Is the 401k a bad idea?

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.”

and…

“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.”

Recent Performance

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.”

Thoughts

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?
















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23 Comments
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  1. Forcing companies to issue pensions is not fair to organizations. They are already providing us with employment and the ability to generate an income.
    Individuals need to take responsibility for their own futures. It’s unfortunate that it’s not that simple. If the government does not do something then we could end up with and elderly population that is not able to sustain itself and that’s a whole other pandoras’ box in itself (no healthcare, poor housing, minimized quality of life, etc.), and then the government will not be preparing for our future accordingly (it’s a vicious cycle).
    This generation (myself included) is caught up in the immediate gratifications that life has to offer and needs to consider and practice the preparation for a better tomorrow for ourselves and generations after us (your children, etc).
    I’m 28 and it is scary how it is likely that Social Security will not be around when it’s my turn to retire. Personally I’m maxing out my 403b (non-profit employee). Once I get ahead on my student loans an clear my debt (btw, being debt free is one of the keys to happiness) I will contribute more into it. That is the system that is in place and I have to roll with it until there is a more efficient alternative.
    I believe everyone needs to be smarter about the management of their income.

  2. It was a weird article from Time. They seemed to say that since not enough people were taking advantage of the 401(k) we should get rid of it, insted of educating people. We’re not doing that with any other topic. No one is saying “not enough people eat veggies so let’s just get rid of them”, it’s actually the opposite and we’re trying to push people to eat more veggies. We should be pushing people to use their 401(k)

    • @Mike
      Good point – I think we should get rid of veggies ;)

      @Matt
      I have been rethinking retirement myself. I don’t think I will ever retire in the traditional sense – not because I won’t have the means too, but I would rather continue to remain as active as possible. Some people remain very active in retirement, but I have seen too many examples of retirement that look way too boring for me…

  3. Hmm, maybe it’s the whole concept of retirement that should be examined. It’s a rather new idea and for most people throughout history when a person became too old to work they were supported by their children. There was no magical age at which you retired. You stopped working because your body simply couldn’t do your job any longer.

  4. This makes no sense…get rid of something because few people use it effectively? Instead, we are to pay a mandated tax over which we may have little to no control in the hopes that the money is still there in 30 years. Isn’t this called social security?

    Ah, more government control in my life :)

  5. Hmm, interesting points. On the one hand I like “forced” savings since so many can’t or just won’t find the discipline to do it on their own. On the other hand, I’m pro as little gov’t as possible. You make a very good point regarding education. I truly wish personal finance was a cornerstone in our educational system. Why can’t it rank right up there with math and science? We all participate in the economics our this society one way or another. For those who hold gov’t office where fiscal policies are made and taxpayer dollars are spent, they need advanced courses. Wait, I think I digressed from the point of this post. Sorry;-).

  6. @bob I agree completely. My grandfather worked at his ‘retirement’ job for longer then he worked the job he retired from! He quit that job 2 weeks before he died at age 96.

    I don’t have a problem with the idea of retirement so much as I think the problem is that (most) people view it as some sort of right instead of the (massive) luxury that it is.

  7. Now that I’m done laughing at the Time article, I’ll share my thoughts.
    The fault, Horatio, lies not in our 401(k)s but in ourselves.
    The 401(k) is similar to an IRA in that one has the chance to save money pre-tax and invest it over time. Choices of investment and rules regarding limits differ, but same higher level concept.
    Teresa Ghilarducci may have an interesting idea, but we already give over 13% to FICA (the combined employee and employer withholdings) why does she think this extra 5% is a panacea? Her plan describes a deferred fixed annuity. 5% to replace 26%? Don’t know that I’d go for that.
    The real question is whether we want to keep our freedom of choice of give it up in exchange for a guarantee. But we have that now. All 401(k) accounts have an option of a short term bond fund which over that same period cited above, lost nothing. Maybe people need to be better educated on how to invest, but taking away our options isn’t the way I’d go.
    Why was I laughing earlier? Because at the height of the last market boom, these same people were suggesting that the social security trust fund be invested in the stock market. Now that the market is just off its lows, let’s kill the 401(k). As Bono would say, er, brilliant.
    I have a better idea, why don’t you (the Time authors, not the kind readers here) just keep buying high and selling low and stop telling me I should do the same. I am a big boy, and I invest appropriately for my own risk tolerance. Every time you try to help, you make the system worse, not better.
    Joe

  8. Mr. Not the Jet Set

    Terrible article – the one by Time, that is. I was reading this at the in-law’s house this past weekend in complete disgust. I never even got to their suggested alternatives to the 401k. I can’t say that I’m interested in their solutions when they have so poorly stated the problem.

    “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.”

    1- That average balance figure was taken from 2008 and compared with 1998. Hello! 2008, in the grand scheme of things will be an anomaly. The market was artificially high and was tanking in 2008 – this is not good science.

    2- Their contention that the average 401k does not have enough for retirement is right. But the problem is that on average, Americans change jobs every 2.3 years. Even if you double that, and change every five, you’re still rolling that old 401k to an IRA or at worst not contributing to it any more. 401k balance for your current job is not a good measure of retirement savings.

    So again, not interested in their solutions.

  9. Oh, please, no, the government shouldn’t make companies have pensions.

    The government really should do as little as possible.

  10. I have been using IRA’s and 401k’s for 27 years. Sure, the market tanked the last couple years, and if the government doesn’t get out of the way, it just might tank all the way next time. The point here is that at the low, I was still ahead.

    Now if you want to look at why few people use the 401k, there are two main reasons. First is America’s greed and ignorance of reality. The I want all, and I want it right now attitude. We are a bunch of spoiled rotten brats!

    Second is the fact that the companies matching funds are pathetic! Better than nothing, but pathetic. What a GREAT deal for corporate America to get out of a HUGE pension obligation, and replace it something that all you have to do is put in $1200 a year, as in my case, as long as I put in 5% of my earnings. Now that is a retirement I tell you! A great view in the trailer park!

    The real problem is not the 401k. It is all the money we employees, and employers flush down the Social Security toilet. Just think about it. My 7.65%, and my employers 7.65% could go into a very conservatively invested investment vehicle even earning an average of 5 or 6%. After 40 years, we would be so wealthy, our kids wouldn’t even have to work.

    But instead, we bankrupt America by sending out checks each month to people who for the most part use it for beer money, and the people who pay the taxes to send these checks are watching their jobs leave on the next ship.

    Now that is a plan for success! Change I can believe in! The jingle that is left in my pocket!

  11. I agree that one of the problems is that employees are not educated about finances. Further, Americans do not want to sacrifice today in order to provide for tomorrow. This can be seen in our consumer debt.

    However, I do have a complaint concerning 401Ks in that what is offered is usually a limited menu with low-quality items. Were it not for matching, my husband would not be putting money into his 401K. Instead, we would pour it into a better quality IRA.

  12. No I want less government control. Public employees in the state of Oregon have to contribute 6% of our income to a state run fund. Some local governments do pay it on behalf of the employees but it is a screwy system. Let me invest it in a Roth IRA!

  13. The problem is Time seems to believe a comfortable retirement is a right, not a privilege. That is so typical of the entitlement mentality that seems to have taken root in America over the past two decades or so.

    There is nothing wrong with the 401(k) program – it works well for folks who are personally responsible. Maintaining a 401(k) account is not rocket science: for most people it requires little more than adjusting fund balances and managing contribution amounts every three months. Savvier folks (those who take a couple minutes a day to follow current events) can adjust their fund allocations.

    Oh, and by the way, Dave Ramsey is wrong. Only truly stupid retired people will ever eat Alpo – it’s more expensive than ramen noodles! ;-)

    My $0.02 (after taxes)

    Len
    Len Penzo dot Com

  14. The problem with the 401k, as with any other “product” pitched by an advisor or financial planner, is that you lose control of your money. You hand it over and hope that the market goes up. That’s it. If it goes down, you can blame your losses on someone else while your head stays in the sand.

    I noticed that some comments mentioned “investing” in your 401k; the 401k is a savings program, not an investment vehicle. Seems like small potatoes, but the two are 180 degrees from one another. Read Kiyosaki’s “Conspiracy of the Rich” where he gives a great explanation of the origins, purposes and pitfalls of the 401k among many other topics.

    The best financial education we could get is not how to pick the best stocks or mutual funds to put into our 401k (which I don’t have, by the way); that’s as useful as getting and education on how to beat Vegas. We should be learning how to build businesses and investments where we control our own futures and produce monthly income streams INTO our pockets rather than OUT of our pockets like you get with the 401K.

    PS: I do feel that it is my right to not have to work my entire life until I’m too old to appreciate what it has to offer, and once achieved, it is a wonderful luxury to have.

    Trent

  15. Trent – your comment implies that putting one’s money into stocks for the long term is something you feel is not an investment. Am I mis-reading you?
    401(k) is only a shell, a tax status, and investment limitation, some plans are better than others. Mine has a brokerage account, so I can invest in anything stock or fund that I could outside of the 401(k).
    Sounds like you choose starting a business instead. Not that I want to debate the pro/con of it, but for those who ‘work for the man,’ a 401(k) can be a useful tool for retirement.

  16. @Trent: Those who contribute to 401(k) plans have a lot more control over their contributions than you give credit for. For example, I saw the economic storm clouds building in late 2007 and eventually transferred all of my 401(k) money from stock market funds to a stable value fund over 6 months before the markets collapsed in late 2008.

    While the stock markets plunged, my 401(k) didn’t lose a dime.

    Yes, those who “stick their heads in the sand” may get burned – but there is plenty of control for people who pay attention to their 401(k) accounts.

  17. @trent What I was saying was that most people feel that retirement is something they are owed, whether they’ll have the money to do so or not. Certainly anyone has a ‘right’ to retire if they can afford to do so. Just like the second amendment secures our right to own guns it doesn’t say the government has to provide us with any guns.

  18. Actually, the 401k is neither a savings program nor an investment. The 401k is simply a section of the tax code that allows certain qualified investments to grow tax-deferred. As Dave Ramsey describes, “it’s the coat that keeps the investment warm…. warm from the bitter cold of taxes”.

    Where you put your money inside of that 401k depends upon your choices inside of what your company and the plan’s custodian allow – company stock, bonds, mutual funds, even short-term savings. The options vary widely.

    If you, perhaps wanted to invest in something else, like real estate or businesses, then you would have to do it outside of your 401k and lose your tax-advantage. Given the past two years, I’m not terribly sure how either one of those would be considered safer than mutual funds (which are bouncing back). On top of that, you add your company’s dollar for dollar match (up to a certain percent)…. I’ll keep my 401k, thankyouverymuch.

  19. Forced savings seem to be what the majority of people need as most people do not have the discipline necessary to save for retirement on their own. An interesting article.

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