A little bit ago, I observed that in the same way as there’s a tax penalty for buying individual health insurance, as opposed to having employer-provided insurance, there’s a similar tax disadvantage for investing in an IRA vs. an employer-sponsored 401(k). For no good reason that I know of, except as a strong incentive for employers to offer retirement plans, an employee can invest a lot more tax-deferred money in a 401(k) than in an IRA.
And, of course, the book I summarized the other day, Social Insecurity, starts with the premise that employers have not just a historical practice of providing retirement benefits, but pretty much have a moral obligation to do so.
So my question today is: why?
In a tabula rasa situation, would it make sense for employers to provide retirement benefits? Why not have a retirement plan sponsored by your church, or community group, or a large national organization that you belong to?
Historically, employers have offered retirement benefits for a couple reasons, which aren’t particularly the case any longer:
- It was an easy way of increasing total compensation without upfront costs, both during the wage controls of WWII (as with health insurance) and in the growth period afterwards, back when prefunding pensions wasn’t required (ERISA was enacted only in 1974) or, even afterwards, when employers didn’t have to account for their pension expense (FAS 87 was effective in 1987).
- It was a means of employee recruiting and retention, back when they could set a 10 year vesting period. Now there’s a 5 year vesting period for defined benefit pensions, and 3 years for employer contributions to a defined contribution plan. And from what I see, employers don’t really care too much about this aspect, and employees don’t trust their employers, anyway — if they’re looking at a job with a 6% match, they might conclude that it doesn’t count for much because the company can change it at any time.
- It was a means of ensuring that employees would retire “on time” rather than continuing to work into old age. Now, pension consulting firms such as my own are trying to get their clients to think about whether their employees will be able to retire, but it doesn’t seem to be much of a consideration any longer; in part, I think, employers are simply accustomed to canning people whenever they want (and good luck with that age discrimination lawsuit!), and, besides that, I suspect that employees with modest 401(k) balances are likely to retire anyway and just hope for the best — and if they outlive their assets, it’s nothing that’s going to impact the company.
- Employees are a “captive audience” in a way — a large employer can send out communications, and can autoenroll their employees via payroll deduction in a way that no other entity can.
- Employers, if they choose to do so, are able to select providers and bargain for low-fee fund options, and arrange for other sorts of assistance (for instance, target-date funds, online modeling) for their employees. (On the other hand, an employer can pass all these fees on to employees and disregard the cost.)
- Low-income employees may be disconnected enough from other forms of investing and saving that there is not particularly good way of replacing the employer’s role, if these employees wouldn’t seek out other financial institutions, and if, with low account balances, such institutions wouldn’t be interested in them, or would charge high enough fixed fees to severely hamper their savings.
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