ERISA at 50: past reflections, future possibilities

It is hard to overstate the impact that the Employee Retirement Income Security Act (ERISA) has had on the course of the U.S. retirement industry. ERISA was first introduced in 1974 by President Gerald R. Ford and signed into being on Labor Day of that same year. The Act represented a significant expansion of government power into what had largely been a private market area, reflecting a growing need for better regulatory structures to be put in place around disclosures and safeguarding assets within pension plans.

Much has changed within the landscape of American retirement during the past 50 years. This milestone anniversary represents a chance to look back as well as forward into what further steps may still be needed to protect lifetime income for all working Americans, beyond the replacement rates offered by Social Security.

Looking ahead, the retirement industry must keep expanding the number of people who are enrolled in workplace retirement plans. Currently, only about half of workers are participating in an employer-sponsored plan. Astonishingly, around 75% of the workers who aren't participating aren't doing so because their employers do not offer these types of plans.¹

ERISA isn't wholly responsible for the system currently available today. The 401(k) retirement savings plan wasn't formally created until 1978 and wasn't widely adopted by corporate retirement plans until the 1980s/1990s. The shift from defined benefit plans to defined contribution plans was motivated by companies' desire to move the liability of defined benefit plans off their balance sheets. However, this transition came with a profound impact on the retirement security of millions of Americans, as their guaranteed income plans have largely disappeared. The emphasis has shifted ever-increasingly onto individual workers who must now be in charge of their own retirement savings, while not helping them generate the income needed to fund their retirements.

The next significant step in the legislative retirement landscape was the Pension Protection Act of 2006 (PPA), which is coincidentally celebrating its 18th birthday in 2024. This Act was designed to build on the foundation of ERISA, to further strengthen protections for workers and to allow for workers to save significantly more in their retirement accounts than was previously allowed. It also gave permission for automatic enrollment, a facet of retirement planning still firmly advocated for today.

One of the most significant provisions to come out of the PPA was the Qualified Default Investment Alternative (QDIA). QDIA is a default investment option that employers can offer in their employee retirement plans. These default investments essentially gave rise to the modern 401(k) investment landscape and the diversified "life-cycle" fund (greater equity exposure for younger participants, more fixed income for older participants), i.e., the now ubiquitous target date fund.

The growth of target date funds has been rapid, largely thanks to the safe harbor language in the PPA that protects employers in the event of a market downturn. Prior to the PPA, default investments were usually money market funds, or other vehicles that were less likely to lose value during adverse market conditions. By helping capital appreciation to become part of the recognized goal of a retirement account, alongside the greatly raised limits on contributions, the PPA allowed for workers to properly build a nest egg. The growth of target dates is now well known, and they continue to hold a significant position among in-plan retirement assets.

What's next?

The U.S. retirement industry is never really standing still, despite the relatively stable regulatory environment. We don't see any major retirement legislation currently on the horizon, especially as SECURE Act I and II provisions are being worked through, and the Tax Cuts and Jobs Act is set to expire at the end of 2025.

That said, new products are always in development. One area currently driving development within the retirement planning landscape is the growth of advisor managed accounts. These accounts allow for significantly more customized options than those offered by target date funds. Beyond age and target retirement year, these managed accounts incorporate factors including non-retirement account assets, detailed information about participants' salaries, contribution rates and histories, and overall risk tolerances.

By 2021, advisor managed account assets had grown to more than $400B from approximately $150B in 2014. While most plan sponsors now offer managed accounts within their plans, there is still work to be done to establish the value proposition.² The higher costs associated with managed accounts naturally act as a barrier to entry and make for a more difficult conversation with participants, so plan sponsors need to carefully consider the additional value that participants will receive from the more personalized service.

The fact remains though that the U.S. retirement system is largely predicated on individuals making their own decisions regarding how much to save and where to direct their dollars. And, while the majority of these individuals default to their employer-sponsored retirement plans, those who would prefer more customized advice or whose situations are more complex and could benefit from more directed financial planning could be well served by a managed account offering such as advisor managed accounts or an SMA.³ The shift of U.S. retirement is toward personalization, more decisions being made by individuals and more crossover between the traditional areas of retirement and wealth financial planning. Managed accounts may represent the next step in the retirement planning evolution.

The future is lifetime income

Conversely, there is one area in the retirement landscape that is reversing back toward the pre-ERISA era, a time when most workers had defined benefit pensions and knew exactly what income payouts they would receive in retirement. This area of growth is the in-plan guaranteed lifetime income solution, a retirement option that is designed to replicate the worker's paycheck during retirement.

This growth area was cemented by the SECURE Act of 2019 through the safe harbor provisions for lifetime income solutions that are a part of retirement plans. The Act, which amends ERISA Section 404, lays out the process that plan sponsors have to engage, in order to include guaranteed income contracts within their retirement plans. As the Act pertains to the selection of an insurance company to provide the guaranteed retirement income contract, those with fiduciary responsibilities will be deemed to have satisfied their fiduciary obligations if they:

1. Engage in an objective, thorough and analytical search for the purpose of identifying insurers from which to purchase such contracts,
2. Consider the financial capability of each insurer to satisfy its obligations under the guaranteed retirement income contract, and
3. Consider the cost (including fees and commissions) of the guaranteed retirement income contract offered by the insurer in relation to the benefits and product features of the contract and administrative services to be provided under such contract.⁴

These provisions allow for the inclusion of annuity contracts within the retirement plan, and for the integration of lifetime income. This will help retirees think about their spending plans and convert their savings balances into a stream of income that can last them throughout their retirement. And while much of the legislative work has been done to allow for guaranteed lifetime income products to be embedded within retirement plans, we still see a lot of work to be done to work with plan sponsors, their advisors and consultants, and individual plan participants. Work also remains on education around the value that lifetime income can provide, what these products fundamentally are and how they can work within a plan, and how the area of lifetime income is going to continue to evolve as more record keepers integrate these products and more plan sponsors take them up.

It has been a fascinating few decades for retirement industry legislation, from ERISA through the PPA and now with the implementation of the SECURE Acts. We believe the growth of managed accounts will continue to have an outsized impact on how retirement assets are managed, and the integration of guaranteed lifetime income is poised to make retirement more accessible and manageable for millions of American workers.