At Work

Why do we say 401k plans and IRAs are failing?

Having a pension, any annuity or steady stream of income in retirement is great, even essential. Those of us who have a good pension rarely appreciate the value and security they provide. Unfortunately . . .

The percentage of workers in the private sector whose only retirement account is a defined benefit pension plan is now 4%, down from 60% in the early 1980s. About 14% of companies offer a combination of both types. Source: CNN Money

Meanwhile in the public sector, federal, state and local workers still enjoy a defined benefit pension plan 84% of the time, higher than even during the peak of coverage for private sector workers.


Back in 1979 62% of did not have a defined benefit pension and although allowed by law, most people never heard of an IRA. 401k plans weren’t viable until 1981 and initially were mostly in large employers; the ones that typically had a pension plan too.

If 62% of American private sector workers never had a pension plan of any type, how do we conclude that access to various types of plans today is an indication of underperformance of defined contribution retirement plans?

There is a failure to perform for sure and that failure is with American workers. If you make it to age 55 and have not accumulated at least one years income in investments, whose fault is that? Not the plans; heck you don’t even need a plan.

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7 replies »

  1. Dwayne, thanks for your post. One of the reasons the 401(k) “underperfoms” is because too many plan sponsors limit plan provisions so that they only focus on retirement preparation.

    In surveys, over 2/3rds of Americans consistently confirm that they are living payday to payday. Other surveys show that income and expense are variable and volatile – meaning there is plenty of potential for many interruptions in retirement preparation. While over 2/3rds say they are living payday to payday, 80+% of the same surveyed population say they participate in a retirement savings plan when one is made available.

    So, the 401(k) works just fine for people who have enough disposable income and/or who have retirement preparation as a priority. Where it “underperforms” is where people do not have enough disposable income or where they do not have retirement as a priority.

    The solution, is for plan sponsors to amend their retirement savings plan to anticipate that one third to two thirds of their population do not have adequate disposable income nor do they have retirement preparation as a priority. The solution is to ensure that the 401(k) plan can meet other financial needs in the years prior to retirement. That is, plan sponsors should improve the liquidity options within the 401(k) plan (improving plan loan provisions, eliminating hardship withdrawal provisions) so that workers will confidently save more than they believe they can afford to earmark for retirement – reasonably relying on access to monies through plan loans for financial needs along the wan to retirement.

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    • I disagree with that view. First, we need to question that living payday to payday thing. There is plenty of evidence that spending on unnecessary things is a major cause of that, not a lack of income, plus it’s their own judgement. In addition, in my experience even people with plenty of income are inclined to misuse their plans via loans, withdraws and poor investment decisions. I know someone who retired (with a pension) but immediately took $200,000 out of the 401k to buy an RV. Another who saved a total of $45,000 over a career, but spends thousands upon thousands on a car hobby. Still others panic and sell stocks when the market turns down. A pension is always the best, but the problem is not the 401k, it’s the people and their lifestyles and spending.

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      • Amen!

        But controlling one’s spending is anathema to modern consumer society.

        The consumer lifestyle requires ever increasing income and never reducing spending. Same with government.

        Fortunately, my thrifty lifestyle enabled me to save, invest, retire early and live comfortably on a modest income. It also helped that my employer offered a 401K , pension and health insurance.

        .

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    • I don’t think that the government or anybody else can convince people to save for retirement. I feel that there is a strong need for financial education in high school. But I also know that kids will not listen since they can’t even imagine living until they are 67. When I was in high school in the late 1970’s, I didn’t believe that Social Security would still exist today. Kids today hear that it is going broke by 2032 and other say (AARP) that it is a lie. Either way, has anyone really seen a senior citizen dying in the street? If they are, they are too proud or have mental issues that prevent them from getting help. Some may be living in very poor conditions, but for the most part since the New Deal, the people and the government will not let that happen. We use taxpayers money to built low rent senior citizen buildings.

      Until old people start dying in the streets again, I don’t think that all of the people will take saving for retirement seriously.

      I have also seen people spend their 401K or take loans, not fully understanding that it has to last for the rest of their lifetime. Where I worked, the first pension check will be the same size as your last no matter what inflation does to you and medical costs can only go up as you age.

      In 1981, at 18, I joined the NJ Air National Guard just to earn a pension because my civil job did not have one. I wish I could remember why I felt that I needed to so. What made me so smart back then? If I could figure that out, maybe I can convince others.

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  2. This posting confused me a little. I had to re-read read it several times. If I understand it correctly, the CNN Money stat of 60% is wrong because only 38% of the private workers had defined pension plans in 1980 according to NASI.org.

    After a little research I found that the 401k wasn’t “invented” until in 1980 when benefit consultant Ted Benna realized that the Revenue Act of 1978 created section 401K of the IRS code which allowed for tax deferred savings. In 1981 the IRS issued rules to allow employee deductions and by 1983 most large employers had 401K plans.

    IRA plans were created by the Employee Retirement Income Security Act of 1974 (ESISA) and was intended for people who didn’t have pension plans. The Economic Recovery Tax Act of 1981 basically allowed everybody to have an IRA plan. This is when I remember that local banks started to offer IRA accounts.

    Roth IRAs did not come along until the Taxpayer Relief Act of 1997.

    NASI.org use of the word “underperform” is confusing. To me, underperform, when used with financial instruments, usually refers to “rate of return”. I think in this case they are trying to say the people are not taking advantage of 401Ks? To be fair, the powerpoint slide could be part of a larger presentation and maybe I am taking it out of context. But I do agree that people are not taking advantage of 401Ks and IRAs or private brokerage accounts which access has become easier and cheaper with online accounts.

    What comes to mind is that you can lead a horse to water but you can’t make him drink. As a perfect example, Obama took the whole country to the well for Obamacare and many still refused to drink and not all of those people refused on costs but because they didn’t want to be told what to do.

    For poor people, retirement savings is a tough sell because they cannot even get by day to day for what they need. For the middle-income people, then cannot determine needs from wants. For the upper middle class and above who don’t save, I believe it is just the lack of a financial education. I think they live in the “now” and just assume they will either save later or will always make enough money.

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    • Amen!

      But controlling one’s spending is anathema to modern consumer society.

      The consumer lifestyle requires ever increasing income and never reducing spending. Same with government.

      Fortunately, my thrifty lifestyle enabled me to save, invest, retire early and live comfortably on a modest income. It also helped that my employer offered a 401K , pension and health insurance.

      .

      Like

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