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I recently read – again – that 401k plans are a scam. You can’t save enough, you can lose money, etc.
Consider these words of wisdom. “It is a scam. When I worked in corporate America I contributed the max amount each year. At the time it was $19k per year. It took 5+ years to hit $100k. When I stopped contributing it barely grew.”
We don’t know the years involved, but nevertheless it’s nonsense. Investing the $19,000 a year even in a GIC would get you over $100,000 in less than five years.
It’s a long term investment folks! Not to be borrowed from or used for hardship expenses. Think of it as a lockbox for your future security.
That’s not how many, I dare say most, participants view the 401k.
Somehow we have been convinced the 401k is a poor replacement for the pension which was never universal, was designed to hold workers to a job for decades and was dependent on the financial state of the employer – think Studebaker – defunct in 1968 after being in business since 1852 and leaving retirees high and dry with no funded pensions – helping to precipitate ERISA which in itself unintentionally accelerated the demise of many pension plans.
[Note for history buffs, Studebaker made most of the wagons for the migration West and made the carriage taking Lincoln to the theater] my Dad sold Studebaker and Packard. I learned to drive on a Studebaker Lark and even drove an Avanti – once the fastest production car in the world at the time – 170 mph.
Although I enjoy a good pension – plan was started in 1911 – and would not trade it, linking your financial fate to the fortunes of one employer or even union has its risks. Unfortunately, the transfer of risk to the worker via 401k has not gone well either with too many workers taking only a month to month view of investments or poorly allocating funds.
Outside IRS rules, there is a lack of uniformity in 401k plan design and certainly regarding employer contributions and investment options. They are clearly underused, misused and not fully understood by workers, but they are not a scam.
They can provide a valuable component of financial security. I first contributed to our 401k when I implemented it in1982 at the urging of the Board of Directors. It seemed to be the thing to do even with a pension plan. I always contributed something until the day I retired in Jan 2010, at times just enough to get the company match. Today after nearly 15 years retired and ten RMDs closely links to 4%, my balance has grown considerable and easily exceeds the balance on December 31, 2009.
The US needs a better universal retirement system, more user friendly, more uniform, guaranteed employer participation, but that’s something for the next generation to solve.
For now, we better focus on making Social Security sustainable.
401Ks/403Bs are excellent replacement for pension. The so-called golden handcuff is broken. No one wants to work at a miserable company for the rest of his/her life. Also, the employer has always used the “golden handcuff” to threat/cajol the employees to stay. During time of business contraction (read: recession), employers find ways to reduce/eliminate the vested pension from the laid-off employees. Now, a laid-off employees can roll over their hard-earned 401k/403b account to IRA or to the next employer’s 401k plan.
We’ve been fortunate in this regard. We both used to work for the state of California, which started offering a self-directed option for 403Bs/401Ks through Schwab. We moved our accounts there and were able to select our own funds (we use Vanguard funds). When we each changed jobs, we rolled our accounts into IRAs, still at Schwab.
As it happened, our next jobs both used Fidelity for retirement accounts, which is where we’re both saving now (in Fidelity funds). My husband is now in the private sector and gets a company match on his 401K. When I retire next year, I will likely roll my 403B and 457 accounts into my Schwab IRA. In short, we’ve had good options and a fair amount of control, and it’s worked out really well for our net worth.
I really enjoy Dick’s posts reflecting on his experience as a benefits manager–so thank you again, Dick. I do also agree with some of the posts that fees matter, and are often buried or at least undisclosed. Some 401k’s and 403b’s (for non-profits) are much better than others, especially regarding fees, some of which may be buried in the investment options. A switch in employers is a great moment to transfer balances into the lowest fee IRA’s. The emergence of Roth options in these plans has also enhanced their value, as the people who use them the most are most likely to have higher tax rates later in life. I have refused to use a custodian because of a bad plan, and I know that it is very hard for most users to evaluate the quality of a plan. [Hint: the difference between theoretical return and actual return is being diverted somewhere, and often the administrator (but not always or in every plan) will tell me if I ask specifically.]
Kudos. I keep seeing these items all over and they typically are from someone that abused the system.
I agree the system needs change, but until there is political will to change something besides the preservation of politicians, this is not high on the list.
“… It’s a long term investment folks! Not to be borrowed from or used for hardship expenses. Think of it as a lockbox for your future security. …”
Nope. Times changes. Labor economics changed as well.
Lockbox, yes! But not in the way you suggest.
Think of your 401k as a “lifetime financial instrument” – something that you will keep for the rest of your life (and that of a surviving spouse).
Keep in mind that 70+% of Americans live paycheck to paycheck and that most Americans have accumulated debt and current financial commitments.
So, if people only save what they believe they can afford to earmark for a distant, uncertain, perhaps unlikely retirement which is decades away, where monies are “locked up” and unavailable for 30, 40 or 50 years, they won’t save early, nor will they save enough.
Minimize leakage? Yes. Eliminate hardship withdrawals, curtail post-separation, pre-retirement distributions. Replace it with tax-free liquidity!
Think of your 401k as the “Bank of Dick” – where you are both the lender (future self) and the borrower (current self). So, if you don’t have the discipline to save and to repay a loan to yourself … well, better to have saved and spent, than never to have saved at all. Remember, 90+% of plan loans are successfully repaid. Most who default do so at separation (median tenure of American workers has been less than 5 years for the past 7 decades). Defaults at separation occur, in part, because most firms loan processing is still limited to payroll deduction (which is so 20th Century)!
Bottom line, when it comes to saving more (and retaining those savings until retirement), most workers need tax-free access via 21st Century loan functionality. Workers need to be confident that the money is available if needed.
“The US needs a better universal retirement system, more user friendly, more uniform, guaranteed employer participation, but that’s something for the next generation to solve.”
Nope. We’ve had a universal retirement system since 1982 – consistent saving starting at age 25 of the maximum amount in an Individual Retirement Account, earning say 6% on investments, when coupled with Social Security, provides a more than adequate (90+%) pay replacement for those who retire at Social Security Full Retirement Age 67 (anyone born after 1960).
The IRAs offered by Fidelity, Vanguard and others are as user friendly and uniform (index investments) as anyone might want.
Guaranteed employer participation? Like Social Security, that diverts wages and reduces worker control, and ability to prioritize. So, if you are one who believes employer participation is essential, factor that into your decision-making regarding employment – as there are 700,000+ employers who already offer 401k and other retirement savings plans.
“The US needs a better universal retirement system”
I completely agree.
The smaller closely held companies I worked with during my career always seemed to have similar major objections to adopting and operating various defined contribution plans – complexity and costs. Defined benefit plan costs and complexity have always made defined benefit plan adoption a nonstarter for the nonpublic employers I worked with. Some retirement plans which are available only to smaller companies (by employee headcount) generally have smaller contribution limits and the qualified plans that are used by the larger companies can become compliance and cost nightmares.
I have often thought that if all plans were based only on the employee earned income then in the long run employers would move to a simplified universal plan as doing so would then likely be in the employer’s best financial interest. In my ideal universal plan the employer sole obligations would be a simple adopting of the universal plan (similar to the current IRS form 5304-SIMPLE adoption form does for SIMPLE plans), timely remitting withheld contributions in a reasonable time frame (maybe monthly or quarterly rather than as soon as administratively possible that is often currently required) and reporting the transactions on the employee annual W-2, something employers already are required to do for employee elective contributions.
A good universal plan should ideally result in no more individual plan tax returns (5500) being needed, no plan compliance testing by design, no plan audits, no gotchas, no adopting or changing elective or mandatory individual plan provisions when the law changes, no high administrative costs and no plan provisions intentionally designed to benefit solely the owners and other highly compensated participants. Such a universal plan would likely mean all employer contributions along with employee elective contributions would then both be reported as W-2 compensation as well as the offsetting plan contribution deduction. The annual plan contribution limit could be set at the same annual dollar contribution maximum for 401(k)s, IRAs, SIMPLE, etc., etc. If your employer choose not to adopt a qualified plan you could choose to fund a Individual Retirement Account with the same contribution limits, features and benefits limited only by the amount of the employee’s annual compensation. I think such simplification would be good for the employee, the employer and our country’s finances as a whole. Of course such thinking is by a Humblehead who favors investing in broad based low cost index funds and I would expect strong resistance to such change from those who directly benefit from the current complexity and whose income is currently sourced to the plan costs currently paid by employees and employers.
Let our generation be the one to solve these headaches and not kick the can to our children and grandchildren.
I’m not pro 401K plans based on my experience. When I was working, my employer match was in company stock; no choice. Due to 9/11, the company filed chapter 11 bankruptcy in 2005 and all match I received was gone. Poof! When they restructured, they stopped the company stock match.
Another reason I’m not fond of these plans is the hidden fees your company pockets by you joining the program. NetBenefits did an article about this 20+ years ago.
If I were starting out today, I would only do the minimum in a 401K and the rest in a Roth.
We never pocketed any fees, never heard of that. For several years the company paid all administrative costs separately, but at one point I negotiated a higher match in return for record keeping fees being paid by the trust. We also matched with stock for several years until the Enron fiasco and then stopped. The irony looking back is that the company stock proved to be the best performing fund.
Sorry, I wasn’t referring to your company. The NetBenefits article is where I learned about it. Sounds like you really did go above and beyond offering a good plan.
No problem I didn’t think you were.
The concept of 401k’s certainly isn’t a scam. The plans have worked extremely well for me. I do, however, believe that 401k’s are overly subject to the individual proclivity to save (or not) and to the consequences of life events, including loans, job changes etc.
For 30 years, I contributed with a full employer match of 6.5% to a 403b, and, to nearly the allowed limits, to a 401a. The funds were conservatively invested (50% fixed), but nonetheless grew such that upon retirement they could replace my working income, through annuities. My ability to contribute undoubtedly owed much to having modest living expenses and no children. That said, had I only contributed enough for the full employer match, I could have still replaced about half my working income and relied on SS for the remainder.
I have had responsibility for managing 401K plans with several companies. I always tried to get 3 things accomplished. Compliance was tops. ERISA and other regulations were a constantly moving target. Two, provide a fair selection of low cost index funds including target date funds. I tried to get Fidelity or Vanguard to operate the plan but sometimes we were too small to interest them. Three, allow immediate vesting of company match. Many companies had 3 year or longer vesting. Were these “scams?” I don’t think so.
An area I got involved in with little success, was 403b plans. My wife was a teacher in a PA school district for 15 years. She was fortunate to be able qualify for a traditional defined benefit pension. For later hires, the plan became a defined contribution plan. She also could contribute to a 403b plan without employer match. When she first signed up, Fidelity was offered as an option and they had some excellent choices. After about 5 years, the district took Fidelity off the list and the choices were really terrible…VALIC, Kades Margolis, Lincoln. I was told by Fidelity that they refused to “pay to play.” I complained to the School Board without response. I found her union was very supportive of these poor choices. These groups also were contributors to the union’s programs and were offered at al pre-retirement events. She suspended her contributions at that point. I continued to dig into the Lincoln website and finally found something that might work. However, the Vanguard index fund required a 1.25% fee to Lincoln plus an annual platform fee. My wife did contribute to this plan. I would say that 403b plans should be under the same rules as 401k’s with ERISA protections. See article for more…
https://www.morningstar.com/personal-finance/why-you-should-watch-out-403b-plans
I was very fortunate to have both a generous pension and 401k plan with the company I worked for for 34 years and retired from last year. After 10 years in the 401k plan, the company match increased to 117% (7% for the first 6% of an employee’s contribution). Even those who weren’t astute investors in the many Vanguard options offered, were able to more than double their contributions! The only negative fund offered was a company stock fund which was only allowed for the company match. I used this for many years while the company stock was booming. I exited that fund before the bottom dropped out but many of my colleagues did not. I was just concerned about having so much exposure to the company and its stock.
BTW the company still offers both these benefits (no longer a public company) to every new employee who is hired.
I have read multiple financial articles which say be careful about having too much company stock in your retirement funds. Having both your income and a large portion of you retirement assets attached to you company can lead to disaster if your company folds.
Working as an engineer for a software company during the final 20 years of my career, I was surprised by the number of very smart people (engineering and computer science PhD’s) that claimed they couldn’t understand how to invest or what to buy in our 401(k) program. Some just invested poorly, while others did things like borrow from their fund and then quit. So I’m on board with what Dick is saying here – the retirement system needs to be better such that the lowest common denominator of financial knowledge can successfully contribute and work towards the goal of retirement. Personally, I also think the requirements that allow borrowing from your 401(k) need to be tightened.
I’ve known colleagues who failed to contribute enough to get the match.Talk about lowest common denominator of financial knowledge… never mind what to invest in once they’ve contributed. Like you, I refer to very smart people.
Tighter guardrails wouldn’t have helped that, but agree they would help other people.
Funny to see this thread as I’m about to post a 401(k) topic myself and we see them on HD very rarely.
I agree about the loans. In addition to stunting the growth of their 401k balance, many times I have seen the employee leave the job and be hit with tax plus 10% penalty because they could not pay the loan off.
Quinn is right, we need a better system.
Richard, as I’ve written before, my experience on the union side of the table mirrors your own experience regarding employees use of the 401k.
With proper planning and implementation the 401k can beat the pants off a pension, but sadly this is often not the case.
I would love to have a Studebaker Hawk, especially the one with the supercharged 289 which I believe was the same as in the Avanti. South Bend IN has an awesome Studebaker museum.
Been to the museum. That’s where I learned about them building Lincoln’s carriage. They have one like it there. I spent a lot of time in a Studebaker growing up.
If you have a greater interest in the affiliation of Studebaker to covered wagons, I highly recommend the very amusing book The Oregon Trail by Rinker Buck. In his tale of schlepping the way west on modern highways with his brother, Buck details the history of the iconic wagons.