Top Universities Sued Because...401(k)-Style Retirement Plans Provide Less Bang for the Retirement Buck

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Earlier this week, MIT, Yale, and New York University were sued because their 401(k)-style retirement plans have had excessive fees and provided employees with a bewildering array of often-low-quality investment options. The Universities, in effect, allowed the transfer of a significant share of their employees' potential retirement benefits to Wall Street.

This should be a "teachable moment," an opportunity for the robotic chorus of 401(k)-style champions — including in Pennsylvania's legislature, editorial boards, and other news media — to register that typical 401(k)-style retirements are a lousy deal for workers.

The suit is on solid factual ground because an overwhelming amount of evidence exists that 401(k)-style plans have high fees and lower returns than pooled defined benefit plans. According to the National Institute on Retirement Security, achieving the same retirement benefit with a 401(k)-style plan can take nearly twice as much in contributions.

It is particularly telling that the suit comes from these elite Universities. If the faculty of MIT, Yale and NYU aren't well equipped to make good retirement choices when given too large a set of options, who is?

The high fees and low returns of 401(k)-style retirement plans mean that switching all or part of Pennsylvania's retirement plans to 401(k)-style savings will INCREASE, not decrease, taxpayer costs for public-employee compensation. For example, if contributions to retirement remain unchanged, but some of the money goes into 401(k)-style savings, future employees' retirement benefits will fall. With a lower retirement benefit, schools and the state would likely have to increase salaries to keep the overall compensation package competitive. (As documented by Rutgers economist Jeffrey Keefe, Pennsylvania public employees earn slightly less in total compensation than comparable private employees. Cutting retirement benefits by transferring more money to Wall Street would increase the amount by which public-employee compensation trails private.)

The most common argument for switching Pennsylvania's public employees partly or completely to 401(k)-style savings is to avoid the risk of future underperforming financial markets leading to additional unfunded pensions liabilities and costs to taxpayers. But because of the inefficiency of 401(k)-style plans, the proposed switch guarantees future higher costs to avoid the risk of higher future costs. That course of action doesn't make a lot of sense.

As we have repeatedly pointed out (including at the end of this brief), other states offer a variety of sound approaches to reducing the risk of future unfunded liabilities without abandoning the efficiency of pooled defined benefit pensions for the inefficiency of 401(k)-style savings. But getting to a negotiation of such a pension solution would require the proponents of 401(k)-style plans to be teachable.

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