50 Years Later, Was Erisa Worth It?
From: www.morningstar.com
Our analysis reveals how the landmark law has affected workers’ retirement income.
In 1974, Congress transformed the American retirement system.
By a unanimous vote in the Senate and a margin of 407-2 in the House, it passed the Employee Retirement Income Security Act.
The goal was to protect workers who had lost their pension, like those of the bankrupted Studebaker-Packard corporation. It was intended to protect defined-benefit pensions. Fifty years later, as the landmark law turns 50, it’s clear the law did not have the anticipated impact.
While Erisa did improve the security of benefits, private-sector pensions are largely gone, in part because of Erisa’s rules for funding and insuring them.
But, Congress did something else with Erisa. It created a body of law with minimum standards for retirement plan design that has helped millions of Americans save in defined-contribution plans, like 401(k) plans.
So, was Erisa worth it? Has it improved Americans retirement prospects? Unambiguously: yes.
In our recent report, my colleague Jack VanDerhei and I explored the impact of Erisa with the Morningstar Model of US Retirement Outcomes. Specifically, we analyzed what retirement adequacy would look like for today’s US workers if individual account plans (defined-contribution and IRAs) did not exist.
In other words, if Erisa had not been enacted, and defined-contribution plans and IRAs were unavailable as retirement savings vehicles, what percentage of US working-age households would have adequate financial resources in retirement?
Without Erisa, we see a massive increase in the percentage of workers who are projected to be at risk of experiencing retirement shortfalls—showing that Erisa’s tax benefits and protections have benefited millions of American workers and retirees.
Without the Incentives and Protections of Erisa, Workers Would Not Save Nearly as Much as They Do
To conduct our analysis of the American retirement system without Erisa (which we refer to as a “counterfactual analysis”), we started by setting all defined-contribution and IRA balances to zero for the entire simulation period. (Note that we exclude IRAs in this analysis because Erisa created them.) We then estimated post-tax balances for all households, using the larger of the existing and imputed amounts, when applicable. We modeled post-tax contributions based on IRA contribution probabilities and IRA contribution amounts (which we assume are the IRS limits), simulating potential savings behavior in the absence of other retirement accounts.
We left the defined-benefit plan parameters the same as those in the baseline model, as there are many factors behind the decline of defined-benefit plans that were not promulgated by the original Erisa provisions. For example, previous survey work documented that a significant percentage of defined-benefit plan sponsors had either closed their plan to new hires or frozen the plan for all members as a result of changes in accounting standards and/or legislative changes involving funding standards. There had also been considerable controversy over the change in the Pension Benefit Guaranty Corporation premium requirements as it moved from a flat rate system to a system in which the required premium is based in part on the plan’s funding status.
We compared the results from our counterfactual simulations with our status quo results. The exhibit below shows the increase in the percentage of households running short of money for Gen Z, millennial, and Gen X as a function of average indexed monthly earnings, or AIME, quartile. We noted that the differences are significant.
We see the same overall trend for each of the three generations: Those in the lowest income quartile experienced the smallest impact, presumably since they rely more on Social Security than their higher-income counterparts (this portion of the overall retirement income was not modified in the counterfactual simulation).
Likewise, those in the highest-income quartile experience less of an impact than those in the middle 50%, since a larger portion of their overall retirement-income resources would come from other sources in addition to individual account retirement plans, such as post-tax brokerage accounts.
When aggregated across all four income categories, the probability of Gen X households running short of money in retirement would increase from 47% under the status quo to 59% in the counterfactual simulation with no individual account retirement plans.
Millennials would have a worse situation, with the aggregate probability increasing from 44% to 69%, while the Gen Z households would be faced with the prospect of an increase from 37% in today’s environment to a devastating 72% without individual account retirement plans.
We also analyzed the results from other perspectives, such as race and ethnicity and gender and family status, which we detail in the full report.
Conclusion
Overall, the results of the counterfactual analysis indicate that American workers would be significantly less prepared for retirement if individual account plans were not available.
Our full report also includes analysis of the potential impact of the Automatic IRA Act of 2024 proposal and plan design change—all plans moving to an automatic enrollment with automatic escalation up to 15% design—on retirement outcomes. In both cases, we found that the impact would be significant.
