The Washington Post published a story earlier this week by Jia Lynn Yang that had all the information needed to conclude that the 401(k) isn’t working out. She reports that the 401(k) has caused serious stress for working Americans and cites some scary financial data from the Center for Retirement Research. Since Congress created the 401(k) about 30 years ago, financial unpreparedness has gotten much worse: In 1983, researchers found that 31 percent of working age households were “at risk” of losing their standard of living when they retired; by 2009, it was 51 percent. The average worker who retires should have more than $300,000 in their 401(k) account, but in 2007 – even before the markets crashed and wiped out trillions in savings – the average person about to retire had only $78,000. The story didn’t mention that the cumulative underfunding of retirement accounts is nearly $7 trillion.
But instead of fingering the 401(k) as the cause of the stress and retirement insecurity most of us are facing, or even blaming Congress or the employers replacing pensions with a cheaper, badly designed personal account, Yang and her editors conclude that the fault lies with the many employees who are just too “clueless,” as Ms. Lang puts it, to deal with financial responsibility.
This lets the real villians off way too easily. Essentially, the big retirement-policy experiment of the past three decades has been replacing guaranteed pensions with … a tax cut, called 401(k)s. Since the 401(k) is failing so badly to achieve the most important goal our retirement system should have – the achievement of retirement security for most Americans – it should be replaced with something better, and we can put the money gained by closing the 401(k) tax expenditure to better uses. I also disagree with Yang’s statement that “even the program’s biggest critics concede that the system … is here to stay.” Not necessarily. The 401(k) is essentially a tax loophole that over-rewards the well-off for saving money they would have saved anyway. More than 70 percent of the tax deductions are taken by people in the top 20 percent by income. Every member of Congress claims we need to close tax loopholes and non-performing subsidies, and if tax reform ever happens, the 401(k) should be a fat target.
The article suggests that the 401(k)’s failures are really our own: ignorance, irresponsibility, making mistakes. It never mentions the effect on these accounts of the fees charged by plan administrators, investment advisors, and mutual funds, which can shave 25 percent off an account over a lifetime of work and investing. Yang never mentions that employers tend to put far less money into 401(k) plans than they do into pensions, that employers often reduce their contributions or freeze them altogether when times get tough, and that some employers make their contributions in company stock – often a poor choice and one that can lead to insufficiently diversified investments.
Yang does mention that it isn’t easy for individuals “to manage your investments intelligently through stock market highs and lows.” But I’m not sure she understands just how difficult it is, even for a former Assistant Secretary of the Treasury like Alicia Munnell, whom Yang quotes as saying “managing your own money is just horrible.” Market risk is out of one’s control, to a certain extent. To illustrate, Gary Burtless of the Brookings Institution estimated that a 401(k) participant retiring in 1974 would have a retirement income 64 percent lower than that of a worker who retired in 1999 if both workers contributed the same amounts over 40 years to a portfolio split equally between long-term government bonds and stocks (Burtless 2008). In short, two workers pursuing the exact same (and generally sensible) strategy achieve wildly different retirement income possibilities simply because of good or bad timing.
The tens of billions of dollars taxpayers are wasting to subsidize 401(k) savings each year would be much better spent on the more egalitarian, safer, and more nearly universal Social Security retirement system.