Great ideas like the 401(k) must evolve to meet new challenges

There are three reasons why the 401(k) and other defined contribution (DC) savings plans are, and will remain, the primary retirement savings vehicles for working Americans:

• The 401(k) has evolved to meet the needs of savers
• The renaissance of the 401(k) has been driven by national policy with bipartisan support
• Substantial research in the field has proven what works to raise retirement readiness

Today, more than 73 million workers actively participate in DC plans. Assets in 401(k) plans totaled $6.8 trillion at the close of 2014 — that’s nearly double the amount from a decade ago. Over the past 30 years, the 401(k) plan has become the most widespread retirement savings offering by private employers.

That extraordinary growth is one of the great success stories of American retirement policy.

The early days

Having spent much of my early career working in the nascent 401(k) business, it would be difficult to isolate one event, regulation, or infrastructure change that sealed the success of the 401(k). How can you know when an idea is going to shift the landscape, or chart a new course for the long-term? The short answer is, you don’t.

Even in its earliest development, though, the 401(k) emerged as an idea worth working on. Two keys to its success, in my view, were the power of bipartisan support for policy, and the ability of the 401(k) to maintain flexibility to meet investors’ needs.

Driven by public policy

The 401(k) was established by the Revenue Act of 1978, but it was not until 1981 that the IRS passed regulations adding clarity to payroll deduction and allowing employees to determine what portion of their wages and salary would be deferred to savings. By 1983, nearly half of all large U.S. companies were offering a 401(k) or considering one. By 1997, DC assets surpassed assets held in traditional pension plans.

The renaissance

Congress recognized the vital role DC plans play and established a set of best practices with the passage of the Pension Protection Act (PPA) in 2006. Those best practices include automatic enrollment and opt-out structures for both participation and savings escalation. The legislation, signed by President Bush on August 17, 2006, was based on two bills introduced by Representative John Boehner (R) and Senator Charles Grassley (R). The PPA received bipartisan support, passing the House with a vote of 279 to 131, and securing Senate approval with a 93 to 5 vote.

With that single piece of legislation, Congress took a huge step toward creating a defined contribution system with the potential to deliver on its most important goal: enabling workers to reliably replace their pre-retirement income for life.

Automation battles inertia

But participation rates did not rise dramatically in the early years. In 2003, for example, the Department of Labor found that while 39.9% of workers in the private sector had access to a 401(k) plan at work, only 67.9% of those with access participated. Among lower-income workers, only 59.6% chose to save in their 401(k).

At the same time, growing research pointed to the impact of automatic enrollment on participation rates, particularly among lower-income workers.

Plan design soon emerged as a way to encourage workers to save. The money management and retirement industry seized the opportunities made available by the PPA and set a new standard. Plan design, particularly with automatic features, drove the next phase of 401(k) success.

It became clear it’s easier to raise participation and savings rates with auto enrollment and auto escalation than to take those steps through traditional communication. The adoption of auto enrollment in workplace savings plans rose to 50.2% of plans in 2013, and 44% had automatic escalation as a plan design feature.

Growing the opportunity

Assets in private sector DC plans are expected to grow to more than $6.3 trillion by 2019, according to research firm Cerulli Associates. But not everyone is participating in the 401(k) success story. There are challenges.

There are more than 30 million Americans without access to workplace retirement savings plans.

We need to expand access to some form of workplace savings option to all workers. Providing an auto-IRA through payroll deduction could be one solution for workers without access to a 401(k). Some individual states are already acting on this idea. But broad, national legislation to solve this issue would be much better than a patchwork of initiatives.

The future is technology and design

Innovation has been the driving force behind the 401(k), and innovative technology will play an even larger role in its future.

Many of our daily activities are already automated, with alarms reminding us about appointments, or notes directing us to pay bills. Automation is also playing a larger role in retirement saving. Employers are finding that technology can help provide the educational experience and tools needed to help individuals make decisions about how to save for retirement.

The 401(k) will see expanded opportunity in mobile technology, integrating retirement savings into other financial and lifestyle decision-making such as the use of mobile apps for banking and making purchases online. And technology can fuel a personalization of communications that can strengthen the saving experience.

Setting a new standard

We need to find ways to help retirement savers comfortably and consistently save more – at least 10% of their income. A workplace savings plan with auto enrollment and auto escalation targeting a deferral rate of 10% or more can put savers on the path to real retirement readiness. The industry norm for plan design must include this "full auto" feature and should raise the bar on savings rates. I strongly believe that over time, taking into account the uncertain future of Social Security, saving 15% of income may need to become the new norm.

There is nothing wrong with the 401(k) that cannot be fixed by the 401(k). As the preferred instrument for retirement savings, it will continue its evolution. We need to support what’s working and expand on those elements to give Americans a reasonable opportunity to meet their goals successfully and retire with a dignified standard of living and pride in their accomplishment.

The views and opinions expressed are my own and are not meant as investment advice. Affiliate of Putnam Retail Management and Great-West Financial.