The 401(k) Is a Scam, Part I

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.


  1. Bear in mind that by the early eighties markets had languished for sixteen years and the “Reagan Boom” was just getting underway.
  2. For various reasons I’ll get into in my next installment.

Author: ER Dude

Sick of your job? After a thirteen-year career, Early Retirement Dude fled corporate America for good. You can do it too! Visit or email

14 thoughts

  1. Interesting!
    In Canada a 401K is similar to our RRSP (Registered Retirement Saving Plan) I wonder how closely your insights will be related.

  2. As an early retired 401k millionaire without a pension I’m pretty happy with the fact that the money is mine and not at risk like many pensions in the country. I got to decide how it was invested and I got to decide how much my retirement funding needed to be, not some company benefits specialist or government official. And I got to retire early with more than enough money. I will be very interested in the next installment, it is a fascinating topic. I’d love it if my company had kept the pension that existed when I started work but I do not blame them for protecting shareholders from an uncontrollable future cost that would likely have ultimately bankrupted them.

    1. Hi, Steve…thanks for the reply.

      A few thoughts:

      >not at risk like many pensions in the country

      I’m gonna get into the widespread reneging on pensions in my next installment, particularly wrt taxpayer burden through the Pension Benefit Guaranty Corporation, SNAP, the VA, etc.

      >I got to decide how it was invested and I got to decide how much my retirement funding needed to be

      No way to measure this exactly, but I’ll hazard the guess that you’re much more financially sophisticated than the average American worker.

      >I do not blame them for protecting shareholders from an uncontrollable future cost that would likely have ultimately bankrupted them.

      I do. The shareholders knew what they were signing up for–or at least they should’ve–when they bought the stock.

      >it is a fascinating topic

      Right? I’m enjoying spinning this out. Thanks for responding.

  3. Interesting topic. That’s why I keep coming back here 🙂 You have the balls to write frankly about sensitive topics. I bet many would carrying the torches already.
    I am reading personal finance blogs for a while but never heard about this perspective of 401k. As a foreigner, I have always seen it as a magical artifact in the hands of the FI/ER-warriors. We over here do not have anything similar to that. If I would ask 10 people on the streets if they have investments probably one would answer that he owns some kind of real estate or land, two that they have a whole life policy and seven would ask “from what?”. The pension crisis is a reality here, many people rely solely on that which is hardly cover their basic needs. This was a wake-up call for me also when I had to realize that growing up in an environment where it was engraved into you that only work hard and you will be ok for the rest of your life, the government will take care of you in your golden years. Now I take it granted that I will not have a pension so I have to take care of that myself. The situation is even worse for my parents’ generation as they were taught according to the old standard but got the brave new reality. I don’t think that they will be able to stop working. Ever. Strange world.
    Looking forward to reading the next installation.

    1. >You have the balls to write frankly about sensitive topics.

      Thanks, man. What I think I really have, though, is the fuck-you money to write about sensitive topics.

      That said, it seems to me that most people miss the idea that fuck-you money doesn’t have to mean being an arrogant ass and blowing people off. It’s just as much if not more about maintaining your humility. You have to be willing to say, “Hey…I’m OK with being wrong about something, because I don’t care one bit if anybody thinks changing my opinion is a sign of weakness.” Believe me, I’ve worked in places where reversing yourself, admitting fault, etc., could cause your career permanent harm.

  4. “But also a long term decrease in exposure to fiduciary liability.”

    All plan sponsors are on the hook for fiduciary liability, including those who sponsor 401(k)s. There are many different types of fiduciary duty/liability. I think it’s important to clarify that while some fiduciary liability may be shifted to participants in a 401(k) plan (i.e., investment risks related to choosing which of the offered funds to invest in, and the risk of investment losses), that’s a very small part of the overall fiduciary liability framework in place. In order for this specific liability to be shifted to participants, the plan sponsor must give participants adequate notice and disclosure, otherwise the liability doesn’t shift. For example, the selection of the funds available within the plan (from which participants choose) is the plan sponsor’s (the fiduciary’s) decision and is subject to liability. In addition, there are still many other duties a fiduciary must satisfy with respect to a benefit plan, regardless of type.

  5. Interested to see your future installments on the topic of 401(k)s…I’m a public educator and have a great pension situation; however, I am concerned with the “what if” scenarios that unfold from pensions generally. The one I am in is fully funded and has $140b in assets, but….

    Also participate significantly in 403(b) to buttress the pension, so I am interested in that aspect as well.

  6. I think we need to accept the paradigm shift that employees, not their employers, are responsible for their financial future. Employers never should have been seen as responsible to begin with. I’ve heard the argument that the reason for people’s retirement turmoil is because people don’t have pensions anymore. I think that’s crap, as again, -I- am responsible for my retirement, not my employer. If SS wasn’t offered when I was a child, I wouldn’t have planned it into my retirement planning. Which is a joke, because practically no one young is doing their retirement planning! And the ones that are happen to reach FIRE much, much sooner.

    It’s interesting how the nation (world?) is split into two types of people: People who want to have the control to do it themselves and accept the outcome, and people who want someone else to do it for them and accept THAT outcome. The first sounds a lot more daunting, I know, but damn it’s a lot more satisfying. And interesting.

    1. Hi, Ron. Thanks for the comment! I’ll say up front that while I don’t think we’re going to change each other’s minds today, we have the opportunity for a very cool and educational conversation–both for us and the people reading it.

      For starters, I hear and understand you when you lead with “paradigm shift.”

      When I saw your comment my first thought was collective bargaining. As you know, workers since the dawn of time have been subject to the job market power of their employers, and consequently they’ve suffered from abusive working practices/conditions. Completely impossible for a single employee to personally negotiate with, say, the Ford motor company. But again as you know, roughly a hundred years ago workers started banding together for the sake of leverage, and they were able to win concessions. People literally fought and bled and died for today’s benefits…pensions, healthcare, holidays, etc. This wasn’t “I want other people to do this for me” or “I want to do this solely by myself,” but rather “if we band together then we can do this for ourselves and each other.”

      So I think in your second paragraph you’ve set up a false dichotomy. There are certainly people who want to do everything for themselves and accept the consequences, and there are certainly people who want someone else to do it for them and accept that outcome as well. However, there’s also a middle way: if we do things together we can achieve more than the two other options allow–both for ourselves and our employers.

      Also, you say:

      >I’ve heard the argument that the reason for people’s retirement turmoil is because people don’t have pensions anymore. I think that’s crap

      I think it is too. It’s a much more complex situation. I’d say instead of THE reason, the disappearing pension is A reason. There are others, of course, and one of the major ones if not the most important one is that people as consumers overspend their means. The average person in the US is terrible at managing money. As a society we have to fix that. A healthy and well-educated nation requires a healthy and well-educated populace.

  7. Something you have left out of “how we got here” was the passage of FAS 87 in the mid 80s. When that accounting standard came out i said to everyone this is the end of the pension plan and all laughed at me. They aren’t laughing anymore. FAS 87 required that the unfunded liability of the company’s pension plan be put on the balance sheet of the company.

    1. Investors want certainty; that’s for sure. Being able to hand-wave a return assumption for a major expense item is a guaranteed way to scare them off. I’ll look into this for the (long-awaited) second part of this series.

  8. i know this is an old thread but wanted to say that i fully agree that the 401K is a scam. as well as pensions. some people have benefited from each but just like a huge ponzi scheme at some point there are folks that will get screwed. lots of pensions have bankrupted. Lots of states with underfunded pensions. Think CA. i would rather have had an increase in pay versus a 401K. i have a great employer which contributes 3% regardless of any contributions made by its employees. i have never contributed a dime. they changed 401K plan type to a Safe Harbor plan which is geared specifically towards the highly compensated earner. i used to be able to borrow up to 50% of the account balance but with the Safe Harbor plan it was reduced to 50% of the account minus the highest loan balance in the last 12 months. i am not one of the HCEs so who cares. i have had a legitimate reason to file a hardship withdrawal and have had to jump through all sorts of hoops for their finally to be a solution that allows me access to MY money. Once the money passes into my account, my employer, their plan trustee or the IRS shouldn’t be able to create rules that limit access to what should be mine. I am glad to pay the taxes and penalties. 20% tax + 10% penalty sure beats 100% loss in market declines, which are accelerating. The employer will always get 100% tax deduction of the contribution while the employee’s money is held hostage in the stock market. That is my only option, no cash options, which in reality wouldn’t be any better with a failing USD. When I make this argument with my friends, even though they can see the breakdown of the stock market, they always think the market will improve in a year or two. Not to mention that SS is already bankrupt and just a pile of IOUs. I am 51 and sure as hell not depending on the government to take care of me. Will never invest a dime in the 401K, ever. Tax me now. Really scared for the reality when the responsible folks that have saved for their retirement, realize they have been hoodwinked.

  9. AGREE! I have taken money out of 401K bought real estate and yes retired early from corporate world. I am lucky to be a member of the FIRE group. I have cash flow and I do not have to worry about how much to spend based on the limited amount of 401K. While I was employed I wanted to cash out my plan. I new about the penalties and tax consequences and still could not touch my money. I was unable to take the funds out of the plan until I was no longer with the company or dead! I was not happy…FYI…ROI is much better in real estate!

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