This week Time Magazine had a thought-provoking article titled Why it’s time to retire the 401(k). The article is pretty long and detailed and as you would expect it points out many of the flaws of the 401(k) and argues that for many people it is doing more harm than good.
History of the 401(k)
The article starts by going into the history of the 401(k)…
“Invented nearly 30 years ago as an executive perk — one more way to dodge Uncle Sam — the 401(k) was never meant to replace the employer-guaranteed pension fund, supplemented by Social Security, as the cornerstone of our nation’s retirement system. But propelled by a combination of companies looking to cut costs and consumers who wanted control of their retirement destiny, that’s exactly what happened.”
“Congress was trying to close a loophole on executive bonuses when it created the 401(k). Most companies intended 401(k)s — which were originally called salary-reduction plans but then renamed for the portion of the tax code that makes them possible — to be a perk for highly paid executives, not a pension replacement. That’s because lower-paid employees probably could not afford to defer a portion of their paychecks. So companies held on to their pension systems even as they added 401(k)s, which by law they had to make available to all employees. When the market took off in the 1980s, the rank and file clamored to get in.”
The article points out that, “from the end of 2007 to the end of March 2009, the average 401(k) balance fell 31%.” My 401(k) actually almost fell 40%, but who’s counting? The article goes on to present a few more dismal retirement figures…
“The average 401(k) has a balance of $45,519. That’s not retirement. That’s two years of college. Even worse, 46% of all 401(k) accounts have less than $10,000. Today, just 21% of all U.S. workers are covered by traditional pensions, and the number shrinks every year.”
The 401(k) Alternatives
The article continues by suggesting a few alternatives to what we know as the 401k…
- “The most popular solution is the so-called automatic 401(k). Under that plan, all workers would be enrolled in 401(k)s when they’re eligible. Companies would establish default settings to boost returns and make the portfolios safer as workers near retirement.”
- “Teresa Ghilarducci, an economics professor at the New School, has proposed a plan in which the government would divert 5% of everyone’s wages. In return, you would be guaranteed in retirement a check for 26% of your final salary every year until you died.”
- “The ERISA Industry Committee (ERIC), a group that represents the nation’s largest employers, has proposed a system of exchanges that would allow individuals the ability to buy a guaranteed retirement account on their own. Some government regulation would be needed, but it would be a private plan. What the ERIC plan and others like it are essentially proposing is a form of retirement insurance. So instead of putting 6% of your salary into a 401(k) or some other investment account, each pay period you would send 6% of your check to a retirement-insurance provider. The policy would work similarly to a traditional pension in that it would provide a guaranteed monthly check equal to about a quarter of your final pay, from when you quit working until you die. Some employers might even be willing to pay the annual premium as a perk. If not, employees would pay for it much as they currently fund their own 401(k)s. But the policy would be portable. Contribute for 30 years and you would be guaranteed income in retirement, no matter how many employers you worked for. Combine your retirement-insurance check with the money you get from Social Security, which can equal as much as 50% of final pay, and presto: you have something approaching retirement security.”
Since so many companies are saving millions of dollars by offering 401(k) plans rather than pensions, I don’t see pensions coming back in style. But it is scary to me how many people put no thought to their retirement – and without a pension, they will be trying to survive off of Social Security (if it is even around when we retire).
I think some of the 401k alternative options could have some promise, but I think education is the key. We have been trained to brush our teeth every day because we know that if we don’t our teeth are going to fall out. You would think that we should know by now if we don’t save for retirement, we will be eating Alpo in retirement (as Dave Ramsey says).
But that only takes care of one half of the equation, once people understand that they have to start saving, then we have the challenge of investing wisely in the 401k – which is another can of worms. One thing I liked that my old employer did was that they had a staff financial planner available for any employee to visit to discuss 401k allocations. It wasn’t a perfect solution, because it still required the employee to be motivated enough to set up an appointment, but it seemed like a step in the right direction.
(By the way, if you are looking for a great book to help you pick your 401k allocations check out The Shortest Investment Book Ever)
So, I want to hear what you think. Do you think killing the 401k is a good idea? Should we just start from scratch? Or should the government force companies to offer pensions again? Thoughts?