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Should We Get Rid of 401(k) Plans?

Written by Nickel - 30 Comments

The latest issue of Time Magazine featured an article that was very critical of the 401(k) system. In it, they argued that “the 401(k) is a lousy idea, a financial flop, a rotten repository for our retirement reserves.”

Why all the hate?

So just what is it that Time hates about 401(k) plans? For starters, 401(k) plans were never intended to replace traditional pensions. Rather, they were created as an executive perk. Over time, however, their existence allowed many employers to kill off their pension plans.

401(k) plans have also come under fire because:

  • Not enough people participate in their employer’s 401(k) plan
  • Of those who do participate, many don’t contribute enough
  • Many participants invest too conservatively
  • Others invest too aggressively

The problem here is that these things aren’t unique to 401(k) plans. Rather, criticisms such as a lack of participation, saving too little, and inappropriate allocations can be leveled at most investment vehicles, including traditional and Roth IRAs, taxable investment accounts, etc.

Beyond this, people choose whether or not they will participate, they choose how much they will set aside, and they choose their investments. If some people wind up making bad decisions, should everyone be forced to give up their 401(k)? Not in my book.

Don’t get me wrong, there are certainly a number of bad 401(k) plans out there. Some of these have very limited investment choices, others have exorbitant fees, and so on. But advocating that we should “retire the 401(k)” is throwing the baby out with the bathwater.

What are the alternatives?

Yes, it sucks that juicy pension plans have largely disappeared, but that’s the reality. With traditional, employer-run pension plans out of the picture, what other options do we have? Well…

The article advocates for guaranteed investment accounts that would essentially function as “retirement insurance.” Every pay period, you’d contribute a fixed percentage of your paycheck and, upon retirement, you’d collect a guaranteed monthly check based on your final salary.

An advantage of such plans, whether they are backed by the government or a private entity, is that they would follow you from job-to-job. You would also be free to invest in addition to these plans, though (presumably) things like tax-deferred 401(k) plans would be off the table.

Setting aside the possible disadvantages of such plans, it’s important to keep in mind that there’s nothing stopping private companies from introducing these sorts of things whether or not the 401(k) still exists. In fact, there are great many annuity products already out there that fill a similar need.

In the end, I’m trying to figure out why killing off the 401(k) is a good idea. Yes, I realize that not everyone has access to them, and that some people can afford to contribute more than others. Given all the challenges associated with saving enough for retirement, however, it seems to me that taking options off the table would be a step backward.

What do you think?

Published on October 21st, 2009 - 30 Comments
Filed under: Retirement, Saving & Investing

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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30 Responses to “Should We Get Rid of 401(k) Plans?”

  1. 1
    ChristianPF Says:

    I actually have an article in the works, spurred from that same Time article – and personally I think they are jumping the gun a little bit. It’s easy to say how bad it is after a big drop, but like you mentioned removing it as an option probably isn’t going to help. Since many companies are saving millions offering 401ks rather than pensions, I think hiring a financial planner for the purposes of helping their employees invest wisely – would be a good start.

  2. 2
    Jeremy Says:

    Like you pointed out, it doesn’t matter what the plan is called or what features or tax benefits it comes with, but if it’s an optional item that people aren’t required to do it will always fall short. People are lazy and would rather not plan for the future.

    The only real solution is to create a mandatory savings which you mentioned. Unfortunately, this is exactly what Social Security is supposed to do, but it has been designed and implemented poorly and hasn’t scaled over the years. Plus, these aren’t separate accounts based on what you put in and it’s all pooled, so it will never be sustainable over the long run.

    401(k)s are fine, so leave them alone. If people have the foresight to contribute to one, kudos to them. But regardless of the nice tax benefits it won’t solve the problem of getting people to save their own money for retirement. It never will, so that doesn’t mean the plans are bad, outdated, and unnecessary. They work extremely well for those who use them. So instead we should be focusing on how to get people to save for retirement, not discussing how to kill off one of the only good options available.

  3. 3
    Aaron Says:

    hmmm… lets do some basic 401(k) related math here.

    Annual Salary: $47500 (close to national avg)
    ~5% Monthly Cont: $200 (no match)

    Now lets invest this at the approximate 11.6% avg annual market rate for the last several decades from age 30 to age 65. That is $200 a month for 35 years at 11.6%, add 3 and carry the 2, and we end up with… $947,798.02.

    For some reason I think this person, who never got a raise and never got a match, might just be able to suffer through retirement.

    Given the numbers, I think it would be fair to say that 401(k) plans aren’t the problem here and for Time magazine to suggest that they are somehow broken is, in my opinion, incredibly irresponsible.

    The real problem lies in the fact that there are too many people in this country who make bad choices with their finances because they have never been taught and have never taken the time to learn how to properly prioritize how they spend their cash. They focus on short term pain and look for short term (ie: quick fix) solutions.

    Which leads us to an interesting place. Even if you use a more conservative rate for planning than the 11.6% shown above (good idea honestly) those who DO take the time to prioritize their expenses properly honestly don’t need a 401(k) or a Roth or even a pension to reach retirement in a fiscally secure state even if they may choose to take advantage of the benefits that these plans offer. Conversely, no quantity of legislation or political maneuvering will help those who DO NOT take the time to plan wisely.

    If you don’t believe this, try taking a look at the amount of money taken out of your paycheck for social security, run it through a basic savings calculator at the market rate and then compare the numbers to your expected Social Security benefits payment and see just how much difference there is between personal responsibility and the “public-option”…

    I guess the proverb is true, The lazy man craves and gets nothing, but the desires of the diligent are fully satisfied.

  4. 4
    Dan Says:

    I read the article, and I was a little bit underwhelmed by its arguments.

    The problem with 401k’s compared to pensions is that we have amateurs trying to do for themselves what professionals used to do for a company. (The funny thing is, though, mutual fund managers don’t really do that great, so by extension, can we say that a pension plan administrator does no better than an amateur?)

    If they want to get rid of the 401k, fine, but they sure as #@$%^ better up the contribution limits and income caps on the traditional IRA and make it easy to facilitate the employer match.

  5. 5
    Evan Says:

    I don’t think the traditional pension has to be dead, but people have to get back in line with actuary realities.

    a) People don’t live 10 years into retirement anymore – they live 20 or more! So we have to add more money to the pot OR lower the monthly pay out.

    b) Salaries will have to reflect more being added to the pot. But who is willing to do that? How many people would take $47K no pension (someone used that number above me) vs 35K/yr but in 20 years you’ll get your salary? Most people wouldn’t go for that.

    c) People change jobs too often in today’s culture – so even if we brought back pensions most wouldn’t qualify.

  6. 6
    Dave Says:

    It is a sad but true, what Jeremy said about people being lazy and not planning for the future is true. There is nothing technically wrong with the 401(k) as a tool to stash tax-deferred money. But like any tool, if the operator doesn’t know how to use it, it is worthless! For the 401(k) to work properly, people have to do several things. Skip any step and the 401(k) won’t work. Those steps are:
    1.) Save as much as you can as soon as you can for as long as you can. (6% of your salary won’t cut it. It needs to be 10, 15 or 20%).
    2.) The longer you have before you need your money, the more risk you need to take i.e. invest in stocks while you are young and shift more into bonds and cash the older you get. Don’t believe that? Ask anyone who tried to retire last year after the stock market dropped 50%.
    3.) And don’t ever cash out your 401(k) when you change jobs. Roll it over to an IRA. And don’t ever borrow from your 401(k). Money needs 15, 20, 25 and 30 years to compound.
    Skip any of those steps and your 401(k) will look like a 101(k).

  7. 7
    TH Says:

    I twitch a little bit at the “government run” portion of the article – after all, they’ve done such a wonderful job with Social Security. Even a private administrator wouldn’t necessarily do any better than the 401k – after all it all in the same market. The only real difference that I see is that it takes control how much and where your retirement savings are invested. And let’s face it – most money managers don’t do all that great. I’ll take my chances on my own, thanks!

  8. 8
    Brca1 Says:

    401ks, indeed most of personal finance, requires some knowledge and reading up on. If you don’t you can lose your shirt. Are 401ks perfect? no. Are they a reasonable tool for retirement? I believe so. They are a tool like, credit cards, mutual funds, annuities, etc they all require learning and a real understanding of how they work. Of course you don’t learn calculus before you learn to add. So until we teach/learn the basics of finance we have no hope of understanding the more complex theories and lessons.

  9. 9
    Neal@Wealth Pilgrim Says:

    I see your points here…but as a participant…why would I care if nobody else contributes?

    Saving for retirement is important…we all agree on that. If a few do it….it’s better than nobody…right?

    Keep the 401(k) alive!!

  10. 10
    JoeTaxpayer Says:

    One alternative is to remove the caps on IRAs and have a single deposit limit across the two accounts.
    Surely there are 401(k)s with fees so high they negate the tax savings over time, but this is not to say that every last custodian charges such fees.

  11. 11
    Ethan Says:

    I think the Times is just trying to be provocative. Nothing is going to beat the “people make bad decisions” problem. And since pension managers and politicians are hardly exempt from that problem, placing your retirement in their hands is not a solution.

    Another way to look at it is this… it is logically *impossible* to depend on anyone else to plan for your retirement, because your actions are necessarily based in your own judgments. If your employer tells you that you have a wonderful pension, does that mean you have a wonderful pension? No:

    What are the terms?
    How well is it funded?
    How conservatively is it managed?
    What inflation protection do the actual benefit payments have?
    What do your dependents get if you die?
    Will the benefits fund the retirement you desire?

    Your actions presume answers to these questions. If you accept your employer’s pension at face value and decline to save any money of your own, you are still planning your own retirement… you just made those two decisions, didn’t you!? And those two decisions will make or break you.

    So there’s literally no such thing as depending on someone else to plan your retirement. Doesn’t exist. I like the advice that Oprah recalls being given early in her career: “Always be the only one who can sign your checks.” It’s another way of saying “You can’t possibly avoid this responsibility, or its repercussions. So don’t kid yourself that you can, and don’t make it harder to stay on top of than it already is.”

  12. 12
    Rick Francis Says:

    It makes some sense to revise the 401K’s defaults:
    1 Make employees opt in rather than opt out.
    2 Make the default investment a target retirement fund so keeping the default isn’t a terrible mistake.
    3 Offer investment advice to employees
    4 Educate employees about the importance of fees
    Would you believe a 0.75% in fees could cost a retiree a quarter of a million dollars? Check out my latest post to see the math.
    Getting rid of the 401K won’t solve the problems. Private Insurance is only going to add another layer of expenses since the insurance companies have overhead not to mention profits!
    -Rick Francis

  13. 13
    Brian Austin Says:

    I just wrote a post about pay yourself first where I discussed 401(k) plans. Without getting political the problem is that most people will face a period in their careers where 401(k)s won’t be an option. However people need to continue to invest in their future throughout their careers whether 401(k)s are on the table or not. People need to be educated to other alternatives. The message is to pay yourself first and save for the future, even if the vehicle for doing changes.

  14. 14
    Mike Says:

    Leave a comment if you find the Green background and Black text difficult to read. I hope I am not the only one having a difficult time reading the text.

  15. 15
    Nickel Says:

    Mike: Do a hard refresh with your browser. Shift-Click the reload button or click control-f5 (depends on your browser). The layout is new, but your browser still has the old css in its cache. The background should be white.

  16. 16
    pharmboy Says:

    They oughta drop 401k’s along with the rest of the tax code and adopt the FairTax.

    It’s very frustrating that my 401k investment options kinda suck, and my wife has nice Vanguard options except her plan charges fees that are over 4 times what we pay for the exact same mutual fund on the open market.

    And actually I’m not contributing any to my 401k this year, because we’ve got higher priorities for the money, but I bet I’d have some $$$ to spare if FICA taxes didn’t take 30 grand from my wife and I (considering our side and the employer side).

    Stupid government.

  17. 17
    Financial Samurai Says:

    What’s ridiculous is the low level we can contribute. Saving $16,500 a year isn’t going to allow anybody to retire comfortably any time soon with the way the market has performed over the past 10 years.

    We need to raise the limit contribution to $50,000 at least!

  18. 18
    Michael Harr @ TodayForward Says:

    An awful lot of great comments on a terrific post.

    @ChristianPF – Robert Shiller, Yale economist and author, brought this up in his New York Times column early this year. In it, he advocated offering a tax credit to individuals and families to seek out financial advice that would get them somewhere around an hour of fee-based financial planning advice. This is something that I’m working on through a web application, but your point is very well taken.

    @Aaron – I actually did the numbers over a career with retirement at age 65 for a lifelong minimum wage worker. Based on the current contribution rate of 15% into Social Security, if this lifelong minimum wage worker had invested in the American Funds Investment Company of America, he would be a half a millionaire even at the bottom of the market last year. While contribution rates were lower back in the day, I thought it a good look at what is possible in the go-forward discussion of retirement planning and Social Security.

    @Rick Francis – thanks in large part to research conducted in 2001 and 2002 by Madrian and Shea, the Pension Protection Act of 2006 made some critical changes in the way 401k plans are offered. The Act required that employees opt out of the plan upon becoming eligible for the plan rather than having to opt in. This was a major change and something that has important ramifications. In the Madrian and Shea research, they found that 86% participated in the 401k plan if they were automatically put into the plan and had to opt out compared to only 37% participation when employees had to opt into the plan. If the goal is increased retirement savings, opt out (the current system after the Act) is the way to go.

    In addition to the participation change, the Act also required that 401k plans offer diversified investment options by default which could either be (1) static asset allocation funds or (2) target date retirement funds. Either of these were more appropriate than the three leading allocations of 401k participants which were:

    1. Cash
    2. Company Stock
    3. Bonds

    While target date retirement funds and static asset allocation funds certainly didn’t guarantee success, it was for most participants a better option that the three aforementioned (ignoring short term market swings, of course).

    As for your advocacy of advice and fee education, you’re preaching to the choir. The problem is that most plan administrators (that guy/gal that is charged with trying to maintain a 401k plan with adequate investment options, low fees, etc.) usually has no idea what they’re doing. Smart Money ran an article in the November issue that is currently on news stand. It does a terrific job of highlighting the competency deficiency of many plan admins for small to mid sized companies.

    @Brian Austin – your comment is spot on. While it’s great if you have access to a 403b, 401k, etc., there needs to be something for those who do not have access. This could be addressed in many ways, from increasing the contribution limit on IRAs to a comparable figure (and allowing the same pre-tax contribution ability) if you don’t have access to opening up a government administered supplemental retirement savings account program. I say government administered in the most hands-off kind of terms, but other countries have supplemental retirement savings plans where employers deduct from payroll the contribution amount and then remit payment to the individuals preferred custodian.

    @Financial Samurai – there is a way to contribute significantly more than the $16,500, but not if you work for someone else…well, unless you happen to have access to a 403b and 457 dual combo. Those that can contribute the normal max of $16,500 and who also have access to a 457 plan can contribute up to $36,000 (total) not to mention catch-up provisions that can push this number ever closer to the $50,000. Who are these people? Professors, firefighters, and generally those who work for quasi-government institutions that are also not for profit. I’m happy for those that qualify, but it is one of those ‘what’s good for the goose is good for the gander’ kind of deals.

    Shoot, I’m just glad they indexed contribution limits with inflation. There were many, many years at a paltry $2k limit on IRAs…many years.

  19. 19
    Financial Samurai Says:

    Sounds good Michael. Too bad I or perhaps maybe people don’t know or have access to 403b and 457 :)

    Good for profs, firefighters etc. They deserve anything they more they can get from the gov’t!

  20. 20
    Adam Says:

    One thing I didn’t see mentioned is that most plans have a limited selection of mututal funds and maybe the company’s stock. This is a problem because most mutual funds are not index funds, and consequently will get nowhere near the average market rate. On top of their less-than-steller performance, they charge fees which further errode the potential earnings. Not that I’m advocating index funds as the solution to all investment problems, but for a majority of people its the best they can do, because they neither have the will nor time to learn, practice, and make profitable returns navigating the market.

  21. 21
    Aaron Says:

    @Adam – Good point about the limited options and associated fees associated with many 401(k) plans. In my experience, the tax deferment does cover the lost opportunity cost of fees and sub-index fund returns but not by a whole lot. The main reason for investing in a 401(k) is whether or not you get a match. That 50% match is a huge win. For what it’s worth, my personal strategy is the old 401(k) up to match, then Roth up to contribution limit, then traditional IRA (more options), then remaining 401(k) (fewer options) then, finally non-tax sheltered investments, in that order. I am not overly dogmatic about this though… I would rather see someone start saving for retirement in a sub-optimal fashion instead of them not planning for retirement at all…

    @Michael – Thanks for the info about the minimum wage worker getting to around 500k. It is good to see the hypothetical cases and how they work out. I am still, however, a huge advocate of people doing the calculation themselves even if they just include their half (7.5%) of the Social Security deductions. Given the behavioral nature of personal finance it makes it much more painful when you see your own personal numbers. When I ran the numbers for myself I realized very quickly that the sub-par returns that Adam mentioned look wonderful in comparison. I could have easily given half of the difference away to charity and still been way ahead of the game…

  22. 22
    Greg Says:

    Last time I looked the Pension Benefit Guarantee Corp had taken over nearly 4000 pensions!

    Professional money managers routinely perform worse than the market average.

    Social Security is obviously in deep ….

    No one is ever going to care more about your retirement than you.

    @Neal@WealthPilgrim “why would I care if nobody else contributes?”

    These people will become a burden on the rest of us. In most cases people are capable of understanding personal finance and taking care of themselves but as a society we have never emphasized this in school or our communities.

    I don’t care what they call it but the government needs to incentivize people to take personal responsibility. And there needs to be consequences for not taking personal responsibility.

  23. 23
    J. Money Says:

    I wasn’t around when pensions were king, but I must admit I’m a huge fan of 401(k)s. Having gone from a 3% company match to a 100% match (no, that’s not a typo), I can do nothing BUT love them. That’s a free $16.5k every year on top of your own $16.5k! The sad part is that only 1/5 of my co-workers even contribute…

  24. 24
    Financial Samurai Says:

    Wow J, 100% match! That’s sweet! Tell your c-workers they are stupid! :)

    We’ve got $3,000 match, and profit sharing, which is kind of different. But, it equates to $10,000-$20,000 generally. I don’t know the math though.

    Free money rocks!

  25. 25
    Greg Says:

    J.Money…. one question… Where do you work?

    Make that two questions… Are they hiring?

    My company matches to 6% but there is a traditional pension as well… unfortunately, I don’t have faith that it will be there when I retire.

  26. 26
    Rafael Dominguez Says:

    No government option will ever work. Consider the political environment we find ourselves in now where the federal government is wanting to become quite intrusive.

    Pension plans need to go away. This is precisely what has destroyed, along with health care costs, the auto industry…legacy costs.

    I think it is irrelavent whether or not the 401k goes away, because most simply don’t live within their means enough to max out the contributions.

    For those that do manage their lives, it is more prudent for the government to increase the Tradiional IRA and Roth IRA contribution limits to match the 401k limits. IRAs have much greater investment options, fewer fees and employees will avoid worrying about whether or not they are vested in their employer matching contributions.

    Americans, start managing your lives; live within your means and be responsible for your well being and for the well being of your family members…America would be better for it and so will you.

  27. 27
    SaveABunch Says:

    At the very least, make sure you contribute at least the full amount of your company match! It is crazy to leave free money on the table whether you agree or disagree that the 401k is a good option.

  28. 28
    Tim Rosen Says:

    Pros and Cons:

    Pros:

    a.) A systematic discipline to save/invest on a regular basis, for a long period of time.
    b.) The “Potential” for a company match.
    c.) “No touchy!” until age 59 1/2 or there are taxes/penalties.

    Now…..Cons:

    a.) Income risk. The defined benefit plan provided the income, now a participant will have no clue as to what their future income will be.
    b.) Increased Market risk. Employees from all walks of life are now expected to “chart their own course” through treacherous waters they have Not navigated before, assisted generally by a meager color brochure with pie charts that they do not understand.

    c.) Imprudent Investor behavior. When left to themselves, participants in a 401(k) are more likely to sell (get out of) a fund which they feel performed poorly, thus realizing undue losses and missing the actual growth of the markets. The result is that will not benefit from the “Market average growth” for the past couple of decades.
    Hyper-activity, frequently changes fund choices causes increased losses and fees, and will many times lead a participant to seek the “safety” of the Money Market account.
    d.) Greatly limited choices. I’ve seen as little as 6 choices, and as much as 1oo Fidelity Funds (which isn’t really helpful), versus over 30,000 choices in the free markets, equaling an unlimited number of allocation combinations.

    I have posted a video response to the Time article, though I do not believe it should be “retired.” I believe employees should receive Unbiased advice, and be made aware of alternatives i.e the tax-free Roth IRA, or non-qualified investment options outside the employer plan.

  29. 29
    laura Says:

    @ Rafeal 26

    Just because some companies didn’t manage their pensions well doesn’t mean pensions should be done away with. My company manages the pension well and I’m very grateful.

  30. 30
    Michael Harr @ TodayForward Says:

    @Laura – most pensions are well managed (contrary to popular press), but the system of defined benefits has a fundamental flaw – guaranteed income streams for a future without any guarantees. When you commit to a guaranteed payouts, you have to meet an awful lot of assumptions. In the case of a private company, they need to properly fund the pension, manage it well, and be sure not to guarantee too much in benefits. Of course, these are things that can be controlled.

    However, one cannot control life expectancies, market conditions, political stability, economic outcomes, etc. For this reason, I don’t believe pensions are viable options over the long-term.

    Should we have a government option that expands existing Social Security benefits, is it the right thing to do to tax future generations because we didn’t properly account for environmental factors that are admittedly uncontrollable?

    Because of this, I do not support any type of guaranteed benefits for retirement income.

    Please remember that when Social Security was born, average life expectancies were only 62 with retirement benefits starting at age 65. Today, newborns can expect to live well into their 80s on average (excluding mortality prior to age 18). The real reason we have troubles with Social Security has far less to do with how it is invested, how the benefits are calculated, or how often the till has been dipped into. It has much more to do with the simple fact that we are living considerably longer than expected.

    Longer life is good, but it sure is expensive.

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