We have found a heretic…may we burn him?
No, not quite yet. Let me lay out my thoughts first and then feel free to light me up in the comments.
We know there’s a retirement crisis in the US, mainly because the average worker hasn’t saved a sufficient amount to finance post-career lifestyle security. This has been adequately discussed elsewhere. As I’ll contend in this series of posts, much of this crisis has been caused by private-sector employer preference for doing away with traditional pensions and confining workers solely to the 401(k); a preference arising in large part from perverse incentives. These perverse incentives result in worker exploitation, greater burdens on taxpayers, and wealth concentration—all outcomes that are contradictory to the original intentions of the 401(k) plan’s architects.
So in this first installment I’ll review how this situation came to be. Next time around I’ll discuss the specific reasons I characterize the 401(k) as a scam, and finally I’ll present some possible solutions.
How We Got Here.
In 1978 Congress added provision 401(k) to the tax code, primarily to give highly-compensated workers a method for long-term tax deferral. By 1980, though, retirement benefit specialists like Ted Benna, Herbert Whitehouse, and others had realized that this provision could give average workers earning average pay a plan for saving for retirement on the same tax-deferred basis.
But the 401(k) plan’s architects never intended it to be the average worker’s main retirement benefit. Again, plan availability was initially limited in offering and practicality only to those workers who were more highly compensated than average, and even then fully utilized only by those who had an appetite for stock risk.
At that time and where the 401(k) happened to be available to average workers, they had good reasons to pass:
- Pensions were believed to be risk-free.
- Job security and the concomitant social contract between employer and employee were still the norm.
- Defined-benefit plans often required a worker copayment, but since participating in a 401(k) meant double-saving for retirement, it was beyond the means of many.
- The collection of full Social Security benefits at age 65 was held to be a certainty.
- The children of Great Depression survivors were commonly conditioned to distrust the stock market.
- Potential middle-class investors were disdainful of stock returns.1
Nonetheless, by 1983 surveys showed that “nearly half of all large firms were either already offering a 401(k) plan or considering one” as an additional retirement benefit. And by 1990 workers were widely embracing 401(k)s thanks to a good—if volatile—decade for stocks. So the pace of 401(k) proliferation accelerated.
This was an excellent development for employers, who were coming to favor 401(k)s because they’d realized they had considerable incentives to phase out traditional pensions: most notably cost savings, but also a long-term decrease in exposure to fiduciary liability. So they pushed them at workers. Hard. Employers also lobbied Congress for changes to key laws governing retirement systems, resulting in the passage of the Pension Protection Act 0f 2006, a pro-401(k) law I’ll get into in my next installment.
Consequently, by 2012—roughly twenty years after the 401(k) came into widespread use—US Census data showed that private sector defined-benefit plan availability/participation had shrunk to ten percent across the entire worker base. And worker-centric analysts like the Economic Policy Institute began using such data to support their contention that the 401(k) was “a poor substitute” for pensions, usually attributing this to the inability of the average worker to save sufficiently.2
So again, this is the situation we’re in now. As I said earlier, I contend that the 401(k) in its current form is being deliberately misused by employers in direct contradiction to the intention of those who crafted it; to the benefit of themselves and the detriment of their employees.
But is this really a scam? Or is it merely an agreement between two willing parties? I’ll get into that in the next installment.