- The Washington Times - Saturday, April 15, 2006

An obscure paragraph added to the Revenue Act of 1978 by an unknown author has drastically changed the way Americans save for retirement and, possibly, how they vote.

Over the past 25 years, since a 38-year-old retirement consultant in Philadelphia got IRS approval to establish the first tax-deferred account system, 401(k)s have exploded, dramatically increasing the nation’s investor class and boosting individuals’ total savings.

Economic and political analysts say 401(k)s have enriched millions of American workers, particularly lower-income people, and their longer-term impact on the economy, especially investment capital formation, and the electorate is now coming into fuller view.

“The 401(k)s have done an enormous amount of good for the prosperity and stability of our country. When citizens have a vested interest in the economy and own more property, the more stable and politically conservative your society will be,” said Heritage Foundation economist Bill Beach.

Since 1990 total worker assets in 401(k) plans have grown by an average of 13 percent per year, from $385 billion to an estimated $2.1 trillion in 2004, the most recent year for which figures are available, according to the Investment Company Institute (ICI).

More than 43 million U.S. workers participated in 401(k)s at the end of 2004 — up from 10 million in the mid-1990s — representing nearly a third of the entire 144 million work force.

“On average, 67 percent of participants’ assets are invested” in stock mutual funds, ICI says.

One of the most surprising conclusions by economists studying the growth in 401(k) accounts is that they have contributed to a sharp increase in private savings, a view sharply at odds with reports showing that the savings rate has been declining for years.

But many economists say that the government’s savings yardstick does not measure the full extent of individual savings in stocks, which are becoming an increasing part of retirement nest eggs.

“There is an ongoing debate about how much 401(k)s have increased savings, but there is now a belief that it has increased savings, particularly among lower-income households,” said Sarah Holden, an ICI economist.

Putting money into a special fund that is invested over a long period of time “means something to a person’s behavior in terms of what you are going to buy. If you have an account that is labeled 401(k), you look at it as something that is not liquid and that you can’t spend today,” she said.

Miss Holden’s studies of 401(k) investors showed them to be “a tough crowd who stick with it through thick and thin in bear markets. They are accumulating significant [savings] balances,” she said.

Mr. Beach thinks the true savings rate in the U.S. is at least 15 percent when money being put into 401(k)s and other tax-advantage investment vehicles is added to traditional savings measures.

“Mutual stock funds are all counted as investments even though they are savings. You’re talking about $4 trillion in actual savings when you lump all this together. I think the savings rate is really high,” he said.

A recent ICI study of 401(k)s found that workers overall emerged from the bear market of the past several years with significantly increased retirement assets.

“By year-end 2004, the average account balance among 401(k) participants who had held accounts since at least 1999 increased by 36 percent, despite experiencing one of the worst bear markets for stocks since the Great Depression; rising 15 percent in 2004 alone,” the study said.

The average account balance rose from $67,016 at the end of 1999 to $91,042 at the end of 2004. The reason, Ms. Holden said, was the consistent contribution rate by workers into 401(k) plans, compounded by increasing stock values.

Theodore Benna, recognized as the “father of 401(k) plans,” discovered the tax-deferred savings opportunity while looking at language in the 1978 act inserted to address how profit-sharing plans should be taxed.

He thought the wording of section 401(k) of the revised tax code permitted him to set up a tax-deferred plan for employees and asked the IRS to rule whether it was allowable. To the surprise of cynics who said the IRS would turn him down, the IRS approved the plan in 1981.

Mr. Benna, who now is a consultant who helps small businesses set up employee retirement accounts, thinks 401(k)s are the best way for workers to save for their retirement.

“Do we have better alternatives than the 401(k)? The answer is still no,” he told U.S. News & World Report last month.

The popularity of 401(k) plans, known as defined contribution plans, has led to a sharp decline in company pensions, known as defined benefits plans in which companies pay retirement benefits to their workers for life. Pensions impose huge and growing costs on businesses, partly because retirees are living much longer today.

As companies have sought to downsize and cut their overhead, many have been either abandoning or gradually withdrawing from pension plans and replacing them with less expensive and portable 401(k) plans that workers can take with them when they move from job to job.

The sharp growth in the 401(k) investor class has political implications as well, analysts say.

“Investors, regardless of income, wealth, gender or race, vote more Republican than noninvestors,” Republican strategists Grover Norquist and Cesar Conda wrote in a Wall Street Journal analysis of the political impact of the Bush tax cuts.

Frank Newport, editor in chief of the Gallup Poll, says “there is not a lot of data” to support the correlation that investors tend to vote Republican, though voters “who invest are more likely to be in the higher middle to upper income group and in general to be more Republican.”

Still, he adds, “it’s possible that as we move toward what Bush has called an ownership society, it could change what’s important to Americans when they vote.”

While the political and voting demographics of investors remain thin, one survey conducted by a group called Investors Action Alliance commissioned an exit poll of 1,000 voters in the 2004 election, 70 percent of whom identified themselves as investors in stocks and bonds, either directly or through 401(k) mutual funds.

The poll found that these investors preferred President Bush over Massachusetts Sen. John Kerry, the Democratic presidential nominee, 52 percent to 46 percent, while noninvestors split 45 percent for each candidate.

“The investor gap is not simply a function of income and age. It shows up in many demographic slices,” wrote financial columnist James Glassman, a resident fellow at the American Enterprise Institute, who launched the polling group.

“For example, our survey found that among voters under age 50, investors preferred Bush, 51 percent to 43 percent, while noninvestors favored Kerry [53 percent to 36 percent],” Mr. Glassman wrote.

Several bills dealing with tax breaks for investors were moving through Congress. One of them is the pension reform bill that passed the House on Dec. 15 by a 294-132 vote. One of its key provisions would encourage employers to automatically enroll new employees in 401(k) plans, making all workers employed by businesses with such plans regular investors unless they choose to opt out.

That provision, which has received relatively little attention in political circles, would effectively turn most of the nation’s work force into investors with a growing personal stake in Wall Street and the corporate economy, economic analysts such as Mr. Beach said.

When economists at ICI calculated the effect of automatic enrollment, their model projected that the participation rate would rise to 92 percent of eligible employees. Notably, they found that the “positive impact of automatic enrollment on participation rates proved even stronger among lower-income workers.”

That is the strategic core of the Democrats’ political base that Republican strategists hope to appeal to in future elections and some think that moving them into the investor class is one way to do it.

Meantime, the biggest question that looms over the growth of 401(k) accounts is whether they will provide future workers with enough income for a comfortable retirement over a longer life span, as 401(k) plans increasingly replace the old defined benefits plans that many businesses have been eliminating in an era of corporate cost-cutting.

Economists at ICI, which represents the investment industry, say their studies show that 401(k) plans are on track to provide between half to two-thirds of a worker’s income in the decades to come.

“We developed a model in which we simulated a full career for a worker and took them to age 65 in 2030 and 2039 to calculate the income-replacement rate in retirement,” Ms. Holden said.

“We found that it would replace about half of their income among those in the bottom quartile and about two-thirds of their income” among higher earners.

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