How many times recently have you heard the line “Well, I looked at my 401(k) statement and now it looks more like a 201(k). Hahahaha!” ? And are you getting pretty sick of that line like I am? I mean, for cryin’ out loud, there’s not even a §201(k) in the Internal Revenue Code! How ridiculous is that!? Heh… heh. Well, that line kills ‘em at the accountant’s conventions, trust me.
But seriously – we’ve all been hurt, hurt bad, by the market downturn that occurred late last year. And it’s not just 401(k)’s that were hurt: IRAs, taxable accounts, Roths… everything has been spanked. But the 401(k) is a dominant type of account that millions of Americans own and are painfully familiar with, and so this type of account has garnered special attention of late, by our nation’s lawmakers.
Tweaks For 401(k) Plans
You see, it has been a topic of conversation in Congressional committee circles of late, that the 401(k) is the root of all the pain we’ve been experiencing, and as such, being “broken”, someone needs to “fix” it.
What’s Wrong?
By all rights, the mere existence of the 401(k) plan probably has a lot to do with the specific pains many investers are feeling: without the 401(k) (and lots of ancillary 401(k)-like accounts such as the 403(b), the 457, etc.) most Americans would have little if any involvement in investing decisions. After all, the lion’s share of the IRA market is made up of IRA rollovers from these qualified defined contribution plans – and therefore individual investment (brokerage or mutual fund) account ownership used to be a fairly insignificant percentage.
When the 401(k) plan was introduced, its primary function was to take the place of the costly define benefit pension plans that corporations were beginning to abandon. The thinking was that, instead of using corporate monies to fund the pensions, employees could defer current income into an account, which would grow over time and provide a source of retirement income, replacing the pensions.
The concept itself isn’t bad – a benefit is that the employee now had much better insight into his or her own retirement, therefore having an incentive to save. The company benefits because it doesn’t have the liability of the pension to provide for the lifetime income stream. The employee benefits further because the company increases his income or matches his contributions, plus, the employee can opt out of the plan if he chooses, providing more disposable income. The end result though, is that the employee takes on nearly all the risk, with little, if any guidance.
The Root Problem
The problem that wasn’t addressed is the root of the issue: the pension plans were being abandoned because it was so costly to provide a guaranteed lifetime income stream, in part because managing the pension trust fund, investing the inflows and planning the outflows, requires the expertise of a fiduciary advisor.
As originally envisioned, the 401(k) plan participant would use his financial advisor to help him with investing decisions. The problem is that the average worker doesn’t have a financial advisor that he works with, and so this critical advisor was replaced with documentation, seminars, and training that has been woefully inadequate. The average 401(k) participant blindly chooses investments from the paltry choices allowed, not really understanding the concepts of diversification, risk/reward matrices, or general allocation principles.
One of the options that has been discussed in Congress lately is to further incent employers to provide investment advisors to employees, in order to help the employee with the process of investment management. The Pension Protection Act of 2006 had a provision that opened the door for this sort of assistance from employers, but an incomplete definition of “independent investment advisor” has kept most employers from acting.
Current thinking is that new regulations will be put in place that will give greater incentive to employers to implement an advisory program – as well as to define “independent investment advisor” as an advisor who has no vested interest in any investment choices by the employee-invester. this conflict-free advisor would also be required to operate as a fiduciary for the employee.
Another possible option that could be implemented is investment alternatives that would provide a conservative choice, possibly a lifetime income stream option, such as an annuity. The primary downside to annuities has always been the high costs and “black hole” nature of the underlying investments.
In order for this to work, the annuity products would need to be aggregated in very large numbers in order to reduce the overall cost structure enough to be viable. In addition, the providers will need to give much more transparency to the process in order for the advisors to be capable of assessing the option as an alternative.
The conclusion is that the 401(k) is not broken – it just needs some tweaks. And from what I’m hearing about current discussions on Capitol Hill, it sounds like the tweaks being suggested are a definite step in the right direction.
What if you could impact this yourself, without government intervention? This being high season for thinking about income taxes, it bears repeating that, if you’re the average American, you could increase your take-home pay with the stroke of a pen – literally – by making a change to your W4 withholding.
In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) that, among many other provisions, provided for the implementation of the Individual Retirement Arrangement. This original IRA was not deductible from taxes, and the annual contribution limit was the lesser of $1,500 or 15% of household income.
So, while the originally-anticipated participants in the plans were expected to have a financial advisor available to them (401(k)’s were expected to be primarily an executive benefit), the vast majority of 401(k) participants today do not have such an advisor. And the problem is, it turns out that it’s not so simple for the average person to manage their nest egg without advice. So this is why Congress has been discussing this recently.
You probably know a little bit about this subject – like one IRA is deductible on your income taxes, and the other one has some kind of tax benefit… but the differences are hard to understand, and can be even harder to explain! Below are the major differences between the two, followed by the similarities. This discussion is liable to be useful as you consider 
So, with approximately 40 weeks remaining in the year, this will amount to, at most, $10 per person per week. In January, 2010, payroll tax withholding schedules will be adjusted again, allowing for this credit to be spread out over the 52 weeks, so the differential will be less at that time, approximately $7.70 per week. Assuming the law is not extended, the rates will return to previous levels as of January 1, 2011.
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