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401k: Kill it or Expand Its Reach?

401k: Kill it or Expand Its Reach?
October 03
01:02 2017

Sometimes we take the 401k retirement savings vehicle for granted, dwelling on its shortcomings instead of focusing on all the good it has accomplished. The facts, however, tell a different story. The 401k defined contribution savings plan has been the most successful national retirement policy implementation in the history of the United States. “We should be thankful that the majority of workers have access to a retirement savings vehicle,” says Edward Dressel, President of Retire Ready Solutions in Dallas, Oregon. “According to the Economic Policy Institute, prior to the Revenue Act of 1978, only around 38% of private sector workers had access to a pension plan. That means 62% were left with few options for retirement savings. New Census Bureau research shows that 79% of workers have access to a 401k. So, the 401k has really provided a means of retirement savings for many Americas that was not available before.”

The 401k plan filled the void left as the defined benefit plan faded away, slowly, at first, but then with increasing acceleration in the 1980s. We asked several retirement pros to name three reasons employees might be thankful for their 401k plans. Here’s what they told us:

Chad Parks, CEO Ubiquity Retirement + Savings, San Francisco, California, said: “1) Unlike the rapidly declining, if not nearly extinct pension system, the money you contribute to your 401(k) is yours. That means it cannot be hijacked by a company or municipality’s bankruptcy or money issues; 2) The IRS incentivizes you to save. You can contribute as much as $18,000 in 2017 towards your 401(k), pre-tax. It’s one of the legal ways to divert significant money from Uncle Sam and into your future pockets; and, 3) In case of emergency, you can take a penalty-free loan from your plan, and pay it back over time. That’s not something you can do with a pension plan.”

Chris Costello, CEO & Co-Founder of bloom in Leawood, Kansas, said: “1) The pre-tax savings – there is speculation about tax reform and the potential of taxing contributions going into a 401k, but right now – for most people – that ability for individuals to save on their tax bill is a significant benefit; 2) The potential employer match (i.e. free money); and, 3) Payroll deductions that enable dollar cost averaging, one of the wonders of the world when it comes to investing!”

Trevor Gerszt, CEO of Goldco, located in Woodland Hills, California, said: “1) The 401(k) makes saving money convenient; 2) Employer matches give employees free money that can boost their savings; and, 3) Options for loans and hardship withdrawals make it easy for people to tap into their savings if they really need the money.”

Aaron Milledge, the co-founder of an independent Registered Investment Adviser in Erie, Colorado, said: “1) Autopilot savings – Automatic ongoing contributions to a 401k builds a good habit of savings without actually requiring the participant to deliberately set aside cash to invest; 2) Tax efficiency – Both traditional and Roth 401k plans can offer tax benefits to participants either in the present or the future; and, 3) Talent retention – Employers often overlook 401k and profit-sharing plans’ flexibility in contributing a significant amount of money into an employee’s retirement account each year.”

The success of the 401k plan has been so far reaching, it’s almost impossible to imagine what could realistically replace the defined contribution plan. “The 401k has been so beneficial to retirement savers because the majority of Americans have access to a 401k and they are able to contribute pre-tax dollars, which increases the incentive to save for many,” says Dressel. “Additionally, many employers contribute to their employee’s retirement accounts, which increases not only their balances, but also is having additional income.”

Indeed, as the 401k plan has grown in importance, traditional alternatives have been shown to be vulnerable. “Pensions are dying and Social Security is due to be insolvent,” says Parks. “The 401k plan remains one of the most promising solutions in solving for our nation’s looming retirement crisis. It’s flexible, inexpensive, and offers extensive tax advantages to both the saver and the employer. There’s no downside.”

If there were ever a “perfect storm” for retirement savings, the 401k plan has demonstrated it has all the ingredients. “Retirement savers have really benefitted from three features of 401k plans: matching contributions, tax savings, and more recently, lower investment and plan expenses,” says Milledge”

And while some see the glass as half empty, he reality is, as Dressel states, the vast majority of workers have access to a 401k plan. We cannot understate the importance of what this provides employees. “401k plans have enabled millions of Americans to take control of their financial futures and save for their retirement,” says Gerszt. “By allowing them to take pre-tax dollars from their paychecks and accumulate tax-free until distribution, 401k plans have made saving for retirement much easier for the average investor.”

It has transformed from an investment plaything to a reliable and consistent template that can lead to a comfortable retirement. More importantly, for many, it no longer represents merely the strongest leg of retirement’s three-legged stool, but the rock solid single pedestal upon which a comfortable retirement sits “The 401k – although terribly named – has become the primary retirement savings vehicle in this country with almost 80 million Americans participating as of today,” says Costello. “When employees take advantage of this throughout their career, utilize an appropriate asset allocation, and resist temptation to time the markets by actively buying and selling within their 401k; it can grow to become the single-largest source of retirement income for retirees.”

Despite these positive trends, there’s always talk about changing the formula of the 401k. There are some features that are now so fundamental to the 401k, however, that, if removed, risk destroying the very success upon which the 401k has been build. Costello points to auto-enrollment as one such example. He says “this plan feature has shown time and again to work better than anything else in terms of increasing plan participation.”

In the past few weeks, there were dozens of media reports (sources unclear) purporting to claim the new tax plan would eliminate the very backbone of the triumph of defined contribution plans. “There’s concern about the tax structure changing under our current administration,” says Parks. “One solution is to remove the tax-benefit of contributing to your 401k plan pre-tax. That benefit is a huge selling point to people contributing. If your contribution doesn’t lower your taxable income, will you contribute as much, or even the maximum? From our experience, the answer is no.”

There has been almost universal condemnation of this rumor. “Eliminating the potential tax savings from salary deferrals into a traditional 401k would be a bitter pill to swallow,” says Milledge. “Some participants demonstrate a nearsighted bias that focuses their decision-making on how much they could save in taxes by participating in the plan and minimizes the long-term benefits of consistent saving.  As such, the tax benefit is a powerful motivator to encourage employees to enroll and participate in the plan.”

Gerszt is most blunt on this subject. He says “getting rid of the ability to use pre-tax dollars would kill the 401k as we know it today. It’s much easier to save money when it’s coming out of your paycheck; once you have that paycheck in hand there are a million and one pressing expenses that you’ll want to spend that money on instead of saving it.”

This isn’t the only policy gossip that appears every now and then. For some time now we’ve heard of a more radical idea that, if implemented, might just lead to an outright revolt among voters. “The most destructive thing to the future of 401k plans,” says Gerszt, “is the various proposals that pop up from time to time encouraging the government to seize 401k assets and convert them into government bonds. That would kill savings overall, as investors would no longer be certain that their assets would be free from confiscation.”

Still, for all this hearsay, there is a real threat to the sustainability of the 401k achievement. “State sponsored defined contribution plans run the risk of harming the financial industry and actually decreasing investor options and success in the long-run,” says Dressel. “The desire to ensure that all workers have access to a retirement savings vehicle is a noble one. But allowing public bodies to compete against private companies will create an unfair playing field where the free market principles which work to better company performance and improve worker options are actually impeded. Also, the many underfunded state pension systems should be a warning to us that public bodies have not always managed retirement systems well. I believe that if more states enact publicly sponsors DC plans that this will be a harmful development.”

This is not to say the 401k is perfect and that there’s no need to improve it. These improvements, though, would be more like tweaks rather than wholesale changes. Edward, President of Retire Ready Solutions in Dallas, Oregon, says, “Plan features that mitigate poor human financial behavior need to be the norm,” says Dressel. “Auto-enrolling participants and auto-escalating contributions have shown great success in improving participant outcomes and yet many employers have been slow to put these in place.”

Part of this problem of decision paralysis on the part of employees comes from the purposeful complexity we saw during the era when mutual funds took over the 401k industry in the 1990s. It remains difficult to get over that initial first impression many workers had will the 401k plan. “401k has a branding issue,” says Parks. “Our industry has purposely created mystique and jargon around it, in order to charge and maintain high-fee structures. If you can’t understand it, but you know you need it, you may be willing to spend more on it. Then again, and more common, you may not know what you are spending. That needs to change.”

Along the same lines, too much of the emphasis in the past has been on investing rather than saving. As demonstrated by the popularity of Qualified Default Investment Options, most employees would rather have someone do it for them, not do it themselves. Costello says we need to “quit trying to educate the masses and force people to DIY their single most important financial asset. The solution isn’t more brochures, on-line calculators or free pizza lunch-n-learns. People need this done FOR them from companies that are bringing financial help to masses through simple, conflict-of-interest free, online technology solutions.”

In addition to focusing on saving, a broader effort on general financial education might also be helpful. “Financial wellness and education are peripheral needs to the existing 401k construct,” says Milledge. “Saving for retirement is one piece of a much larger, more complex puzzle, and the more employees are educated about budgeting, debt management, investment basics, and insurance, the higher the likelihood of meeting retirement goals. Including a financial wellness program alongside a 401k would help employees understand the bigger picture about their finances and how the various aspects work together.”

Lastly, and perhaps most importantly, we need to realistically assess and address the impediments to access to 401k plans. We have consensus on a solution (401k MEP plans) that eliminates many of the impediments facing potential plan sponsors, yet we have not seen Congress move on something they say they all agree on. “Government should look at remedying obstacles that keep small businesses from offering 401k plans,” says Gerszt. “Small businesses make up almost half of private-sector employment, but only a quarter to a third offer 401k plans, mostly due to the time and cost it takes to manage those programs. Making it easier or less costly for those small firms to offer 401k plans can help millions more Americans to save for their retirement.”

It’s clear the 401k is the most efficient path towards making it easier and less costly for millions more Americans to save for retirement. Perhaps 401k MEPs will finally emerge from its legislative cocoon in the new tax law.

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on Twitter, Facebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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