Money & Policy

Why It’s Time to Kill the 401(k)

This actuary says momentum from the savings program broke our retirement system

(This article previously appeared on the Benefits and Compensation with John Lowell blog.)

Nearly 40 years ago, Ronald Reagan asked voters if they were better off than they were four years earlier. And, that was the beginning of the end for Jimmy Carter’s reelection hopes. So, without trying to end anything for you, I ask if you are better off from a retirement standpoint than you were 20 years ago.

For Americans as a group, I think the answer is a clear no.

Momentum From the 401(k) Broke the Retirement System

Our retirement system has been broken by the momentum that has gathered around the 401(k) plan. After all, when Section 401(k) was added to the Internal Revenue Code in the Revenue Act of 1978, it was never intended to be a primary retirement vehicle for Americans. In fact, there doesn’t seem to be much agreement on why it was thrown into the Act.

When it was, however, traditional defined-benefit pension plans were in their heyday. People who were fortunate enough to be in those plans then are now retired and an awful lot of them are living very well in retirement. On the other hand, people who are now retiring and have only been in 401(k) plans have their retirement fates scattered all over the place. Some are very well off; others are essentially living off Social Security.

Where Workers Went Wrong

Let’s consider where those people went wrong.

For many, when they first had the opportunity to defer a portion of their paychecks for their future retirement, they chose not to do so. They had bills to pay and couldn’t make ends meet if they didn’t take that current income. By the time they realized they should have been saving all along, they couldn’t catch up.

Others were doing well until they lost a job. Where could they get current income? They took a 401(k) distribution.

Yes, I am very well aware that the models show that people who are auto-enrolled and auto-escalated (the portion set aside automatically rises annually) in a 401(k) plan with an employer match will fare quite well. Those models all assume no disruptions and constant returns of usually around 7 percent.

Let’s return to reality.

When Saving Is Impossible

The reality is that young workers are (likely because of all the campaigns telling them to do so) deferring liberally when they start in the workforce. The problem is, and I get this anecdotally from young workers, that most of them reach a point where they just can’t defer at those levels any more. They get married, buy a house and have kids, and the financial equation doesn’t work. So, they cut back on 401(k) deferrals. I know a number who have gutted one or more of their 401(k) plans in order to buy a house.

Where were we 20 years ago? For many Americans, they were about to be getting those notices that their pension plans were being frozen due to a pension law passed in 1987. And, they did it at just the time that their workers could least afford it.

For all the data and models that tell us it should be otherwise, more people than ever are working into their 70s, generally, in my opinion, because they have to, not because they want to.

Are We Better Off Than 20 Years Ago?

As a population, we’re not better off in this regard than we were 20 years ago. In fact, we are far worse off.

Even for those people who did accumulate large account balances, many of them don’t know how to handle that money in retirement and they don’t have longevity protection.

We need a fresh start.

We need funding rules that make sense and we need a plan of the future.

Creating the Retirement Plan of the Future

It shouldn’t be that difficult. I’d like to think that my actuarial brethren are smart people and that they can design that cadre of plans. They’ll be understandable, they’ll be portable as people change jobs, they’ll have lump-sum options and annuity options and they’ll even have longevity insurance. They’ll allow participants the ability to combine all those in, for example, taking 30 percent of their benefit as a lump sum, using 55 percent for an annuity from the plan beginning at retirement and 15 percent to “buy” cost-of-living protection from the plan.

That’s great, isn’t it? Even most of the 535 people in Congress would probably tell you that it is. But most of those same 535 people don’t really understand a lick about defined-benefit plans or about retirement plans in general.

In order to get that fresh start, we need laws that will allow those designs to work. We surely don’t have them now.

Over the years, Congress has punished the many plan sponsors because of a few bad actors. If 95 percent of defined-benefit plans were being funded responsibly, then Congress changed the funding rules for 100 percent of plans to be more punitive because of the other 5 percent.

Isn’t it time to go back to the future to get this all fixed?

Let’s kill the 401(k) as a primary retirement plan and develop the plan of the future. It could be here much sooner than you think.


John Lowell
By John Lowell
John Lowell has been a consultant and actuary for more than 30 years. He is a partner in October Three Consulting and president of the Conference of Consulting Actuaries.

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