferences on the balances, move it to a new tax-qualified plan, or leave the money in the old plan. Alternatively, any cash withdrawal would likely be subject to income tax and penalties. Age at retirement—the decision as to when to retire determines how many years the worker has to accumulate plan balances and how long the money has to last in retirement. There is little consensus about how much constitutes “enough” savings to have going into retirement. We may define retirement income adequacy relative to a standard of minimum needs, such as the poverty rate, or to the consumption spending that households experienced during working years. Some economists and financial advisors consider retirement income adequate if the ratio of retirement income to pre-retirement income—or replacement rate—is between 65 and 85 percent. Retirees may not need 100 percent of pre-retirement income to maintain living standards for several reasons. Retirees will no longer need to save for retirement, retirees’ payroll and income tax liability will likely fall, work expenses will no longer be required, and mortgages and children’s education and other costs may have been paid off. However, some researchers cite uncertainties about future health care costs and future Social Security benefit levels as reasons to suggest that a higher replacement rate, perhaps above 100 percent or higher, would be considered adequate. To achieve adequate replacement rate levels, retirees depend on different sources of income to support themselves in retirement. Social Security benefits provide the bulk of retirement benefits for most households. As of 2004, annuitized pension benefits provided almost 20 percent of total income to households with someone age 65 or older, while Social Security benefits provided 39 percent. Social Security benefits compose over 50 percent of total income for two-thirds of households with someone age 65 or older, and at least 90 percent of income for one-third of such households. Table 2 shows estimated replacement rates from Social Security benefits for low and high earners retiring in 2007 and 2055, as well as the remaining amount of pre-retirement income necessary to achieve a 75 percent replacement rate. These figures give rough guidelines for how much retirement income workers might need from other sources, such as employer-sponsored pensions, as well as earnings and income from other savings or assets. It is important to keep certain economic principles in mind when evaluating the effectiveness of retirement accounts, or any pensions, in providing retirement income security. First, balances accumulated in a DC plan may not represent new saving; individuals may have saved in another type of account in the absence of a DC plan or its tax preferences. Second, evaluating worker income security should consider total compensation, not just employer contributions to DC plans. All else equal, we should generally expect more generous employer-sponsored pension benefits to lower cash wages and that the split between current wages and deferred compensation is largely a reflection of labor market conditions, tax provisions, and worker and employer preferences. Many workers do not have DC plans, and median savings levels among participants show modest balances. While it is worth noting that for workers nearing retirement age, DC plans were not considered primary pension plans for a significant portion of their working careers, participation rates and median balances in such plans are low across all ages. Only 36 percent of working individuals were actively participating in a DC plan, according to data from the 2004 SCF. Further, workers aged 55 to 64 had median balances totaling $50,000 in account-based retirement savings vehicles, including DC plans and rollover accounts. Leakage, when workers withdraw DC savings before retirement age, can also reduce balances; almost half of those taking lump-sum distributions upon leaving a job reported cashing out their balances for non-retirement purposes. Participation among lower-income workers was particularly limited, and those who did have accounts had very low balances. The majority of workers, in all age groups, are not participating in DC plans with their current employers. Employers do not always offer retirement plans, and when they do, plans may have eligibility restrictions initially, and some eligible workers do not choose to participate. According to our analysis of the 2004 SCF, only 62 percent of workers were offered a retirement plan by their employer, and 84 percent of those offered a retirement plan participated. Only 36 percent of working individuals participated in a DC plan with their current employer (see fig. 2). Data indicated similar participation rates for working households, as 42 percent of households had at least one member with a current DC plan. For many workers who participated in a plan, overall balances in DC plans were modest, suggesting a potentially small contribution toward retirement security for most plan participants and their households. However, since DC plans were less common before the 1980s, older workers would not have had access to these plans their whole careers. In order to approximate lifetime DC balances when discussing mean and median DC balances in this report, our analysis of the 2004 SCF aggregates the “total balances” of DC plans with a current employer, DC plans with former employers that have been left with the former employer, and any retirement plans with former employers that have been rolled over into a new plan or an IRA. Workers with a “current or former DC plan” refers to current workers with one or more of those three components. For all workers with a current or former DC plan, the median total balance was $22,800. For all households with a current or former DC plan, the median total balance was $27,940 (see fig. 3). For individuals nearing retirement age, total DC plan balances are still low. Given trends in coverage since the 1980’s, older workers close to retirement age are more likely than younger ones to have accrued retirement benefits in a DB plan. However, older workers who will rely on DC plans for retirement income may not have time to substantially increase their total savings without extending their working careers, perhaps for several years. Among all workers aged 55 to 64 with a current or former DC plan, the median balance according to the 2004 SCF was $50,000, which would provide an income of about $4,400 a year, replacing about 9 percent of income for the average worker in this group. Among all workers aged 60 to 64 with a current or former DC plan, the median balance was $60,600 for their accounts. Markedly higher values for mean balances versus median balances in figure 3 illustrate that some individuals in every age group are successfully saving far more than the typical individual, increasing the mean savings. These are primarily individuals at the highest levels of income. Leakage, or cashing out accumulated retirement savings for non- retirement purposes, adversely affects account accumulation for some of those with accounts, particularly for lower-income workers with small account balances. Participants who withdraw money from a DC plan before age 59 ½ generally pay ordinary income taxes on the distributions, plus an additional 10 percent tax in most circumstances. Participants may roll their DC plan balances into another tax-preferred account when they leave a job, and employers are required, in the absence of participant direction, to automatically roll DC account distributions greater than $1,000 but not greater than $5,000 into an IRA, or to leave the money in the plan. As of 2004, 21 percent of households in which the head of household was under 59, had ever received lump-sum distributions from previous jobs’ retirement plans. Among these households that received lump-sum distributions, 47 percent had cashed out all the funds, 4 percent cashed out some of the funds, and 50 percent preserved all the funds by rolling them over into another retirement account. Workers were more likely to roll over funds when the balances are greater. Among households that had cashed out all retirement plans with former employers, the median total value of those funds was $6,800. For households that had rolled over all retirement plans with former employers, the median total value of rolled- over funds was $24,200. Some evidence suggests that pre-retirement withdrawals may be decreasing. One study finds that those receiving lump-sum distributions are more likely to preserve funds in tax-qualified accounts than they were in the past. For example, data show that in 1993, 19 percent of lump-sum distributions recipients preserved all of their savings by rolling them into a tax-qualified account, compared to 43 percent in 2003. Further, 23 percent used all of their distribution for consumption in 1993, declining to 15 percent in 2003 (see fig. 4). According to the same study, age and size of the distribution are major determinants of whether or not the distribution is preserved in a tax-qualified account. For example, the authors found 55.5 percent of recipients aged 51 to 60 rolled their entire distribution in a tax-qualified account compared with 32.7 percent of recipients 21 to 30. Additionally, 19.9 percent of distributions from $1 to $499 were rolled over in tax-qualified accounts, as opposed to 68.1 percent of distributions of $50,000 or more. Additionally, some participants take loans from their DC plan, which may reduce plan savings. One survey found that in 2005, 85.2 percent of employers surveyed offered a loan option. Most eligible participants do not take loans, and one analysis finds that at the year end 2006, loans amounted to 12 percent of account balances for those who had loans. Individuals may prefer to take out pension loans in lieu of other lines of credit because pension loans require no approval and have low or no transaction costs. Borrowers also pay the loan principal and interest back to their own accounts. However, someone borrowing from a DC plan may still lose money if the interest on the loan paid back to the account is less than the account balance would have earned if the loan had not been taken. Further, loans not paid back in time, or not paid back before the employee leaves the job, may be subject to early withdrawal penalties. No data have been reported on the rate of loan defaults, but it is expected to be much lower where repayments are made by payroll withholding. However, a loan feature may also have a positive effect on participation, as some workers may choose to participate who otherwise might not, precisely because they can borrow from their accounts for non-retirement purposes at relatively low interest rates. Among workers in the lowest income quartile, only 8 percent participated in a current DC plan, a result of markedly lower access as well as lower participation than the average worker (see fig. 5). Only 25 percent of workers in the lowest income quartile were offered any type of retirement plan by their employer, and among those offered a retirement plan, 60 percent elected to participate, compared with 84 percent among workers of all income levels. Workers in the lower half of the income distribution with either current or former DC plans had total median balances of $9,420. Older workers who were less wealthy also had limited retirement savings. Workers with a current or former DC plan, aged 50-59 and at or below the median level of wealth, had median total savings of only $13,800. Workers with a current or former DC plan, aged 60-64 and at or below the median level of wealth, had median total savings of $18,000, a level that could provide at best only a limited supplement to retirement income. If converted into a single life annuity at age 65, this balance would provide only $132 per month—about $1,600 per year. Notably, workers with low DC balances were actually less likely to have a DB pension to fall back on than workers with higher DC balances. Among all workers participating in current or former DC plans, only 17 percent of those in the bottom quartile for total plan savings also were covered by a current DB plan. In contrast, 32 percent of those in the top quartile for total DC savings also had DB coverage. Among all workers with a current or former DC plan, the plan balances for those with DB coverage were higher than for those without DB coverage. The median DC balance for workers with a DB account was $31,560, while the median DC balance for someone without a DB account was $20,820. Simulations of projected retirement savings in DC plans suggest that a large percentage of workers may accumulate enough over their careers to replace only a small fraction of their working income, although results vary widely by income levels and depend on model assumptions. Projected savings allow us to analyze how much workers might save over a full working career under a variety of conditions in a way that analyzing current plan balances cannot, since DC plans have become primary employer-sponsored plans only relatively recently. Baseline simulations of projected retirement savings for a hypothetical 1990 birth cohort indicate that DC plan savings would on average replace about 22 percent of annualized career earnings, but provide no savings to almost 37 percent of the working population, perhaps because of different factors — working for employers who do not offer a plan, choosing not to participate, or withdrawing any accumulated plan savings prior to retirement. Further, projected DC account balances vary widely by income quartile, with workers in the lowest-income quartile saving enough for about a 10 percent replacement rate, while those in the highest quartile saving enough for a 34 percent replacement rate, on average. Assuming changes in certain plan features, individual behavior, or market assumptions, such as increased participation or account rollover rates, increased projected average savings and increased the number of workers who had some DC plan savings at retirement, especially for low-income workers. Other scenarios, such as assuming higher contribution limits or delaying retirement, raised average replacement rates, but with more of the positive impact on higher-income workers and having little effect on reducing the number of workers with no savings at retirement. Our projections, based on a sample of workers born in 1990, show that workers would save enough in their DC plans over their careers to produce, when converted to a lifetime annuity at the time of retirement, an average of $18,784 per year in 2007 dollars (see table 3). The projections assume that all workers fully annuitize all accumulated DC plans balances at retirement, which occurs sometime between age 62 and 70. Participants are assumed to always invest all plan assets in life cycle funds, and stocks earn an average real annual return of 6.4 percent. This $18,784 annuity would replace, on average, 22.2 percent of annualized career earnings for workers in the cohort. Savings and replacement rates vary widely across income groups. Almost 37 percent of workers in this cohort have no projected DC plan savings at retirement, which brings down overall average replacement rates. Workers in the lowest income quartile accumulate DC plan savings equivalent to an annuity of about $1,850 per year, or a 10.3 percent replacement rate, and 63 percent of this group have no plan savings by the time they retire. In contrast, highest income quartile workers save enough to receive about $50,000 per year in annuity income, enough for a 33.8 percent replacement rate. Even in this highest-income group, over 16 percent of workers have zero plan savings at retirement. In all cases, our replacement rates include projected savings only in DC plans. Retirees may also receive benefits from DB plans, as well as from Social Security, which typically replaces a higher percentage of earnings for lower-income workers. Projected household-level plan savings show a higher average replacement rate of 33.8 percent, with about 29 percent of households having no plan savings at retirement. When we assume that plan assets earn a lower average real annual return of 2.9 percent, average replacement rates from DC plan savings fall to about 16 percent for the sample. Under this assumption, workers in the lowest-income quartile receive an average 7.1 percent replacement rate from DC plans, while highest-income quartile workers receive an average 25 percent replacement rate. Lower rates of return affect the percentage of workers with no accumulated DC plan savings only slightly, perhaps because on the margins some participants might choose (or have their employers choose) to cash out lower balances. Table 3 also shows savings statistics for sub-samples of the cohort who have a better chance of accumulating significant DC plan savings, such as those workers who have long-term eligibility to participate in a plan or who work for many years. As expected, these groups have higher projected savings; replacement rates also show more even distribution across income groups, compared to those in the full sample. However, we still see a significant portion of the workers with no DC savings at retirement. First, we limit the sample only to those workers who are eligible to participate in a plan for at least 15 years over their careers. Average replacement rates for this group measure 33.5 percent, with rates ranging from 21.7 percent for lowest income quartile workers to 42.3 percent for the highest quartile. Even with such long-term eligibility for plan coverage, however, 15.6 percent of these workers, and almost one- third of lowest-income workers, have nothing saved in DC plans at the time they retire. This could result from workers choosing not to participate or from cashing out plan balances prior to retirement. We also analyze the prospects of workers with long-term attachment to the labor market, for which we use people who work full-time for at least 25 years, without regard to plan coverage or participation. Among these workers, average DC plan savings at retirement account for a 26.5 percent replacement rate. Still, almost 29 percent of these workers have no projected savings. This suggests that while DC plans have the potential to provide significant retirement income, saving may be difficult for some workers who work for many years, even among those whose employers offer a plan. Our simulations indicate that increasing participation and reducing leakage out of DC plans may have a particularly significant impact on overall savings, especially for lower-income workers. Of the changes in the model assumptions that we simulated, these had the broadest effect on savings because they not only raised average savings for the entire sample, but had a relatively strong impact on workers in the lowest income quartile and on the number of workers with no DC plan savings at retirement. While these assumptions represent stylized scenarios, they illustrate the potential effect of such changes on savings. We project DC plan savings assuming that all employees of a firm that sponsors a DC plan participate immediately, rather than having to wait for eligibility or choosing not to participate. In our baseline projections, 6 percent of workers whose employers sponsor a plan are ineligible to participate, and 33 percent of those eligible do not choose to participate; therefore, this assumption significantly raises plan participation rates among workers. Accordingly, average DC savings rise by almost 40 percent, raising average replacement rates to 35 percent, and the percentage of the population with no savings at retirement drops by half, down to 17.7 percent (see table 4). Assuming automatic eligibility and participation raises projected plan savings significantly for lower-wage workers, more than doubling the annuity equivalent of retirement savings for the lowest-income quartile. Workers in the highest income group also increase savings under this scenario, with plan savings rising by 30 percent. This change in projected savings suggests that automatically enrolling new employees in plans as a default could have a significant positive impact on DC balances, especially for low-income workers whose jobs offer a plan, although this stylized scenario likely describes a more extreme change in eligibility and participation than plans are likely to implement under automatic enrollment, and that higher participation and savings would raise employer’s pension costs, perhaps leading to a reduction in benefits or coverage. Another stylized scenario we model assumes that all workers who have a DC plan balance always keep the money in a tax-preferred account upon leaving a job, either by keeping the money in the plan, transferring it to a new employer plan, or rolling it into an IRA, rather than cashing out any accumulated savings. Eliminating this source of leakage raises average annuity income from DC plans by almost 11 percent and average replacement rates from 22.2 percent in the baseline to 25.6 percent; it also reduces the percentage of the cohort with no DC savings at retirement by over 25 percent. As with the instant participation scenario, “universal rollover” raises annuity savings and reduces the number of retirees with zero plan savings by the biggest percentages among lower-income workers, suggesting that cashing out accumulate plan savings prior to retirement may be a more significant drain on retirement savings for these groups. These results indicate that policies to encourage participants to keep DC plan balances in tax-preferred retirement accounts, perhaps by making rollover of plan assets a default action in plans, may have a broad positive impact on retirement savings. Other changes we make in our projections related to plan features or individual behavior affect average replacement rates overall, but with less impact on lower-income workers’ replacement rates and on the number of workers with zero plan savings at retirement. These scenarios include assumed changes in annual contribution limits and retirement decisions (see table 5). We model projected retirement savings assuming that annual DC contribution limits for employees rise from $15,500 to $25,000, and the combined employer-employee maximum contribution level rises from $45,000 to $60,000, starting in 2007. Higher annual maximum contributions affect projected savings almost exclusively among the highest-income group, indicating that few workers earning less are likely to contribute at existing maximum levels. The highest income quartile replacement rises from 33.8 to 38.5 percent, while replacement rates hardly change in the lower income groups. Similarly, this scenario has almost no impact on the percentage of workers with DC plan savings at retirement. Finally, we model retirement savings in two scenarios in which workers delay retirement by 1 or 3 years. Encouraging workers to retire later has been suggested as a key element in improving retirement income security, by increasing earnings, allowing more time to save for retirement, and reducing the length of retirement. In our projections, delaying retirement not only provides more years to contribute to and earn returns on plan balances but also might raise annual retirement income because older retirees receive more annuity income for any given level of savings, holding all else equal. In our projections, working longer modestly raises retirement savings in our projections. Working one extra year changes projected annuity income by 5.8 percent, but has little effect on the percentage of people with no DC savings in our projections. Delaying retirement by 3 years raises annuity income from DC plans by 20.9 percent on average, with replacement rates rising from 22.2 percent in the baseline to 25.7 percent overall. The 3-year delay increases annuity levels somewhat evenly across income groups, with higher-income workers showing slightly higher increases. Overall, working an extra 3 years raises average replacement rates about as much as universal account rollover would, but with little reduction in workers with no retirement savings. Thus, while working longer would likely raise workers’ incomes, and in most cases retirement benefits from other sources such as Social Security, our projections show that this change alone would have a modest impact on retirement income from DC plans, particularly regarding lower-income workers and those not already saving in DC plans in the baseline. Recent regulatory and legislative changes and proposals could have positive effects on DC plan coverage, participation, and saving. The Pension Protection Act of 2006 (PPA) facilitated the adoption of automatic plan features by plan sponsors that may increase DC participation and savings within existing plans. Proposals to expand the saver’s credit could similarly encourage greater contributions by low-wage workers who are already covered by a DC plan. Other options, like the so-called “State- K” proposal, in which states would design and partner with private financial institutions to offer low-cost DC plans employers could provide to employees, would seek to expand coverage among workers without current plans by encouraging employers to sponsor new plans. Other options would try to increase retirement account coverage by increasing the use of IRAs or creating new retirement savings vehicles outside of the voluntary employer-sponsored pension framework. Such proposals include automatic IRAs, in which employers would be required to allow employees through automatic enrollment to contribute to IRAs by direct payroll deposit, or universal accounts proposals, in which all workers would be given a retirement account regardless of whether they had any employment based pension coverage. Changing certain traditional DC plan defaults may have a significant impact on DC participation and savings. Research suggests that employees exhibit inertia regarding plan participation and contributions, which can reduce DC savings by failure to participate or increase savings over time. To reverse the effects of these tendencies, some experts have suggested changing default plan actions to automatically sign up employees for participation, escalate contributions, and set default investment options unless workers opt out. Some studies have shown that automatic enrollment may increase DC plan participation. For example, one study of a large firm, automatic enrollment increased participation from 57 percent for employees eligible to participate 1 year before the firm adopted automatic enrollment to 86 percent for those hired under automatic enrollment. Another study finds that, prior to automatic enrollment, 26 to 43 percent of employees at 6 months’ tenure participated in the plan at three different companies; under automatic enrollment 86 to 96 percent of employees participated. Some also advocate automatically rolling over DC savings into an IRA when employees separate from their employers to further increase retirement savings. Our own simulations shows that universal account rollover to a tax-preferred account, such as a new plan or an IRA, would increase projected retirement savings by 11 percent on average, with the biggest percentage increases for lowest-income workers. Various regulatory and legislative changes have focused on default DC plan features. In 1998, the IRS first approved plan sponsor use of automatic enrollment—the ability for plans to automatically sign employees up for a 401(k) plan (from which the employee can opt out), and—subsequently issued several rulings that clarified the use of other automatic plan features and the permissibility of automatic features in 403(b) and 457 plans. Accordingly, the percentage of 401(k) plans using automatic plan features has increased in recent years. One annual study of plan sponsors found that in 2004, 12.4 percent of 401(k) plans were automatically enrolling participants, and this number increased to 17.5 percent of plans in 2005. The percentage of plans automatically increasing employee contributions also rose from 6.8 percent in 2004 to 13.6 percent in 2005. Some experts have argued that initially, some plan sponsors may have been hesitant to use automatic plan features because of legal ambiguities between state and federal law. However, clarifications relating to automatic enrollment and default investment in the PPA have led some plan sponsors and experts to expect more plans to adopt automatic plan features. Automatic DC plan features, however, may create complications for sponsors and participants that may limit any effect on savings and participation. Auto enrollment may not help expand plan sponsorship; in fact, sponsors who offer a matching contribution may not want to offer automatic enrollment if they believe this will raise their pension costs. Also, if sponsors automatically invest contributions in a low-risk fund such as a money market fund, this could limit rates of return on balances. However, choosing a risky investment fund could subject automatic contributions to market losses. Some employees may not realize they have been signed up for a plan, and may be displeased to discover this, particularly if their automatically invested contributions have lost money. Other proposals would target plan formation or increase participation and retirement savings by expanding worker access to other account-based retirement savings vehicles like IRAs. Some of these alternative retirement savings proposals are voluntary in design, while others are more universal. Gen. Assem., Reg. Sess. (Md. 2006). employee access to account-based retirement plans. However, it is unclear to what extent employers would adopt such plans. The Automatic IRA: The Automatic IRA proposal would make direct deposit or payroll deduction saving into an IRA available to all employees by requiring employers that do not sponsor any retirement plan to offer withholding to facilitate employee contributions. To maximize participation, employees would be automatically enrolled at 3 percent of pay, or could elect to opt out or to defer a different percentage of pay to an IRA, up to the maximum IRA annual contribution limit ($4,000 for 2007; $5,000 for 2008). Employers would not be required choose investments or set up the IRAs, which would be provided mainly by the private-sector IRA trustees and custodians that currently provide them. Employers also would not be required or permitted to make matching contributions, and would not need to comply with the Employee Retirement Income Security Act of 1974 (ERISA) or any qualified plan standards such as non- discrimination requirements. Employers, however, would be required to provide notice to employees, including information on the maximum amount that can be contributed to the plan on an annual basis. One congressional proposal would require employers, other than small or new ones, to offer payroll deposit IRA arrangements to employees not eligible for pension plans and permit automatic enrollment in such IRAs in many circumstances. Participating IRAs would be required to offer a default investment consisting of life cycle funds similar to those offered by the Thrift Savings Plan, the DC plan for federal workers, or other investments specified by a new entity established for that purpose. Universal accounts: Similar to the automatic IRA, universal account (UA) proposals aim to establish retirement savings accounts for all workers, and vary slightly based on employment-based pension access. Additionally, some proposals would have employers contribute to the account, whereas other proposals would also have the federal government match contributions. One proposal suggests a 2 percent annual contribution from the federal government regardless of individual contributions, while another would provide for individual contributions only, capped at $7,500 per year. In 1999, the Clinton Administration proposed a UA to be established for each worker and spouse with earnings of at least $5,000 annually. Individuals would receive a tax credit of up to $300 annually. Additionally, workers could voluntarily contribute to the account up to specified amounts with a 50 to 100 percent match by the federal government. This match would come in the form of a tax credit, and total voluntary contributions, including government contributions, would be limited to $1,000. Both the credit and the match would phase out as income increases, providing a progressive benefit and targeting low- and middle-income workers. Federal contributions would have revenue implications, while requiring employer contributions could increase employer compensation costs. Other proposals would expand the size and scope of the saver’s credit to encourage greater contributions by those low-wage workers who are already covered by a DC plan that allows employee contributions. Currently, the saver’s credit, originally proposed in 2000 as an outgrowth of the 1999 UA proposal as a government matching deposit on some voluntary contributions to IRAs and 401(k) plans, provides a nonrefundable tax credit to low- and middle-income savers of up to 50 percent of their annual IRA or 401(k) contributions of up to $2,000. However, according to one analysis, because the credit is nonrefundable, only about 17 percent of those with incomes low enough to qualify for the credit would receive any benefit if they contributed to a plan. Some analysts think that expanding the saver’s credit, or creating direct transfers such as tax rebates or deposits into retirement savings accounts, could increase plan contributions specifically for low- and middle-income workers. Making the saver’s credit refundable to the participant could also provide a direct transfer to the tax filer in lieu of a retirement account match, but offers no assurance that funds would be saved or deposited into a retirement account. A refundable tax credit would also have revenue implications for the federal budget. The DC plan has clearly overtaken the DB plan as the principal retirement plan for the nation’s private sector workforce, and its growing dominance suggests its increasingly crucial role in the retirement security of current and future generations of workers. The current DC-based system faces major challenges, like its DB-based predecessor, in terms of coverage, participation, and lifetime distributions. Achieving retirement security through DC plans carries particular challenges for workers, since accumulating benefits in an account-based plan requires more active commitment and management from individuals than it does for DB participants. Since workers must typically sign up and voluntarily reduce their take home pay to contribute to their DC plans, invest this money wisely over their working years, and resist withdrawing from balances prior to retirement, it is perhaps to be expected that even those who have the opportunity to participate save little. While our results on both current and projected plan balances suggest that while some workers save significant amounts toward their retirement in DC plans, a large proportion of workers will likely not save enough in DC plans for a secure retirement. Of particular concern are the retirement income challenges faced by lower earners. Many of these workers face competing income demands for basic necessities that may make contributions to their retirement plans difficult. Further, the tax preferences that may entice higher-income workers to contribute to their DC plans may not entice low-income workers who have plan coverage, since these workers face relatively low marginal tax rates. Our model results suggest that other measures, such as automatic enrollment and rollover of funds may make a difference for some lower income workers. Should pension policy, as embodied by the automatic provisions in PPA, continue to move in this direction, it should focus on those workers most in need of enhanced retirement income prospects. We provided a draft of this report to the Department of Labor and the Department of the Treasury, as well as to five outside reviewers. Neither agency provided formal comments. We incorporated any technical comments we received throughout the report as appropriate. As agreed with your office, unless you publicly announce its contents earlier, we plan no further distribution until 30 days after the date of this letter. At that time, we will send copies of this report to the Secretary of Labor, the Secretary of the Treasury, appropriate congressional committees, and other interested parties. We will also make copies available to others upon request. In addition, the report will be available at no charge on GAO’s website at http://www.gao.gov. If you have any questions concerning this report, please contact Barbara Bovbjerg at (202) 512-7215. Contact points for our Office of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III. To analyze saving in DC plans, we examined data from the Federal Reserve Board’s Survey of Consumer Finances (SCF). This triennial survey asks extensive questions about household income and wealth components. We used the latest available survey, from 2004. The SCF is widely used by the research community, is continually vetted by the Federal Reserve and users, and is considered to be a reliable data source. The SCF is believed by many to be the best source of publicly available information on household finances. Further information about our use of the SCF, including sampling errors, as well as definitions and assumptions we made in our analysis are detailed below. We also reviewed published statistics in articles by public policy groups and in academic studies. To analyze how much Americans can expect to save in DC plans over their careers and the factors that affect these savings, we used the Policy Simulation Group’s (PSG) microsimulation models to run various simulations of workers saving over a working career, changing various inputs to model different scenarios that affect savings at retirement. PENSIM is a pension policy simulation model that has been developed for the Department of Labor to analyze lifetime coverage and adequacy issues related to employer-sponsored pensions in the United States. We projected account balances at retirement for PENSIM-generated workers under different scenarios representing different pension features, individual behavioral decisions, and market assumptions. See below for further discussion of PENSIM and our assumptions and methodologies. To analyze those plan- or government-level policies that might best increase participation and savings in DC plans, we synthesized information gathered from interviews of plan practitioners, financial managers, and public policy experts, as well as from academic and policy studies on DC plan participation and savings. We also researched current government initiatives and policy proposals to broaden participation in account-based pension plans and increase retirement savings. We conducted our work from July 2006 to October 2007 in accordance with generally accepted government auditing standards. The 2004 SCF surveyed 4,522 households about their pensions, incomes, labor force participation, asset holdings and debts, use of financial services, and demographic information. The SCF is conducted using a dual-frame sample design. One part of the design is a standard, multi-stage area-probability design, while the second part is a special oversample of relatively wealthy households. This is done in order to accurately capture financial information about the population at large as well as characteristics specific to the relatively wealthy. The two parts of the sample are adjusted for sample nonresponse and combined using weights to provide a representation of households overall. In addition, the SCF excludes people included in the Forbes Magazine list of the 400 wealthiest people in the United States. Furthermore, the 2004 SCF dropped three observations from the public data set that had net worth at least equal to the minimum level needed to qualify for the Forbes list. The SCF is a probability sample based on random selections, so the 2004 SCF sample is only one of a large number of samples that might have been drawn. Since each sample could have provided different estimates, we express our confidence in the precision of our particular sample’s results as a 95 percent confidence interval (e.g., plus or minus 4 percentage points). This is the interval that would contain the actual population value for 95 percent of the samples we could have drawn. As a result, we are 95 percent confident that each of the confidence intervals in this report will include the true values in the study population. All percentage estimates based on GAO analysis of 2004 SCF data used in this report have 95 percent confidence intervals that are within plus-or- minus 4 percentage points, with the following exceptions described in table 6 below. Other numerical estimates based on GAO analysis of 2004 SCF data used in this report have 95 percent confidence intervals that are within 25 percent of the estimate itself, with exceptions described in table 7. Because of the complexity of the SCF design and the need to suppress some detailed sample design information to maintain confidentiality of respondents, standard procedures for estimate of sampling errors could not be used. Further, the SCF uses multiple imputations to estimate responses to most survey questions to which respondents did not provide answers. Sampling error estimates for this report are based on a bootstrap technique using replicate weights to produce estimates of sampling error that account for both the variability due to sampling and due to imputation. The SCF collects detailed information about an economically dominant single individual or couple in a household (what the SCF calls a primary economic unit), where the individuals are at least 18 years old. We created an additional sample containing information on 7,471 individuals by separating information about respondents and their spouses or partners and considering them separately. When we discuss individuals in this document, we are referring to this sample. When we refer to all workers, we are referring to the subpopulation of workers within this individual sample. In households where there are additional adult workers, beyond the respondent and the spouse or partner, who may also have earnings and a retirement plan, information about these additional workers is not captured by the SCF and is therefore not part of our analysis. It is also important to note that the SCF was designed to be used as a household survey, and some information could not be broken into individual-level information. Where that was the case, we presented only household-level information. We defined “worker” relatively broadly and opted to begin with the set of all those who reported that they were both working and some other activity, including for example, “worker plus disabled” and “worker plus retired.” We then excluded those workers who reported that they were self-employed from our analysis. Our definition of DC plans includes the following plans: 401(k); 403(b); 457; thrift/savings plan; profit-sharing plan; portable cash option plan; deferred compensation plan, n.e.c.; SEP/SIMPLE; money purchase plan; stock purchase plan; and employee stock ownership plan (ESOP). The SCF and other surveys that are based on self-reported data are subject to several other sources of nonsampling error, including the inability to get information about all sample cases; difficulties of definition; differences in the interpretation of questions; respondents’ inability or unwillingness to provide correct information; and errors made in collecting, recording, coding, and processing data. These nonsampling errors can influence the accuracy of information presented in the report, although the magnitude of their effect is not known. Our analysis of the 2004 SCF yielded slightly lower participation rates than other data sets that consider pensions. For example, 2004 Bureau of Labor Statistics (BLS) data indicate a somewhat higher rate of active participation in DC accounts, 42 percent, compared with our finding of 36 percent. One possible factor contributing to this difference is that BLS surveys establishments about their employees, while SCF surveys individuals who report on themselves and their households; it is possible that the SCF respondents may be failing to report all retirement accounts, while BLS is capturing a greater proportion of them. Also, the SCF considered both public and private sector workers, while the BLS statistic is only for private sector workers. Differences may also be explained by different definitions of workers and participation, question wording, or lines of questioning. The SCF appears to provide a lower bound on the estimation of pension coverage among 4 major data sets. To project lifetime savings in DC pensions, and related retirement plans with personal accounts, and to identify the effects of changes in policies, market assumptions, or individual behavior, we used the Policy Simulation Group’s (PSG) Pension Simulator (PENSIM) microsimulation models. PENSIM is a dynamic microsimulation model that produces life histories for a sample of individuals born in the same year. The life history for a sample individual includes different life events, such as birth, schooling events, marriage and divorce, childbirth, immigration and emigration, disability onset and recovery, and death. In addition, a simulated life history includes a complete employment record for each individual, including each job’s starting date, job characteristics, pension coverage and plan characteristics, and ending date. The model has been developed by PSG since 1997 with funding and input by the Office of Policy and Research at the Employee Benefits Security Administration (EBSA) of the U.S. Department of Labor with the recommendations of the National Research Council panel on retirement income modeling. PENSIM sets the timing for each life event by using data from various longitudinal data sets to estimate a waiting-time model (often called a hazard function model) using standard survival analysis methods. PENSIM incorporates many such estimated waiting-time models into a single dynamic simulation model. This model can be used to simulate a synthetic sample of complete life histories. PENSIM employs continuous- time, discrete-event simulation techniques, such that life events do not have to occur at discrete intervals, such as annually on a person’s birthday. PENSIM also uses simulated data generated by another PSG simulation model, SSASIM, which produces simulated macro-demographic and macroeconomic variables. PENSIM imputes pension characteristics using a model estimated with 1996 to 1998 establishment data from the BLS Employee Benefits Survey (now known as the National Compensation Survey). Pension offerings are calibrated to historical trends in pension offerings from 1975 to 2005, including plan mix, types of plans, and employer matching. Further, PENSIM incorporates data from the 1996-1998 Employee Benefits Survey (EBS) to impute access to and participation rates in DC plans in which the employer makes no contribution, which BLS does not report as pension plans in the NCS. The inclusion of these “zero-matching” plans enhances PENSIM’s ability to accurately reflect the universe of pension plans offered by employers. PENSIM assumes that 2005 pension offerings, included the imputed zero-matching plans, are projected forward in time. PSG has conducted validation checks of PENSIM’s simulated life histories against both historical life history statistics and other projections. Different life history statistics have been validated against data from the Survey of Income and Program Participation (SIPP), the Current Population Survey (CPS), Modeling Income in the Near Term (MINT3), the Panel Study of Income Dynamics (PSID), and the Social Security Administration’s Trustees Report. PSG reports that PENSIM life histories have produced similar annual population, taxable earnings, and disability benefits for the years 2000 to 2080 as those produced by the Congressional Budget Office’s long-term social security model (CBOLT) and as shown in the Social Security Administration’s 2004 Trustees Report. According to PSG, PENSIM generates simulated DC plan participation rates and account balances that are similar to those observed in a variety of data sets. For example, measures of central tendency in the simulated distribution of DC account balances among employed individuals is similar to those produced by an analysis of the Employee Benefit Research Institute (EBRI)-Investment Company Institute (ICI) 401(k) database and of the 2004 SCF. GAO performed no independent validation checks of PENSIM’s life histories or pension characteristics. In 2006, EBSA submitted PENSIM to a peer review by three economists. The economists’ overall reviews ranged from highly favorable to highly critical. While the economist who gave PENSIM a favorable review expressed a “high degree of confidence” in the model, the one who criticized it focused on PENSIM’s reduced form modeling. This means that the model is grounded in previously observed statistical relationships among individuals’ characteristics, circumstances, and behaviors, rather than on any underlying theory of the determinants of behaviors, such as the common economic theory that individuals make rational choices as their preferences dictate and thereby maximize their own welfare. The third reviewer raised questions about specific modeling assumptions and possible overlooked indirect effects. PENSIM allows the user to alter one or more inputs to represent changes in government policy, market assumptions, or personal behavioral choices and analyze the subsequent impact on pension benefits. Starting with a 2 percent sample of a 1990 cohort, totaling 104,435 people at birth. our baseline simulation includes some of the following key assumptions and features. For our report, we focus exclusively on accumulated balances in DC plans and ignore any benefits an individual might receive from DB plans or from Social Security. Our reported benefits and replacement rates therefore capture just one source of potential income available to a retiree. Workers accumulate DC pension benefits from past jobs in one rollover account, which continue to receive investment returns, along with any benefits from a current job. At retirement, these are combined into one account. Because we focus on DC plan balances only, we assume all workers are ineligible to participate in DB plans and do not track Social Security benefits. Plan participants invest all assets in their account in life cycle funds, which adjust the mix of assets between stocks and government bonds as the individual ages. Stocks return an annual nonstochastic real rate of return of 6.4 percent and government bonds have a real return of 2.9 percent per year. In one simulation, we use the government bond rate on all plan assets. Using different rates of return reflect assumptions used by OCACT in some of its analyses of trust fund investment. Workers purchase a single, nominal life annuity, typically at retirement, which occurs between the ages of 62 and 70. Anyone who becomes permanently disabled at age 45 or older also purchases an immediate annuity at their disability age. We eliminate from the sample cohort members who: 1) die before they retire, at whatever age; 2) die prior to age 55; 3) immigrates into the cohort at an age older than 25; or 4) becomes permanently disabled prior to age 45. We assume that the annuity provider charges an administrative load on the annuity such that in all scenarios the provider’s revenues balance the annuity costs (i.e., zero profit). Replacement rates equal the annuity value of DC plan balances divided by a “steady earnings” index. This index reflects career earnings, calibrated to the Social Security Administration’s age-65 average wage index (AWI). PENSIM computes steady earnings by first computing the present value of lifetime wages. Then, it calculates a scaling factor that, when multiplied by the present value of lifetime earnings for a 1990 cohort member earning the AWI from ages 21 to 65, produces the individual’s present value of lifetime earnings. This scaling factor is multiplied by AWI at age 65, then adjusted to 2007 dollars. Using this measure as opposed to average pay for an individual’s final 3 or 5 years of working, minimizes the problems presented by a worker who has irregular earnings near the end of his or her career, perhaps because of reduced hours. For household replacement rates, we use a combined annuity value of worker-spouse lifetime DC plan savings and a combined measure of steady family earnings. Starting from this baseline model, we vary key inputs and assumptions to see how these variations affect pension benefits and replacement rates at retirement. Scenarios we ran include: (1) Universal rollover of DC plan balances. All workers with a DC balance roll it over into an Individual Retirement Account or another qualified plan upon job separation, as opposed to cashing out the balance, in which case the money is assumed lost for retirement purposes. (2) Immediate eligibility and participation in a plan. A worker who would be offered a plan has no eligibility waiting period and immediately enrolls. This does not necessarily mean that the participant makes immediate or regular contributions; contribution levels are determined stochastically by PENSIM based on worker characteristics. (3) Delayed retirement. Workers work beyond the retirement age determined by PENSIM in the baseline run. In one scenario, workers work up to one extra year; in another, they delay retirement for up to 3 years, although 70 remains the maximum retirement age. (4) Raised contribution limits. We set annual contribution limits starting in 2007 to $25,000 per individual, up from $15,500 under current law, and $60,000 for combined employer-employee contributions, up from $45,000 under current law. These limits rise with cost of living changes in subsequent years, as is the case in our baseline model. Lifetime summary statistics of the simulated 1990 cohort’s workforce and demographic variables give some insight into the model’s projected DC savings at retirement that we report (see tables 8 and 9). The 78,045 people in the sample who have some earnings, do not immigrate into the cohort after age 25, live to age 55, and retire (or become disabled at age 45 or older), work a median 29.4 years full-time and 2.1 part-time, with median “steady” earnings of $46,122 (in 2007 dollars). Those whose earnings fall in the lowest quartile work full-time for only a median 14.1 years, while working part-time for 9.1 years, and 13.4 years for their longest-tenured job; this group’s median annual steady earnings measure $16,820. In contrast, those in the highest-quartile of earnings work for a median 34.8 years, including 19.5 years for their longest job, and have median steady earnings of $126,380 per year. The results also show that pension coverage varies somewhat across income groups. About 83 percent of workers in the lowest income quartile have at least one job in which they are covered by a DC plan throughout their working careers, and are eligible for DC plan coverage for a median 9.4 years. In contrast, at least 90 percent of workers in the highest three income quartiles have some DC coverage during their careers. Those in the highest income quartile are eligible for DC participation for a median 25.2 years throughout their career. Cross-sectional results of the sample cohort also provide some insights into the model’s assumptions, as well as some further insights into the relatively low projected sample replacement rates (see table 10). These statistics describe the working characteristics for each employed individual at a randomly determined age sometime between 22 and 62 in order to provide a snapshot of a “current” job for most of the sample. Among those employed at the time of the survey, 61.8 percent had an employer who sponsors a DC plan. Of these workers with a plan offered, 94 percent were eligible to participate, and among those eligible 67 percent participated. Taking all of these percentages together, this means that at any one time only 38.9 percent of the working population actively participated in a DC plan in our projections. Even among these participants, only 56.9 percent reported making a contribution to the plan in the previous year, while 45.7 percent had an employer contribution. Median combined employer-employee contributions in the previous year were 6.2 percent of earnings in our simulation. Other studies have projected DC plan savings for workers saving over their entire working careers. These studies generally find higher projected replacement rates from DC plan savings than our simulations do. However, each study makes different key assumptions, particularly about plan coverage, participation, and contributions. A 2007 study by Patrick Purcell and Debra B. Whitman for the Congressional Research Service (CRS) simulates DC plan replacement rates based on earnings, contributions, and the rate of return on plan balances. CRS projects savings for households that begin saving at age 25, 35, or 45. The study estimates 2004 earnings using the March 2005 CPS as starting wages, and assumes that households experience an annual wage growth rate of 1.1 percent. Households are randomly assigned a 6 percent, 8 percent, or 10 percent retirement plan contribution rate every year from their starting age until age 65. The study assumes households allocate 65 percent of their retirement account assets to Standard & Poor’s 500 index of stocks from ages 25 to 34, 60 percent to stocks from ages 35 to 44, 55 percent to stocks from ages 45 to 54, and 50 percent to stocks from age 55 and above, with the remaining portfolio assets invested in AAA-rated corporate bonds. A Monte Carlo simulation based on historical returns on stocks and bonds determines annual rates of return. Replacement rates represent annuitized DC plan balances at age 65 divided by final 5-year average pay. After running the simulations, CRS finds variation in replacement rates depending on rate of return, years of saving, and earning percentile. In the CRS “middle estimate,” the unmarried householder that saves for 30 years, has annual household earnings in the 50th percentile, contributes 8 percent each year until retirement, and earns returns on contributions in the 50th percentile would have a 50 percent replacement rate (see table 11). The projected replacement rate jumps to 98 percent at 40 years of saving, and 22 percent at just 20 years of saving. Assuming a 6 percent annual contribution reduces projected replacement rates by about 10 to 30 percent. For example, an unmarried householder at the 50th percentile of annual earnings and the 50th percentile of returns saving for 40 years is projected to have a replacement rate of 72 percent at a 6 percent annual contribution (see table 12). All CRS estimates, however, exceed those we report in projections in this report, in part because CRS assumes constant participation in, and contributions to, a DC plan. In addition, CRS calculated annuity equivalents of accumulated DC balances based on current annuity prices; for younger workers retiring several decades into the future, we would expect the price of a given level of annuity income to be higher than today’s levels because of longer life expectancies. This would lower the replacement rates for any projected lump sum. A 2005 study, by Sarah Holden of ICI and Jack VanDerhei of EBRI, simulates, as a baseline scenario, retirement savings at age 65 for a group in their 20s and 30s in the year 2000. The baseline assumes workers are continuously covered by a DC plan throughout their career, and that workers will continuously participate. However, the authors also run the model assuming this group will have participation rates similar to current rates by allowing workers to not be covered by, participate in, or contribute to a DC plan. Their model also incorporates the possibility that a participant might cash out a DC plan balance upon leaving a job. Replacement rates are calculated by earnings quartile for participants retiring between 2035 and 2039 as the annuity value of age-65 plan balances divided by final 5-year average pay. The EBRI/ICI baseline projections, starting with a sample of plan participants, show a median replacement rate of 51 percent for the lowest earnings quartile and 67 percent for the highest. (See table 13). The authors analyze the effect of other plan or behavioral assumptions. For example, replacement rates fall significantly when the projections relax the assumption of continuous ongoing eligibility for a 401(k) plan, although they remain higher than our projections, perhaps because the projections start with current participants and assume continuous employment. When the authors include nonparticipants and assume automatic enrollment with a 6 percent employee contribution and investment of assets in a life cycle fund, replacement rates rise significantly from projections without automatic enrollment. Although they project a larger effect on replacement rates resulting from automatic enrollment than our projections show, EBRI/ICI similarly shows a greater increase in savings for lower-income workers. A forthcoming study by Poterba, Venti, and Wise uses the Survey of Income and Program Participation (SIPP) to project DC plan balances at age 65. In order to project participation, the authors assume that DC plan sponsorship will continue to grow, although more slowly than during recent decades. They calculate participation by earnings deciles within 5- year age intervals. The authors assume that 60 percent of plan contributions are allocated to large capitalization equities, and 40 percent to corporate bonds, and assume an average nominal rate of return of 12 percent for equities and 6 percent for corporate bonds. In addition, the authors run a projection assuming the rate of return on equities is 300 basis points less than the historical rate. They determine a person’s likelihood of DC plan participation based on age, cohort, and earnings, as well as the probability of cashing out an existing DC plan balance when someone leaves a job. The authors simulate earnings histories based on data from the Health and Retirement Study (HRS), and impute earnings for younger cohorts for which data are not available. They assume an annual combined employee-employer contribution rate of 10 percent for each year an individual participates, and do not account for increases in annual contributions or changes made to DC plans in the Pension Protection Act, such as a possible increase in participation by automatically enrolling employees. The authors find retirement savings for individuals retiring by decade between 2000 and 2040 by lifetime earning deciles. For workers in the fifth earnings decile retiring in 2030 at age 65, the authors project a mean DC plan balance of $272,135 in 2000 dollars, and $895,179 for the highest earning decile (see table 14). Earners in the lowest and second deciles, however, project average balances of $1,372, and $21,917. The projected average DC plan assets for 2030 retirees fall to $179,540 for the fifth decile of earnings, $614,789 for the highest decile, and $810 for the lowest decile when the authors assume an annual rate of return 300 basis points below the historic rate of return (see table 15). Finally, a 2007 study by William Even and David Macpherson estimates replacement rate for those continuously enrolled in a DC plan between 36 and 65 years of age. The authors simulate a sample using the SCF, and generate an age earnings profile for their sample using data on pension- covered workers in the 1989 SCF. The authors also use the SCF to generate annual contributions to DC plans, which are estimated using a person’s earnings, age, education, gender, race, ethnicity, martial status, union coverage, and firm size. The authors also create an artificial sample for workers who are predicted to be eligible for a DC plan, but choose not to participate. Finally, the authors assume three different rates of return on pension contributions: a 3 percent rate of return based on historical returns on government bonds; a historic returns portfolio based on an account mix of 75 percent in stocks split between large and small capital equities, and 25 percent split between long term corporate bonds, long- term government bonds, midterm government bonds, and Treasury bills; a 6.5 percent real rate of returns based on the average real rate of return on DC plans from 1985 to 1994 for plans with over 100 participants. In calculating annuity rates, the authors rely on mortality tables for group annuitants as opposed to the population as a whole, and do not include the charge the company makes for marketing and administrative expenses. The authors find that replacement rates vary by income distribution. For example, low-income workers who are continuously enrolled in a DC plan at the median replacement rate distribution are estimated to have a 30 percent replacement rate. (see table 16) The average replacement rate for such workers is 44 percent. Middle-income and high-income workers have median replacement rates 31 percent and 35 percent respectively. The authors’ estimates are likely higher than ours because the authors assume continuous enrollment. In addition to the contact above, Charles A. Jeszeck, Mark M. Glickman, Katherine Freeman, Leo Chyi, Charles J. Ford, Charles Willson, Edward Nannenhorn, Mark Ramage, Joe Applebaum, and Craig Winslow made important contributions to this report.

Summary: Over the last 25 years, pension coverage has shifted primarily from "traditional" defined benefit (DB) plans, in which workers accrue benefits based on years of service and earnings, toward defined contribution (DC) plans, in which participants accumulate retirement balances in individual accounts. DC plans provide greater portability of benefits, but shift the responsibility of saving for retirement from employers to employees. This report addresses the following issues: (1) What percentage of workers participate in DC plans, and how much have they saved in them? (2) How much are workers likely to have saved in DC plans over their careers and to what degree do key individual decisions and plan features affect plan saving? (3) What options have been recently proposed to increase DC plan coverage, participation, and savings? GAO analyzed data from the Federal Reserve Board's 2004 Survey of Consumer Finances (SCF), the latest available, utilized a computer simulation model to project DC plan balances at retirement, reviewed academic studies, and interviewed experts. GAO's analysis of 2004 SCF data found that only 36 percent of workers participated in a current DC plan. For all workers with a current or former DC plan, including rolled-over retirement funds, the total median account balance was $22,800. Among workers aged 55 to 64, the median account balance were $50,000, and those aged 60 to 64 had $60,600. Low-income workers had less opportunity to participate in DC plans than the average worker, and when offered an opportunity to participate in a plan, they were less likely to do so. Modest balances might be expected, given the relatively recent prominence of 401(k) plans. Projections of DC plan savings over a career for workers born in 1990 indicate that DC plans could on average replace about 22 percent of annualized career earnings at retirement for all workers, but projected "replacement rates" vary widely across income groups and with changes in assumptions. Projections show almost 37 percent of workers reaching retirement with zero plan savings. Projections also show that workers in the lowest income quartile have projected replacement rates of 10.3 percent on average, with 63 percent of these workers having no plan savings at retirement, while highest-income workers have average replacement rates of 34 percent. Assuming that workers offered a plan always participate raises projected overall savings and reduces the number of workers with zero savings substantially, particularly among lower-income workers. Recent regulatory and legislative changes and proposals could have positive effects on DC plan coverage, participation, and savings, some by facilitating the adoption of automatic enrollment and escalation features. Some options focus on encouraging plan sponsorship, while others would create accounts for people not covered by an employer plan. Our findings indicate that DC plans can provide a meaningful contribution to retirement security for some workers but may not ensure the retirement security of lower-income workers.