With pensions waning, workers save. Is it enough?

The decline of traditional pensions puts new pressure on Americans to save for their own retirement - and adds urgency to moves by the federal government to encourage such saving.

Recent moves by Alcoa, IBM, Verizon, and other large companies to freeze pension plans have sent a message that's hard to miss: Don't count on your employer for retirement benefits.

In many ways, Americans already know this. While many large employers still offer pensions, the shift toward voluntary saving plans such as 401(k) accounts has been clear for more than a decade. For millions of workers, contributing part of each paycheck is a firm habit. And there's evidence that when they do so, the effort can yield a solid stream of retirement income for those at all income levels.

But for all the rapid growth of 401(k) plans and other tax-sheltered ways for individuals to save, gaps persist.

Consider: Fewer than 20 percent of young workers - ages 21 to 24 - participate in a work-based retirement plan, voluntary or traditional. The number is about the same - 20.6 percent - for working Americans who lack a high school diploma. Many of those who do save, including many young workers, fail to put any money in stocks, where the likelihood of strong investment returns has historically been best.

Given such patterns, the federal government has an important role to play in encouraging more saving by more people, say many benefit experts.

"One thing that we know works pretty well ... is automatic enrollment" in 401(k) plans, says James Poterba, an economist at the Massachusetts Institute of Technology in Cambridge. "We know that has a very substantial and positive impact."

With the trend of corporate pension phaseouts likely to continue or even accelerate, such policies represent a crucial new frontier in the US retirement system.

In Congress, conferees will be working to iron out differences next month on pension reforms that the House and Senate approved before Christmas.

A provision in both bills would encourage more employers to automatically enroll their workers in retirement plans. When companies adopt this practice, employees still retain the choice of whether to participate in a 401(k) program. But the decision that faces them is whether to opt out, not whether to opt in.

In practice, that means many more people will participate. "A lot of these things just exploit people's intrinsic inertia," explains Dr. Poterba.

But many researchers say this "inertia factor" should be expanded in other ways as well. In many 401(k) plans, the default investment choice is a money-market fund, whose low returns may only barely outpace inflation over time. By contrast, most financial advisers say that, especially for young workers, the bulk of retirement savings should be invested in a diversified stock portfolio. And they say the mix of stocks and bonds should evolve over time as people near retirement.

One way to prod people along that path: Make the default investment a "life-cycle fund," a mutual fund in which the assets are managed with a blend of stocks and bonds that investment managers have tailored to the age of the participant.

The Labor Department may soon issue a rule designed to encourage companies on that path, according to news reports.

Currently, many employers are reluctant to make a stock fund or life-cycle fund the default investment, because they worry about lawsuits from workers who see their accounts lose value. The new rule would shield employers from such liability.

"I would say that a huge percentage of them who don't already have automatic enrollment would adopt it overnight," says Jack VanDerhei, a scholar with the Employee Benefit Research Institute (EBRI) in Washington.

Another step, urged by some experts, is for employers to set higher automatic rates of saving. Where companies do offer automatic enrollment, it's typical for only 2 or 3 percent of wages to be set aside in the retirement plan. Doubling that amount - while allowing employees to opt for a lower or higher amount if they wish - would ensure a higher standard of living in retirement. In effect, such automated systems are designed to save people from bad decisions.

But there's debate over whether even more is needed. "Basically, one-third of the elderly population is almost completely dependent on Social Security" for their income, says Laurence Kotlikoff, a Boston University economist.

He suggests a system in which retirement saving in personal accounts is not just the default choice, but is mandatory.

The money would be invested in a broadly diversified mutual fund. An insurance feature would protect against the risk of a stock-market downturn, destroying the individual's savings. The savings would be paid out as an annuity during retirement.

Such a system may not be an easy sell in a nation accustomed to multiple choices. Indeed, without the current promise of being able to withdraw savings if needed, many people might not participate in 401(k) plans at all, some experts say.

But clearly, a flaw of the current system is the highly unequal levels of retirement security. It varies sharply according to income and education.

The good news, however, is that those who have the discipline can put themselves on solid footing. According to one recent EBRI analysis, typical workers now participating in 401(k) plans are saving enough that, in retirement, those savings alone will replace 50 to 66 percent of the income they had earned when they were employed.