Reforming the 401k: Good Ideas and Bad Ideas

When stock market crashed, people’s 401(k) accounts crashed with it. Needless to say people are not happy. They are saying 401k’s don’t work.   Wall Street Journal published an article How to Fix 401(k)s by Anne Tergesen. It listed many proposals for changing the 401k’s (and 403(b)s and 457’s). I think some of the proposals are good ideas while some others aren’t so good. I’m listing the ideas here with some short comments. Read the WSJ article if you are interested in more details.

Good ideas:

1. Auto-enroll all employees. Default contribution % and investment. Average participation rate among eligible employees in companies with a defined contribution plan is about 70%. That’s too low. Auto enrollment and default contribution and investment choices make it easier for everybody to participate in the plan. If the employees did nothing, they will be in the plan, have a reasonable contribution percentage and a reasonably diversified investment.

2. Limit cashout when an employee changes jobs. Too many employees just take a cash withdrawal when they change jobs. This proposal makes sure retirement savings stay in plans intended for retirement savings.

3. Default distribution to an annuity. Make sure the money will last a lifetime. As long as there are opt-outs and the plan is required to shop for the best rate on annuities, I think it’s a good idea to have an income stream you will never outlive.

4. Automatically bump contribution % with pay increase. Help people save more tomorrow. Great idea.

5. Create a state pool for small employers. Small employers on average either don’t have a plan or have really bad plans. It’s really not necessary to have every small employer create their own plan. They can just join a state pool. Leveraging economy of scale is good.

6. Disassociate 401k with employers. This goes one step beyond state pools. Let everyone join a national plan like the Thrift Savings Plan (TSP) for federal government employees. Employers can match into it. Say goodbye to bad plans set up by employers. I like that!

Bad ideas:

1. Expand Saver’s Credit. This proposal gives a tax credit to people who earn up to $70,000. Right now people don’t participate because they can’t take the reduction in pay, not because the tax break is too small. Giving them a small tax credit won’t help much.

2. Automatic IRA. This proposal will have employers who don’t have a retirement plan send payroll deductions to an IRA for their employees. People who want an IRA can do it themselves through direct deposit already. I don’t see how this achieves anything.

3. Replace 401k with a government guaranteed pension. Too much a lure for diverting the money elsewhere. We already have Social Security for a government guaranteed pension. Look at how Social Security money is used. People should have some money for themselves.

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  1. Don says

    I love the saver’s credit, and I would love if it were expanded. But maybe that’s just me, and admittedly, I’m a good saver already.

  2. Harry Sit says

    Don – That’s what I’m saying. If you are already a saver, Saver’s Credit is an extra bonus. If you are not already a saver, a Saver’s Credit is not enough to turn you into a saver. If people are giving up their employer match, they are willing to forgo the credit too.

  3. Pelon says

    Retirement plans are a pet peeve of mine. Can someone please give me a logical explanation for why we need 2,000 plans based on your employment status, your income, your age, your dog’s name, etc? It’s a ridiculous system that only a government could come up with.

    I think good idea #6 is absolutely critical. There should be only one plan with the same saving limit for everyone regardless of income or employer. If your employer or anyone else wants to contribute, they can choose to do so. You get to pick your own plan, so you don’t have to worry about getting stuck with a limited range of investment choices.

    I can’t believe anyone would even seriously consider bad idea #3. I’m already in a “guaranteed” state government pension program that is short multiple billions of dollars. If the whole country got into a similar plan, the shortfall would quickly grow unmanageable. The last thing we need to do is to add an additional burden to the system that already can’t fund Social Security and Medicare.

    Here is one additional suggestion:

    – Teach basic financial skills in school. Most of the changes on that list would not be necessary if people understood the consequences of their actions.

  4. Jeff says

    I think that people should have an option to roll the 401k out yearly to a rollover IRA. Some 401k plans have expensive or poorly performing funds. Folks should have an option of rolling out fully vested assets.

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