No, Mr. Yglesias, 401k’s Do Not “Suck”

Mr. Matthew Yglesias, in an article on Stale, makes the case that 401K plans “suck.”  Maybe the fact that the writer uses the term “suckish” in his article would cause one to discount his opinion, but maybe he’s just caught up in the zeitgeist of the post-millenial era.  There is no doubt that his arguments would carry some water with a lot of readers, particularly since many people are really not familiar with the way economics work, including the mechanics of 401K accounts and Social Security.

His reasons for why 401K plans “suck” are the following, as quoted from his article:

-Poor people get absolutely nothing

-Wealthy people who would have had large savings anyway get a nice tax cut offers no meaningful incentive effect.

-For people in the middle, the quantity of subsidy you receive is linked to the marginal tax rate you pay -in other words, it’s inverse to need.

-Most middle-class savers end up either undersaving, overtrading, investing in excessively high-fee vehicles or some combination of the three.

-A Small number of highly compensated folks now have lucrative careers offering bad investment products to a middle-class mass market based on their ability to swindle people.

Let’s take a look at these points, one-by-one:

-Poor people get absolutely nothing

The average food stamp benefit is $133.41 per person per month, or about $575 per month for a family of four.  The average housing subsidy is about $7000 per year, or around $600 per month.  There is also a lot of money donated privately by individuals to various charities that help the poor.  There are a lot of programs, both public and private, that provide money for low or no income families.  The taxes and donations that pay for these programs come from people who are working and producing wealth.  Most of the money for these programs come from the individuals who produce the most wealth.  Mitt Romney pays millions in taxes and gives millions more each year to charities.  The millions of middle-class people who get up and work hard each day also contribute substantially as a group.

401K’s are not directly for the poor, at least those who stay poor their whole lives, which a substantial portion do not.  They are for the middle-class, and because of 401k’s and pensions the millions of people in the middle-class can retire without becoming dependent on others.  This means there is more money available to take care of the poor.  A society works better if those who are able to provide for themselves do so.   Encouraging those who can provide for themselves to do so helps those who cannot since it is a lot easier for 100 people to support one person than for fifty people to support fifty other people.  The poor may not open or fund 401k’s, but they definitely benefit.

-Wealthy people who would have had large savings anyway get a nice tax cut that offers no meaningful incentive effect.

Contribution limits set by 401K laws limit contributions to $17,000 per year.  For someone at the 40% tax bracket, that equals a tax savings of about $6800 per year.  This deduction won’t really matter much to the wealthy person, and Mr. Yglesias is probably right that there would be little incentive for them to save since the effect on their taxes would be miniscule.  But it really doesn’t make a difference for society because the deduction they get really won’t matter either.  Someone making a million dollars per year probably pays something like $300,000 per year in taxes.  Now they would pay $293,000 instead.  They are still paying $293,000 in taxes while most people are paying less than $15,000 per year.

To earn that income they are probably doing something that allows a lot of other people to make a living and pay taxes.  They probably own a business, or are an actor that makes movies that employ dozens of others on the set, thousands of people in movie theaters, and thousands more in video stores.  They may also be pro-sports players who provide jobs for thousands of stadium workers, hundreds of reporters, and thousands of people in ad agencies and retail stores.  Mr. Yglesias seems to feel that they should not see even a small reduction in how much they pay because they are somehow evil.  Would he rather they sit home and not work?

-For people in the middle, the quantity of subsidy you receive is linked to the marginal tax rate you pay -in other words, it’s inverse to need.

Let’s see what this really means.  If someone makes $50,000 per year and falls within the 15% tax bracket, they would get to reduce their taxes by $1,500 if they put $10,000 into their 401k accounts.  Someone in the 20% bracket would reduce their taxes by $2,000.  But just as with the wealthy person, the person in the 20% bracket would still be paying a lot more in taxes than the person in the 15% bracket even if with the larger deduction.  This could be remedied, if desired, by eliminating the progressive tax structure and  have each person pay the same percentage rate on all of their income, but I’m doubtful Mr. Yglesias would like that solution.   As it is, it seems like the person in the 20% bracket “needs” the deduction more than the person in the 15% bracket since she is paying more in taxes.

Really what I think Mr. Yglesias is saying is that the less money someone makes, the more noble they are and the more they make the more evil they are.  People who make no money are the most noble of all and should be given money since they make no money and therefore won’t benefit by having their taxes reduced.  But most people who don’t make any money also don’t do anything during the day to meet the needs of other people.  They don’t even do enough to meet their own needs.

People who earn an income are almost always doing something that meets the needs of someone or they would not be paid for what they were doing.  In addition, people generally earn income in proportion to the number of people whose needs are filled through their work.  A barista at a Starbucks meets the needs of the owner to serve coffee during their shift and meets the needs of the customers whom they serve during their shifts to have coffee drinks prepared.  The owner of Starbucks meets the needs of all of their customers to have a place to get coffee, breakfast, relax during the day, and even find a place to work and meet with clients.  The owner makes more than the barista, but she also meets the needs of a lot more people.  The owner is also generally working 80-100 hours per week, ensuring that customers’ needs are being met, which also helps to ensure that the barista continues to have a job.  I would say that perhaps the owner is more deserving of a break on taxes than the barista if the criteria is nobility.

Most middle-class savers end up either undersaving, overtrading, investing in excessively high-fee vehicles or some combination of the three.

On this we fully agree.  But the outcomes of 401K accounts have been far better than the outcomes of the alternative, Social Security.  Properly invested, one can expect to receive about ten times per month from a 401K account as one receives from Social Security, even if one only invests about 10% of pay in a 401k account versus the 12.4% people are forced to provide to Social Security.  Even if someone overtrades or pays high fees they would still do far better with the 401K than they would with Social Security.  Given the 10-to-1 return, they could also just put about 2% of their income into a 401K and do better than Social Security.

Ironically, Mr. Yglesias proposes increasing the required Social Security Taxes and expanding that program.  Given that the current trustees of Social Security – Congress – have done so poorly with the 12.4% of income they get, why would anyone propose putting 25% or 35% of pay into that system?  If something isn’t working, is the solution to double down and assume things will change?

Instead, how about we educate people on how to invest in a 401k?  Maybe have people read blogs like this one.  Even Mr. Yglesias does a good job of proposing how one should invest in a 401K at the end of  in his article.  It really is as simple as 1)Put 10-15% of pay away, 2) Spread it out over 3-5 funds that cover a wide range of assets (growth, aggressive growth, international, growth and income, and maybe bonds or REITs), 3) Buy the lowest cost funds you can, 4) Don’t move things around more often than once a year, and then only to rebalance the account so that you have roughly the same percentage of your money in each fund, and 5) Five years before retirement, either increase the amount of income producing assets held to lower volatility or start selling assets to raise enough cash to pay for expenses beyond your income for the next five years. (Basically one year’s worth of cash should be raised each year, so you have five year’s worth of cash at retirement.)  That’s really it.  Now you have been educated.

-A Small number of highly compensated folks now have lucrative careers offering bad investment products to a middle-class mass market based on their ability to swindle people.

I’ll admit that there are bad investment products, but for those in 401K’s that means making 5-8% per year versus 10-12%.  Social Security returns maybe 1% if you live long enough to collect, assuming the program continues to survive.  I would hardly call this “swindling.”  Still, with a little bit of education, people could do a lot better.  Not really that much education – maybe a book and a blog or two.  I would suggest perusing Boggleheads once in a while instead of watching videos on YouTube and updating Facebook and Pinterest.

Central in the theme of his article is that earning money is evil and being poor is noble.  It may be true in a Third world country where the people who are rich get that way by taking from the poor (and diverting funds from America and other first world nations meant to go to the poor to the armies and the palaces of the dictators).  In America, however, there is generally benevolence involved in getting wealthy, since earning money requires meeting the needs of others.  People who are honest and provide things that are worth more than the amount they charge do well.  People who swindle others don’t stay in business long.  Beyond meeting the needs of people directly, this also results in the generation of all sorts of excess goods and services that then improve the lives of the poor.

In America most poor people have color televisions, cell phones, cars, apartments, plenty of clothes and plenty of food.  In many countries they don’t have running water, food, or toilets.  There is a shortage of toilet paper for almost everyone – both for the middle-class and the poor – in Venezuela right now.  But you can bet that the leaders of the country who so nobly take from the rich and the middle-class under the guise of helping the poor don’t want for a roll.

Finally, if people are willing to sacrifice some luxuries now to fund their 401K’s and learn just a little so that they can invest correctly, the 401K also provides a way for middle-class people to become rich in one generation.  If their children then continue the practice of saving and investing from there they can become ultra-wealthy in two generations.   The 401K encourages people to save for retirement.  It also puts the money in a place where it can’t be taken and used for other things – either by the people contributing to the plan or by Congressmen who want to spend the money on pet projects.

No, Mr. Yglesias, 401k’s do not “suck”.  Social Security “sucks.”  Communism “sucks.”  Socialism “sucks.”  401k’s are the best shot people have at a dignified retirement.  And if Social Security had been structured as a private account like a 401K 90 years ago, investing separately in a 401K would not be necessary because everyone who worked would have plenty for retirement from their Social Security accounts.  Instead they are facing the bankruptcy of Social Security in a few years, and a continuation of meager benefits from that program even if it does survive.  They therefore need to fund yet another account to enjoy a dignified retirement – and you would deny them even that.

Please contact me via or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Comments appreciated! What are your thoughts? Questions?

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.