How The 401(k) Will Save Retirement

If current trends hold, future retirees will have far larger 401(k) nest eggs than people retiring today. Could that save Social Security?

When the first baby boomers hit 65 in 2011, those who have 401(k)s will have an average of about $135k in their plans, in constant year 2000 dollars. When the last boomers reach 65 in 2029, they should have about $250k in 401(k) assets.

Those projections are from a new National Bureau of Economic Research paper, "New Estimates of the Future Path of 401(k) Assets." The authors are James Poterba of MIT, Steven Venti of Dartmouth, and David Wise of Harvard and the NBER.

They say that the reason for the rapid growth in 401(k) savings is simple: the younger boomers, and Gen X and Gen Y behind them, will have had far more time to put dollars into their 401(k) plans, and will have had far more time for those assets to earn returns. While 401(k)s were created in 1982, they did not start to gain traction until the early 1990s. People retiring in 2000 only contributed to their 401(k) for seven years, on average.

Now 401(k)s and similar vehicles have momentum. Consider the striking change in how people save for retirement: in 1980, over 90% of private retirement savings contributions were made to traditional employer plans; twenty years later, 87% of private contributions were to individually controlled 401(k)-style plans.

The shift in contributions is causing a similar change in assets. Even today, less than half of total pension assets are in 401(k) plans, with the balance in traditional pensions; by 2040 it's estimated that over 80% of pension assets will be in 401(k) and similar plans.

The researchers found that the growth in 401(k) assets will eclipse the drop in traditional "defined benefit" retirement plan assets, so that a growing portion of the country's wealth will be in the form of retirement plan investments.

That's good news, since it's projected that the third leg of retirement income, Social Security, will start to pay out more than it takes in some time in 2017. Interest earnings will continue to help for a few years, but by 2026 Social Security assets will start to decline. At that point, there will only be enough to pay full benefits for fifteen years, until 2041. After 2041, annual Social Security tax revenue will only be enough to pay about 70-75% of promised benefits.

The projected increase in household's 401(k) savings may make solving Social Security's problems more palatable. 401(k) plan participation and contribution skew toward higher income families; if their 401(k) investments have done well, they may be more amenable to means-tested Social Security benefits. In a companion paper, the same authors show that median income families will see their retirement assets -- Social Security plus 401(k) assets -- double between 2000 and 2040, in constant dollars. If those future retirees are twice as well off as people retiring now, they may accept some reduction in their Social Security benefits to aid those who finish their working life less well off.

A key assumption in their model is that 401(k) assets continue to earn the historic average rate of return for stocks. Some believe (here and here) that Boomer retirements will cause a mass liquidation of equity investments, and plunging stock prices; others disagree.

Nothing is certain except uncertainty, it seems. Nonetheless, putting savings into a 401(k)-type plan, especially one with an employer match, should be the first thing you do with any discretionary savings. Your future self will thank you for it.

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A pdf of the "New Estimates ..." paper is available at Dartmouth professor Steven Venti's website, or just click here to download it. You can find an abstract here.

The companion paper, "Rise of 401(k) Plans, Lifetime Earnings, and Wealth at Retirement," is abstracted here, and available at Professor Venti's site. This is the pdf.