Tuesday, January 5, 2016

Where Did We Go Awry With the 401(k)?

Section 401(k) was added to the Internal Revenue Code by the Revenue Act of 1978. It was such a significant part of that act that when I went to www.congress.gov to read the act summary, there was no mention of this new deferral opportunity. It was tossed into the legislation with little fanfare.

Why was that?

401(k) plans were never intended to be the primary retirement vehicle for the masses. In 1978, after the passage of the relatively new landmark law known as ERISA, defined benefit plans (DB) were all the rage and those companies that had chosen not to take the DB route frequently offered profit sharing plans, money purchase plans, or ESOPs, or because of the special tax treatment that they were given at the time, tax credit ESOPs, known back then as TRASOPs (bonus points for anyone who recalled TRASOPs before reading this).

Those were core retirement plans. Combined with Social Security, they were designed to be two legs of the so-called three-legged stool needed for retirement. The third leg was personal savings and the 401(k) plan was supposed to give people a more tax-efficient way to grow that third leg. Read that again; 401(k) plans were designed as savings plans, not as [core] retirement plans.

Somewhere, things went awry. I have written about this many times and blamed virtually everyone who had a voice. As our government and regulators made it more and more cumbersome to sponsor traditional retirement plans and the US economy took several turns for the worse, companies became less comfortable as sponsors of traditional retirement plans. They often placed the blame anywhere that they could. In fact, they placed it everywhere except where it belonged:

  • Employees didn't appreciate the other plans (it turned out that the people who didn't have them sure thought their friends who had them had a good deal)
  • They could be more competitive without them (don't you get higher productivity and better products and services from happy employees)
  • The 401(k) would be enough (of course many of those same companies retained their executive retirement plans)
Now, in a workforce fraught with high turnover, low morale, and lots of part-time jobs, many of us expect employees to save for their own retirement. Projections done by proponents of those plans show that those who do will have a wonderful retirement. Those projections tend to leave out all of these complications:
  • You can't defer when you are laid off and most of us seem to face one or more layoffs in our careers these days
  • You will have periods in your career when you go through one hardship or another and can't afford to make the deferral you would like
  • If you do have a hardship and have to pull money out, those penalties are severe
  • You absolutely will not get the 7%-9% annual return on investment, net of expenses, that many of those projections would "promise"
But, companies persist in the belief that the 401(k) is the retirement plan of choice. Potential employees ask about the company's "401 plan." In the meantime, some people retire very early and many will be retiring well after the traditional retirement zone of ages 62 through 65 has passed them by. 

Isn't it time to bring back retirement plans and have more than just savings plans? Any of them can be designed today with the proper administration to show employees their account balance as of that day any day that they choose to look.

You can be an employer of choice.

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