How much money do you have saved in your
401(k)? In 50 years, no one will ask. Even better, no one will have to provide
the usual answer: way too little. Our 40-year experiment with 401(k)s —
tax-favored investment accounts for retirement sponsored by employers — will be
seen as an unfortunate interregnum, a massive waste of taxpayer dollars to
bolster the retirement security of the rich while undermining the retirement
security of the rest.
Added to the tax code with little
foresight in 1978, Section 401(k) cannibalized America’s public-private
framework of retirement security. Prior to the regulatory authorization of
401(k)s in the early 1980s, employers couldn’t legally provide tax-favored
vehicles for retirement savings in which workers themselves controlled and
directed the funds.
Instead, the pension plans that were the
norm among medium and large firms — offered by roughly 4 in 5 such employers —
were called “defined-benefit plans”: basically a private form of Social
Security where employers made most of the contributions, handled the
investments, and paid out the benefits at retirement based on a formula that
was legally binding.
Today, vanishingly few private employers
provide a defined-benefit plan, and they’re mostly legacy offerings covering
older workers. If a recently hired worker has a plan at work — and more than a third of
workers still aren’t offered any plan
— it’s a 401(k). Three numbers and a letter spell the future of American
And that’s a problem. There’s a reason,
it turns out, why employers didn’t hand retirement planning off to workers:
401(k)s are terrible at ensuring that those who need to save for retirement do.
Indeed, over the same period in which 401(k)s expanded, the share of
working-age households at risk of being financially unprepared at age 65 jumped
from 31 percent (in 1983) to more than 53 percent (in 2010). Indeed, the
terribleness of 401(k)s helped spark a new field of behavioral economics, which
showed that voluntary plans in which people manage their own investments defy
everything we know about how the brain works.
Traditional pension plans force people
to save and protect them against investment mistakes, market risks, and the
possibility of outliving their savings, not to mention predatory financial
institutions. 401(k)s don’t, and, lo and behold, most people
don’t put enough in them, make serious investment errors, and fall
prey to heavy fees that crush long-term returns. Worse, because 401(k)s can be
tapped into (with a penalty) before retirement and are transferred to workers
when they lose or change jobs, middle-class workers often use them as rainy-day
fund when times are tough, further beggaring retirement security.
Granted, 401(k)s work well for one group
— the group who needs them least. For the affluent, 401(k)s are a lucrative way
to manage retirement investments. They are also a great way to build up an
estate and delay paying taxes. (Traditional defined-benefit plans didn’t become
part of workers’ estates; like Social Security, they promised benefits for the
remainder of a workers’ lives, pooling the “risk” of living longer — and
potentially running out of money — across all those covered by the plan.)
Because they are subsidized through
delayed taxes, 401(k)s are worth the most to households in the highest tax
brackets. Moreover, higher-income workers are also more likely to be offered a
plan, to have their contributions matched by their employers, and, of course,
to have the financial freedom to put money in them. As a result, nearly 70
percent of the $190 billion in tax breaks for retirement and income
security accrue to the top 20 percent.
To be sure, 401(k)s have served one
purpose. Corporate America’s eager embrace of them showed that employers can’t
or won’t play the role they once did. But we now know that individual risk
management isn’t a workable alternative to corporate risk-pooling.
The obvious solution is a strengthened
Social Security system, and fortunately measures to boost Social Security’s
benefits are back on the national agenda (and enjoy overwhelming
public support). John Larson, a Democratic representative from my home state of
Connecticut, has 200 House co-sponsors for his “Social Security 2100 Act,”
which would boost benefits and raise revenues to ensure the program’s solvency
through, yes, 2100.
If 401(k)s were necessary to get such
sensible measures a second look, then they deserve our grudging respect — at
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