Real Change: Outlaw 401(k) Plans

President-elect Obama ran on a platform of "real change." Here's my proposal which would make good on that promise:

Outlaw 401(k) plans. Throw them out entirely and replace them with something that would be an economic stimulus for those who need it the most.

The 401(k) system is a disgrace. Employers get paid off in the form of subsidies to select brokers and advisors who control the investment options in the plan. They, in turn, get paid off by fund families and insurance companies which limit employees' investment options to costly, under-performing funds.

The fox guarding the hen house is the big winner. They have a vested interest in steering employees in the wrong direction. That's why there is no standardized investment education.

It gets worse:

The hidden costs in these plans were starkly illustrated in recent testimony before Congress. The mutual fund industry was aptly describe as the world's largest "skimming operation". It views the $12 trillion in 401(k) assets as a "trough" from which it siphons off an "... excessive slice of the nation's household, college, and retirement savings."

Let's just admit defeat. We are no match for this powerful industry. We need to stop tinkering with these plans, toss them out, and start all over.

Here is my proposal:

All employees would be eligible to participate in the Solin Self-Reliance Plan (SSRP).

Think of the SSRP as a Roth IRA on steroids. There would be no income limitations on eligibility. The contribution limits would be the same as a 401(k) plan: $16,500 for 2009. Contributions would be made with after-tax dollars. The balance of the Roth rules would apply:

No penalty for early withdrawal of the amount contributed;
Tax free withdrawals after 59 1/2.;
No required minimum distributions at any age

Here's the twist:

In order to qualify for the SSRP, you would have to take a standarized, short (5 question) questionnaire, available on the Internet. The results of the questionnaire would suggest either (i) one of 5 pre-allocated, globally diversified, low cost portfolios of index funds, Exchange Traded Funds or passively managed funds or (ii) Target Retirement funds, consisting solely of low cost index funds. It would list fund families who qualified to provide these fund options. The fund families would be required to disclose all costs charged on a standardized form approved by the Department of Labor. The employee would then select from these options.

By limiting investing options in this way, employees are assured of making intelligent choices. This is precisely what the government does with its wildly successful Thrift Savings Plan, the 401(k) plan available to government employees.

I can hear the naysayers now.

What about the corporate match?

Ask employees of Frontier Airlines, General Motors and Kodak. These mega-employers have stopped matching 401(k) contributions. Many more are sure to follow.

What are you really giving up, even if you got the much-hyped match? You still would have to pay taxes at your marginal tax rate when you take distributions. How confident are you that this rate will not offset most of the benefits of the tax deferral? Wouldn't you rather know that your distributions will be tax free?

What is the value of intelligent, low cost, high performing investment options over expensive, high cost options available in most 401(k) plans? Impossible to calculate, but very significant.

Now for the real kicker:

What is the value of not participating in a system that is ripping you off to benefit your employer and the securities industry?

There was a time in this country when rugged individualism was valued. It's time to return to those principles.

The Solin Self-Reliance Plan would be a major step in that direction.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.

Comments

[rocketman69]

Here's my idea: Renew everyone over 30 (a la Logan's Run) and retirement and medical costs drop to almost nothing. Plus it's a great carbon footprint remover and degreaser.

[MadJayhawk]

Where were all the 401K critics when the Dow Jones was at 12,000, home, counting all their paper profits?

The fact is that the 401k program cost the government a tremendous amount of deferred tax revenue and Congress is going to need that revenue to bail out all of congress's many needy friends. Besides that 401ks are something that government can't control so they will come up with some wonderful plan to roll all of OUR MONEY into a government controlled 'investment' plan that can be tapped like social security. Do we really want the same fools running the post office, social security, and medicare running our personal retirement systems? Please tell me no. This 'crisis' gives congress the leverage to get rid of the revenue drain and make themselves look like heroes to the uninformed.

Those who look to European government run retirement and health care plans rarely, if ever, mention European tax levels. Someone has to pay for these things or else the Chinese will own everything.

Someone needs to tell the complainers that any investment involves an element of risk and that investments do lose money sometimes. But wait, they do tell them that. The idiots are too dumb to understand.

Before I retired I always joked to my boss that anyone who did not participate in 401ks up to the max should be fired for being stupid. My 401k is paying for my trip to Australia/New Zealand next month.

[nthelurch]

Full disclosure: I'm in 401k industry. The fault Mr. Solin finds with 401(k)s is with Wall Street which is a problem not with the 401k concept itself but with the Investment Selections within these plans decided on by the Plan's Investment committee.

Many plans offer Index funds as well as Targeted Retirement Funds.

Mr. Solin, why are you throwing out the baby with the bathwater. 401(k) plans were originally designed as a supplement to a three-tiered retirement system for private company employers. They were designed to inexpensively allow employees to increase their savings for retirement so that, when COMBINED with Social Security and the Companies Private Pension, people would have a stable retirement.

The problem with 401(k) plans is that they have been allowed to become the replacement to Private Pension plans simply so that Corporations can lower employee overhead.

If you want to place restrictions on the investments of 401(k)s, just do that because that is all you have proposed other than removing the tax deferred status.

[marka]

I believe that the retirement of today's boomers and those that follow will be the next great financial crisis in this country. The 401k was designed as a supplement to a traditional retirement plan--not a replacement. I predict that ten to fifteen years from now there will be tons of Americans with drastically underfunded 401k plans facing poverty. This was a huge shift in responsibility on to individuals that were ill prepared to accept it. That said--even educated investors would have a hard time making many of the plans that I have seen work, There a high fees, little or no diversification, and the lack of many of the asset classes necessary for an investor to build a well rounded portfolio. Many 401k retirement plans are doomed by their very design. I predict a great deal of anger in the future when people come to realize how badly they have been flim-flammed. It's going to be ugly.

[nthelurch]

Maybe because I work for a TPA (Third Party Administrator) and consult on properly running 401(k) plans, I see more of the plans that can and do work. Plans run by Mutual Fund, Insurance and Investment companies are geared toward getting money under asset and don't tend to benefit the individuals. That's fine with some Employers who make these decisions.

But I do agree that we are going to see huge problems with retirement for individuals.

Many employers have shifted from valuing talent and no longer strive to keep good employees for the long term. These are the ones who got rid of their pensions and replaced them with low-cost, inadequete 401(k)s. If you want to blame anyone, look at the Employers, it is ultimately their decision.

[Social Construct]

Just wait for the great retirement flood to come. When the babyboomers start retiring en masse, I wonder just how much of that 401K money will be there?

[JBS]

Well, right at the moment, it's worth about 90% of what I put in.

[nellieh]

Dan, new hires into the federal government since 1984 are covered by the Federal Employee Retirement System. This is different from the Thrift Savings Plan. In FERS the government has a matching system. I'm not certain, being a CSRS retiree, but I think they match dollar for dollar up to three and $.50 to the dollar for two more. I'm sure I'll be corrected but there is a government contribution. The Thrift is a voluntary saving contribution plan.

[LeftRight]

The FERS system is a smaller defined benefit package (pension) coupled with the TSP. They provide 1% "match" automatically whether you are contributing or not, then they match dollar for dollar for the next two percent, and then they match 50 cents on the dollar for the next two percent. In short, they will match you basically dollar for dollar up to 5% of your pre-tax income.

[siddag04]

:You mean the TSP (Thrift Savings Plan)is a good one? That's what I have, but I've been too afraid to even look at it. I don't even want to know what's happened to my retirement right now, I had Christmas to do...
But the TSP recovered niceley a few years back after a big crash. I do like that one can log on and change their options at anytime themselves, and we do get a pretty good newsletter that tells us whats going on with it. I'm just planning to let it go for a while until the dust settle. I saw fellow employees juggling their options daily trying to shift things around, problem is your high priced well performing funds (C) that were tanking, if you put them into the safe (G), then the gamble is that you could be buying tons more of the C with your paycheck deduction now, if you leave it be. That's my uninformed strategy. I'm just letting it be. It is truly a gamble with our hard-earned pay.

[LeftRight]

I'm doing the same thing, just leaving it alone without looking at it.

On the other hand, the TSP really IS run very well, since they aren't using "managed accounts", which makes the actual fees be MUCH lower, so you can actually keep most of the gains that do happen. Yes, it's collapsed right now, since the market has also collapsed, but if you've got time before retirement it's still a good deal.

[twofish]

Don't companies get some sort of tax break for matching employee contributions to 401k's? Won't they be losing something by stopping those contributions? Perhaps they've decided that since they have so many other outs from paying actual taxes, they don't need this one any more?

[JBS]

No, they won't lose a thing. You get to offset the contribution against profits.

In those years where the company can "lose" money, there's no "profit" to offset against.

[jsarets]

I don't believe in individual investment accounts as a means of financing retirement on a large scale. There's too much uncertainty and stress involved, and I'm concerned that herding the working masses into highly diversified funds distorts the market by desensitizing it to business performance.

My plan is based on tax-free retirement savings accounts that yield a stated rate of interest, managed by your choice of federally-insured thrifts and credit unions. Employees may deposit up to (approximately) 25% of their pre-tax earned income into their retirement savings account.

This account is managed much like any other savings account except that it only accepts this kind of deposit, and upon the first withdrawal, the account is permanently closed to further deposits. In other words, it opens as a deposit-only account and becomes withdrawal-only when the depositor chooses.

Every U.S. citizen is entitled to one and only one account in their lifetime, and once they withdraw they can't go back. However, they can transfer their account between providers as many times as they wish in either phase of the account.

I suggest that withdrawals as well as deposits be tax-free so as to encourage retirement savings without imposing a tax burden on retirees living on their savings. That's why deposits are limited to earned income.

It's a worry-free retirement account promoted by a kind of earned income tax credit.

[Choicelady]

I'm there save for the 25% amount. Workers on minimum wage just could not do that. What in the world is wrong with making Social Security, a safely invested fund, part of your full income rather than capped? It's linked at a low rate to your income, but pooled it helps everyone. You know - some things just used to work before some city slicker came along and found ways to rip it off. Back to basics - Social Security and Medicare BOTH in a 'lock box' that cannot be touched or borrowed against and do NOT figure into the actual national budget. And pensions - yes PENSIONS - with employee and employer contributions safely invested again in conservative but reliable ways. And neither Social Security NOR pensions should be taxed. Return to the idea that security and self sufficiency are core values, not growing rich. You can do that if you want, but don't drag the rest of us into it. Use your OWN money, not other people's. It may be staid and stuffy, but it works.

[jsarets]

That was just the basic framework of the program, the 250-word introduction. There should be a tax-supported mechanism to supplement the savings of the working poor. It's better to put the public funds in savings accounts today so they can accrue interest rather than waiting for people to burden the safety net when they can no longer work.

There are innumerable ways to implement this kind of mechanism. For example, the federal government deposits $1 for ever $N of individual deposits, where N is the worker's income divided by the poverty level, up to a maximum of N=3 or a combined deposit of 25% of income, whichever is lower.

We're always going to want a pay-go retirement safety net like Social Security, where current employees support current retirees. But we want to make Social Security the retirement benefit of last resort. We want to do everything we can to help people save for their own retirement so that workers don't have to pay for everyone's retirement, only for those who couldn't make it any other way.

The big problem with SS is that most people think they're paying into a system designed to pay them back later. Nobody likes to hear that they're paying for a portion of someone else's retirement. But the result is that everybody expects to draw an SS check when they retire as if it's only fair. They don't see it as a lifeline for those who fall through the cracks.

[senorlou]

Sounds good, but what happens to the money while you aren't using it? Is it loaned out? Is it put into the market? What happens to the money while it's just sitting there gaining interested. I think the main problem with savings accounts and retirement accounts is that your average American has no idea what is happening to it when it's out of his/her hands. So, again, what is the money doing while it is accruing interest?

[jsarets]

Just like any other savings account, the provider invests the deposits and issues loans against them. They guarantee a stated rate of return which they pay from a combination of investment and loan proceeds. Surplus returns are typically generated to ensure they can pay the fixed interest.

Thrifts (e.g. Washington Mutual) pass these profits on to their investing shareholders. Credit unions are owned by their depositing members, so the profits are returned to the accounts as dividends. Members of credit unions are also eligible to vote and run in board elections, and most issue loans exclusively or preferentially to their members.

The subtle intent behind the program is that, given the option of where to park their retirement savings, credit unions would surely increase their share of national savings. Not only for the reasons above, but because they typically offer higher rates on deposits and lower rates on loans compared to thrifts.

Credit unions are unique businesses in that their users are also their owners. In a purely economic sense, this solves the principal/agent problem. But from a political perspective, credit unions are the embodiment of progressive libertarianism: private self-financing democratic collectives.

[senorlou]

Just interested. I have no 401K plan, nor do I ever plan to get one, but I'm wondering if any of you would admit to post just how much money you lost in your 401K this past year. Don't mean to be nosey, but I'm trying to learn something here. Peace, and good luck with your money.

[JBS]

I haven't looked too closely at the values since October. It was just too depressing, but the last spreadsheet I did, I had on average about $0.90 on the dollar ... for a mutual fund I'd been in for about 18 years.

I got a double whammy, the fund chosen by my former employer was one of those involved in the 2003 market timing & late trading scandals and lost about half its value then, and had not recovered before it was overtaken by the market crash in 2008.

After a real quick look just now, all the funds in my 401k seem to be down an additional 10% or more since October, so it looks like it's now more like $0.80 on the dollar.

[SisterAnn]

To be honest DorianGre, I would be terrified. There is something about a pile of money that the unethical can't leave alone. They are probably plotting to take your money as I type:-)

We have waited for the future for our Social Security, Medicare, our 401k investment gains, and for life insurance. Now the future is almost here and it seems that all we have paid for is slowly but surely disappearing.

[Arthur954]

This is all very complicated. I am an American citizen living in Spain, and here in Europe the state guarantees your retirement, as well as health care. It costs the economy as a whole A FRACTION of what it does in the US. Everyone is happy with it, employers and employees.
The US system cannot be fixed, it has to be BYPASSED all at once. All those layers of redundant administrative overhead, middlemen, lawers, lobbyists, all kinds of people that have to make a profit ......a mess, an immoral barbarity and a drain on the economy.
There should be a national retirement and health care system in the US, like in every other advanced country, and then, aside from this, if someone wants to have a private pension plan or whatever, they can do it on their own.
LETS NOT INVENT THE WHEEL : ALL THIS IS ALREADY WORKING SUCCESSFULLY IN EUROPE ! the Obama govt. should make a trip to Europe before doing anything cheers !

[senorlou]

Sounds great to me. Curretly, we have no real sane retirement plans in the US.

[sonoffestus]

It's the you're on your own society!

[quindy]

Coming from Europe I have never seen retirees worry about their retirement. Nobody ever wondered what would happen if the markets crash or something like that. Nor have I ever seen a person becoming homeless and destitute because of medical bills. In the last couple of months I have seen some of my friends losing all their retirement due to the stock market crash (they had their retirement money in the company's stocks because that was what was offered??!). And their medical coverage is gone too, because the company went bust. So, now at 50-something they are facing losing everything. Retirement money should be government guaranteed so that people don't find themselves destitute at the time when they cannot work anymore.

[momofvegasgirls]

He's right when he says more companies are dumping 401(k) match. My husbands company here in Las Vegas just did it, and so did Stations Casinos ( which is no longer a publicly traded company and up to there ears in debt).

There's a gamble we didn't count on!

[senorlou]

401K plans were always a bunch of flim-flam. Everyone I know who has one has no clue what companies they are invested in. A lot of them also lost craploads of cash this year. There has to be a better way than this. Give everybody back their 401K money tax free, and let them invest in something more sound and less hazardous to our economy and the human race. Sure, you made a lot off your Exxon stock, and your health insurance and pharmaceutical stocks, but who else did that help aside from you?

[ehan]

Wow, so we are supposed to eliminate a program where for every dollar I put into the plan my employer gives me up to a dollar? REALLY? Where do you suggest I put my money to get a 100% return in a year???

[senorlou]

And how much money did you 401K lose over the last year?

[ehan]

Lets see, last year for every dollar I put into my 401k plan my employer gave me a dollar, so I had two dollars invested. I lost 20% or 40 cents of every dollar) So at the end of the year I had 1.60 for every dollar I put in, which (maybe I got the math wrong) equals a 60% return.

Yes, I am simplifying things but so is this author. Apparently he has never heard of a Roth 401K, automatic asset allocation, ETF's or index funds inside a 401k, and suggests that investments outside of a 401k don't have the same fees that a 401k has (hate to break it to you but they do).

[jsarets]

Your employer took that matching contribution out of your paycheck. All you gain is the tax benefit.

[PATina]

Okay... what's up w/ the font in these comments. I need a magnifying glass to read them.