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Policy Brief, October 2022
In the Future, Americans’ 401(k)s May Be Underfunded—Here Are Some Suggested Solutions


For workers in the United States, defined contribution retirement plans have long been replacing pensions. 401ks and similar plans leave it up to workers to decide how much they contribute to their retirement savings and how they allocate the amount, and employers can provide some matching funds. That’s opposed to a pension plan where employers distribute a fixed amount to workers upon retirement.

A major challenge amid this shift to defined contribution plans is workers not saving enough for retirement. This is caused by a variety of factors, including but not limited to a lack of financial literacy, lack of automatic or portable retirement accounts across employers, and the very real fact that many workers just don’t have the resources to save. Access is an additional issue. The Bureau of Labor Statistics reports that in 2021 only 68% of private sector workers were offered a 401k or similar retirement savings vehicle, and only 51% of workers participated in them.

In our paper, we took a new approach by starting with the history of actual savings and investment decisions of more than 350,000 U.S. workers and then running scenarios for each worker’s future income, job changes and unemployment, outside financial and housing wealth, and 401k balances over the remaining of their working life. We did not assume people optimized, but instead predicted their choices based on past behavior and the behavior of those similar to them.

Assuming a degree of risk aversion that is consistent with other household behavior, we found that 75% of American workers are not saving enough for retirement to be confident that they can maintain their current levels of consumption. Moreover, the shortfall in savings is often significant. For instance, there is a 30% probability that the median person will have to decrease their consumption by 10% once they retire—arguably leading to a significantly lower quality of life.


So why does this shortfall exist? While it’s easy to put most or all of the blame on limited financial literacy, other factors also play a significant role.

Low contribution rates due to low incomes or the necessity to accumulate funds for large expenditures like housing, children, and education are another leading cause for the shortfalls. Lower quality plans in terms of fees and investment options, or suboptimal investment allocations away from stock and toward lower return vehicles or company stock also contribute. Additionally, many employers don’t even offer defined contribution schemes for workers, much less provide a percentage match for them—and workers with low to moderate incomes are more likely to work for such employers.

The shortfall we estimate is even larger once we consider that some workers might not be able to extract equity from their homes, an especially acute issue among people with low to moderate incomes; or we consider the possibility of lower returns going forward.

Finally, the uncertainty about the future level of wealth and the likelihood and size of the shortfall will be felt more intensely by more risk averse individuals, all else being equal, requiring them to accumulate higher levels of wealth.

Through our research, we found that removing penalty-free early withdrawals would increase retirement consumption by at least 5% for those earning the least. On the other hand, creating a minimum required contribution rate of 2% to 5% had an insubstantial effect. The best outcomes for workers were achieved through an age-dependent contribution rate, starting at 4.5% and increasing to 15.5%; however, that implies an average 10% contribution rate, which not only is significantly larger than the average contribution (6.3%), but also is likely far beyond the means of many workers. Furthermore, this increase would largely benefit those who are already earning higher wages, and two thirds of workers would still fall short. And automatic rollovers, while effective, only increased retirement consumption minimally, especially if that were the only policy change.

So, what other policy alternatives could significantly narrow the gap between those who can save adequately for retirement and those who can’t?

Policy considerations

The first intervention to consider is tackling retirement “leakages”: retirement savings gaps that come from workers lacking 401k options, or workers using the funds from their 401ks when they switch jobs instead of rolling them over. Oregon, Illinois, and other states have addressed investment leakages by creating voluntary statewide retirement savings vehicles. All workers can contribute to them, regardless of whether their employer provides an alternative. If the federal government were to consider offering a similar retirement vehicle, workers would have an easier, more accessible way to save for retirement. Barring that, more states might consider following in Oregon’s and Illinois’s footsteps. A related intervention would be the creation of retirement schemes that are both automatic and easily portable from one employer to the next, which would mitigate retirement investment gaps through an individual’s lifecycle.

Another intervention would address retirement leakages that occur because individuals are withdrawing from their retirement savings prematurely. Currently, individuals can withdraw funds if they’re facing various financial hardships, but those hardships are not clearly defined. Creating stricter rules around early withdrawals and enforcing them would reduce options for workers to withdraw and allow their retirement savings to grow and be available when they retire. Of course, stricter rules might reduce participation, so policymakers would have to balance that with the increased protection for participants’ savings for future consumption.

While all these interventions address leakages, none directly address individuals who are saving for retirement, but do not begin early enough or save enough throughout the course of their working lives. To address the former, policies could be enacted that provide (perhaps mandatory) financial literacy classes and workshops, so that workers can become comfortable with investing at younger ages, less risk-averse, and learn the importance of budgeting and starting to save from that first job onward. To address the latter issue, policymakers could create age-dependent minimum savings requirements, so that younger individuals could contribute a smaller amount to their retirement plans since they likely have other financial burdens, such as home payments or college tuition for their children. As individuals grow older and closer to retirement age and no longer need to save for those larger costs, they would be required to devote more savings to their retirement assets.

Of course, none of these interventions addresses the underlying issue of wealth and income inequities. Many workers with low incomes cannot afford to save for retirement at all or can save very little. Therefore, broader policies that address improving the standard of living and resources available to workers at the lower end of the salary scale would make a significant impact and provide them the means to also save for retirement.


1 See Table 9 in the research paper to see how the fraction of retirement-prepared workers varies with this parameter.

Opinions expressed in this article are those of the author(s) and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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