My broker feels that 401Ks – the retirement plans that have largely replaced pensions – are a terrible idea and that most people would be better off in a traditional pension. The main issue with pensions is that they can become a burden on a company since the company may need to add more money from time-to-time, depending on how the markets do. When companies fail, they can also end up dumping their pension plan on the US Government, which will both cost the taxpayer money and can result in substantial reductions in the payouts the retiree receives. Another issue is that companies tend to promise a lot in the pension plan when workers start to demand higher salaries and benefits since it is easier to promise to pay money later than it is to actually come up with the cash today.
The issue with 401Ks isn’t the plan itself. It is the poor level of financial literacy that most people have. This is surprising, given how important money is to most people (and by money, I mean shelter, food, and clothing, not gold rings and trips to the Riviera). If people would spend a little bit of time reading and learning (The Smallivy Book of Investing is still on sale), they would find that managing their 401Ks is really not that difficult.
Given that they probably won’t, there are a few things that could be done that would make it a little harder for people to mess up their 401K. These are:
1. Make enrollment at the maximum company match opt-out. Many people fail to enroll at all since they must opt-in to the 401K plan, or they don’t contribute up to the full company match, leaving money on the table. This could be changed where employees are automatically enrolled at the amount needed to capture the full company match. If they choose to not participate or reduce their contributions, they would need to go in and opt out. Given that most people are slow to act, this would cause most people to do the right thing financially and put money away. Actually, it would be even better if you were enrolled at 10% of your pay regardless of the company match since you need to be putting at least that amount a way to have a secure retirement at your current level of lifestyle.
2. Make a target date retirement plan the default. Given the choice, I’d choose my own funds rather than use a target date retirement fund. For many people, however, a target date retirement fund is better than what they tend to choose. Many plans drop people into a money market as a default, and many people then just leave it there. This guarantees that they will lose a lot of their money to inflation and will lead to a dismal retirement unless they sacrifice like crazy and put a lot of money away. For those who don’t want to mess with it, a target date fund would provide at least the returns that a traditional pension would.
3. Eliminate the ability to withdraw funds before retirement. One of the worst things about a 401K is that you can withdraw funds before retirement. Often this comes with a 10% penalty plus a large tax bill, such that you lose 50% of your money by taking it out early, yet people continue to take the money out on a whim or when they change jobs. You wouldn’t be able to go to your pension plan manager and say you want to take your money out before you reached retirement age. You shouldn’t be able to do so in your 401k either.
These three simple changes would totally transform the landscape when it comes to retirement security in the United States. Are any Congressmen reading? I’d be happy to discuss them.
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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.