The 401k plan has been under a great deal of scrutiny lately, with quite a few proposals being offered to “fix” the system. Granted there are a few problems with the system that is in place, but the overall concept is still good. What follows is strictly my opinion of some of the real “problems” followed by a look at the presently proposed solutions that are being dallied about.
Photo credit: Diedoe
The Problems With 401k Plan
Note: for the purpose of this discussion (and most discussions here) the term 401k is used to refer to all CODA (Cash Or Deferred Arrangements) such as 403b, 457, etc.. In my opinion all these plans should be treated equally.
Problem: To start with, it makes so very little sense to strictly tie the plan to the employer. Of course, this made a lot of sense when employer matches could be solely in company stock (a la Enron), but these days the whole concept is outdated.
Solution: Do away with the present system of tying the plan to the employer. Instead, simply increase the annual limits on IRAs to the same limits for 401ks – let all folks take part in these plans. Employers could still have the tax benefit for matching funds, but the “portability” issue would be gone, as would the need for all these rollover activities. Level the playing field, making the rules that are currently IRA- or 401k-specific apply to the new IRA plan.
Problem: 401k plans have limited investment choices, many of which are inappropriate or inadequate for the investor’s situation and goals.
Solution: Under the “new IRA” option I mentioned above, the field would be open to all investments available from your custodian. Custodians would soon learn to allow investments in virtually all available securities, as the investor can easily “vote with his feet” and move elsewhere with better choices.
Problem: There is no “guaranteed income” choice available in the 401k. Since the original intent of the 401k plan was to replace the defined benefit pension plans – you know, the kind of pension where you’re guaranteed an income, often inflation-indexed, for life – it seems like you should be able to emulate that in a 401k plan.
Solution: There have been a few suggestions on the table in Congressional committee where annuity products would be made available for 401k plan investments. The problem here is that, unless we’re talking about the lowest of low-cost providers (and there are a few out there), annuities are traditionally a very costly way to save and invest for the future.
I can’t argue with the sentiment, a guaranteed income choice would be perfect for a high percentage of folks – unfortunately this whole concept sounds too much like Social Security, and I don’t think we want to have two systems like that going in parallel. This option is still open for debate, in my opinion.
Problem: Most folks who have a 401k plan don’t have a clue about investing, and don’t have access to affordable, unbiased, professional advice.
Solution: This was actually addressed to a degree with the Pension Protection Act, but apparently the legislation’s carrot wasn’t enticing enough to get the ball rolling. In addition, the previous legislation did not go far enough and label the advisor as a fiduciary – a step that I believe is critical to the long-term success of the investor.
Some of the proposals on the table now have taken the step to require fiduciary advisors. The problem now is to get companies to implement this option. Mandating is it probably going too far, but offering tax cuts or other benefits may be useful in giving this some traction.
Conclusion
This wasn’t intended to be an exhaustive list of the issues and solutions, just a list of the top things I’d been thinking about lately. As I indicated before, I don’t think we need to toss out the baby with the bathwater; the 401k plan isn’t broken, it just needs a few adjustments. Maybe you’ve got a few additional ideas, or suggestions to improve what I’ve tossed out here – I’d love to hear them. Leave your ideas as comments below. Thanks!
Sterling Raskie, MSFS, CFP®, ChFC®
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Interesting.
Some comments. Keep or pitch.
Employer role. Studies show savings dramatically greater where money comes direct from payroll, especially using auto features. A “sponsored” multiple employer plan, anyone? Also, add Deemed IRA capability so those whose employment doesn’t include access can make contributions via electronic banking to a plan they are already familiar with.
Limited investments? Directed brokerage anyone?
No, the 401k was never envisioned by Congress to be a replacement for pensions. 401k was added to the code to intentionally DISCOURAGE deferrals. The other name for IRA is individual Retirement Annuity – indexed, inflation-adjusted, survivor benefits… no lack of options in the individual marketplace. Finally, most middle class Americans have lots of retirement income from Social Security and home equity – ICI would argue most already have enough retirement income. Where more guaranteed, indexed income is needed, many would argue best option is to defer commencement of SS to age 70.
Investments – QDIA. Nuff said.
The 401k is already a success for millions of Americans where retirement preparation is a priority. Importantly, the 401k’s past is not its future. CAVU!
It makes sense to have the employer involved if they are making contributions to the 401(k) plan, but I suspect that this is (yet another) benefit that is on the way out. We’ve swung from a society where the employer had cradle-to-grave responsibility for the employee to one in which there is little connection between the employer and employee, other than a paycheck. Neither extreme is healthy. I just hope we land at a happy medium.
I agree wholeheartedly, Helen. But I suspect we have a ways to go for the pendulum to continue swinging in the direction of “disconnection” between employers and employees, before we’ll see things coming back toward a happy medium…
Good review of the situation Jim.
I’d love to see the employer removed from the picture too, but I’m skeptical that will happen because as you write, most folks don’t have a clue.. and don’t “want” to have a clue. It’s easier when the employer does it for them, even though it may not always be in their best interest.
We’ll just have to hope for some middle ground. Where the employer takes an active role in engaging the employee to be involved, as well as providing access to objective advice, but not actually administering the plan. I know, not likely, but we can dream, right? :-)