Time to Replace the 401(k)

A couple weeks ago, I blogged that the 401(k) had failed. My point was that we had taken a perfectly decent supplementary savings plan and, without any real discussion, allowed it to become the sole source of most workers' non-Social Security retirement income. The 401(k) was not designed for that role, and it has come up way short. The simplest proof: Even before the crash, the median household on the verge of retirement had just under $100,000 in all its retirement accounts, including 401(k)s. By the standard financial planning rule of thumb, that works out to $4,000 a year for the rest of your life. Four grand doesn't leave much left over to buy Disney Land trips for the grandkids, does it? And, remember, that's before the crash.

Since then, the 401(k) has continued to take its lumps. Felix Salmon questions whether it was ever a good idea. Seasoned financial writers like Kathy Kristof point out that 401(k)s lose a lot of money to hidden administrative fees, and Congress has penned a bill to make 401(k) administrators do a better job disclosing them. That's a worthy enough goal, but lowering fees is little more than a gesture. It fails to address the fundamental failure, which is that 401(k)s produce nest eggs that are too small and leave near-retirees too vulnerable to the randomness of the market. In short, the 401(k) needs to be retired and replaced with something better.

A coalition of unions and liberal think-tankers called retirement-usa.org has outlined a dozen or so principles for such a successor. Among the attributes I think are key:

• Payouts allowed only at retirement: At the moment, 401(k)s have too many leaks: Savings dribble out in loans and, worse, in withdrawals whenever employees change jobs.

• Payouts stretch over your lifetime: Benefits would take the form of a life annuity, so you can't run out of money, even if you live long enough to be the last living person to remember why we once thought the ownership society was a good idea. In actuarial terms, we spread longevity risk over a the whole population.

• Mandatory contributions: Americans don't save enough in 401(k)s to provide adequate retirement income. Much as it pains me to say it, behavioral economics has shown that there is no way to get people to save enough without making them do it.

You can download the retirement-usa.org working paper here. Let me know what you think. The paper doesn't endorse any particular plan, and thankfully it doesn't just pump for bringing back the traditional pension. (As Charlie Farrell points out, defined benefit pensions have problems of their own.) Instead, it outlines four savings plans that embody many of the key principles of a 401(k) fix. (Two are think-tank proposals, and two are already in effect -- in Australia and the Netherlands, respectively.) Retirement USA's ideas are sure not to please everybody -- there's a lot of government involvement -- but it's also pretty clear that what we have isn't working. It's time to start talking about what comes next.

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Comments

[RachelMICI]

There’s ample evidence that the 401(k) is a successful savings vehicle. At year-end 2008, Americans held $2.4 trillion in 401(k) plans. Since 1978, when Congress added Section 401(k) to the U.S. Tax Code, total U.S. retirement assets as a percentage of household assets grew from 14% in 1978 to 34% in 2008. Clearly, the 401(k) system has played a vital role in helping Americans’ save for retirement. It should be preserved; we would be making a grave mistake to use recent market events as an excuse to dismantle the 401(k) system.

Of course, the 401(k) can and should be strengthened; we’ve advocated a range of ways to improve the system. We support improving disclosure about all 401(k) investment options to ensure that participants have key information—about fees, risks, historical returns, and more; delaying the required minimum distribution age to reflect changing life expectancy; encouraging more employers to offer plans, and making financial literacy a national priority.

The US already has the system you suggest—with mandatory contributions and a required annuity paid out at retirement—it's called Social Security. It’s worth noting that a 401(k) is not designed to be a worker’s sole source of retirement income. Instead, it complements Social Security. Preserving the essential nature of Social Security as a universal, employment-based, progressive safety net for all Americans while addressing its long-term solvency should be a top national priority.

Thanks for the chance to comment – Rachel McTague, ICI Media Relations, Investment Company Institute

[harry greb]

The defined benefit pension system worked perfectly fine for decades. That is, until the corporate paymasters directed their political hirelings to defang the regulations that protected and guaranteed the systems funding, allowing them to abscond with the bulk of the money and leave the taxpayer, via th PBGC, holding the bag.

[BobLablah]

Great ideas. Unfortunately that means they will never happen.