Was the 401(k) a Mistake?

Retirement sure has changed, hasn’t it? A century ago, it meant slowing down a bit as you got old and frail, but still working until you dropped. In the 1950s and 60s, it meant collecting a gold watch and living off a company-sponsored pension along with health benefits and Social Security. But, supporting retired workers is expensive, and companies grew to resent those obligations. So, in 1980, a Philadelphia benefits consultant named Ted Benna realized that Section 401(k) of the Revenue Act of 1978 could let his employees “defer” part of their paycheck into a deferred compensation plan. Just two years later, 7.5 million American workers were using the new plan to save. Today, there are over 710,000 plans covering more than 70 million Americans, holding over $7 trillion in assets.

Current conventional wisdom holds that the best way to save for retirement is to contribute as many tax-deductible dollars as you can to your 401(k) during your working years when you’re earning your highest income and paying your highest taxes. Invest it as aggressively as you can in the stock market or pick something called a “target date fund” that makes investment choices for you based solely on your current age. Then, withdraw your savings and pay tax at lower retirement rates to finance golden years full of Florida sunsets, grandchildren, and pickleball. (Try not to drive your neighbors nuts with the sound of the ball hitting the paddle!)

Now, a new breed of economists and investment professionals are asking themselves, was it all a mistake? Increasingly, the answer is “yes.”

Investing isn’t easy—if it were, everyone would succeed. Investors face three primary challenges to securing results: market volatility, fees, and taxes. Employees investing in 401(k)s (or their nonprofit cousins, 403(b)s and 457s) have to navigate all of those challenges themselves. How many classes did you take on retirement planning in high school or college? And if your name isn’t something like “Chadwick Cabot Lodge III,” Mummy and Daddy probably never sat you down to discuss it.

Now, Ted Benna calls his invention a “monster” and says he regrets how employers have made it their employees’ primary savings vehicle. “It was never designed to be what it is today,” he says. Larry Fink, the chairman of BlackRock money management firm, criticizes it as “a shift from financial certainty to financial uncertainty.” And plenty of observers criticize the 401(k)-industrial complex of driving wealth inequality.

Let’s take a closer look at just one of those fundamental assumptions underlying the conventional wisdom: the notion that taxes will be higher today, when the money is going into the plan, than tomorrow, when it’s coming out. Will that really be true? Today’s national debt stands at $34.8 trillion, and we’re adding a trillion more every hundred days. How confident are you that tax rates won’t go up in the future? (What about your children inheriting your account when they’re in their highest-taxed years, and paying more on the money than you ever would have?) If they do, millions of Americans will be lighting the fuse on a tax time bomb with every paycheck. Yes, they can choose a “Roth” option that flips the usual arrangement in favor of nondeductible contributions today and tax-free income tomorrow. But even guessing right on tax rates still means confronting market volatility and the punishing, sometimes-hidden Wall Street management fees.

Today, financial experts and advocates are looking at potential 401(k) alternatives with higher mandatory contributions and stronger guarantees. Long-term, those could go a long way towards closing the retirement savings gap. And we’re happy to help you craft the most tax-efficient plan for your own golden years. Call us before you book that pickleball court!