By Sam Brkich
If you’re an active reader of retirement-related stories in newspapers and on the Web, no doubt you’ve noticed quite a few stories in the popular press lately that are quite critical of 401(k) programs. Brian Graff recently wrote about these stories here, for example. One of the most egregious examples, from Fox Business, was published Feb. 26 — smack in the middle of “America Saves Week,” ironically enough.
The Fox Business article creates the false impression that 401(k)s evolved by accident rather than as part of a national dialogue on retirement policy. In fact, America has had that dialogue since 401(k)s were created: 60% income replacement at age 65 for career employees supported by three sources: pension plans, personal savings and Social Security. The 401(k) is critical to saving because it’s the only program that removes the tax headwind confronting workers in their prime earning years.
These programs are sufficient to meet their goals for career (not part time or itinerant) employees. Career average pension plans typically replace 15% to 30% of average pay. A 5% 401(k) deferral can meet or exceed this amount. Social Security replaces 30% to 50% up to the wage base.
The New School’s Teresa Ghilarducci, who is quoted in the Fox Business piece, is moving the goal posts when she states that today’s 55-year-old earning $100,000 needs 20 times earnings ($2 million) to replace 100% of income from his 401(k) account on top of Social Security in order to retire. She’s disappointed that the family sedan Congress built 30 years ago isn’t performing like a Porsche.
The article further mischaracterizes 401(k)s as plans for the wealthy by stating that the top 20% of earners receive 80% of the tax benefit. In fact, the typical “top 20%” is a dual income career household with two earners over the age of 50 earning a combined income of $90,000-$120,000. This household enters the top 20% in late career and stays there for only a few years before retirement. Congress specifically targeted this group with the “catch up” contribution to make up for the difficulty of saving when workers begin their careers. Clearly, it isn’t Warren Buffet and Bill Gates who are taking advantage of the 401(k).
Having set up the “failure” by moving the goal posts and mischaracterizing the tax benefit, the article reiterates Ghilarducci’s proposed replacement of the 401(k) with a mandatory contribution (5%) from the employer and the employee, invested by the government with a government-guaranteed 3% return above inflation with no risk of losses.
The proposal notably does not guarantee that it will solve the 401(k) plan’s funding shortfall. Using the guaranteed rate (4.6%), in order to get to the $2 million figure in the article, an employee earning $100,000 needs to save $18,000 each year for 40 years. The required savings rates are substantially above the 5%-10% rate in Ghilarducci’s proposal. They are unrealistic for younger workers.
If there is no funding guarantee, then mandated contributions to professionally managed 401(k) plans would be equally successful.
This one-sided public “discussion” of the need to scrap the 401(k) reminds me of the impatient driver on the interstate who hopes to save time by changing lanes. It’s the lane changing that causes the gridlock and fender benders. Restoration of the three-plan system of pension, 401(k) and Social Security would achieve most of Ghilarducci’s wish list — with relatively little experimentation.
Brkich is a Board member of the Council for Independent 401(k) Recordkeepers (CIkR), an ASPPA sister organization.
