Excerpt: The Accidental Birth—and Spread—of the 401(k)

In 1980, a benefits consultant named Ted Benna was assigned to create a savings program for his employer. So he did what anyone would do in that situation: he pulled out a copy of the Internal Revenue Code. Looking through the code, he found a little-noticed portion that gave employers special tax status for encouraging workers to save for retirement. He ran with the idea.

“Well, how about adding a match, an additional incentive?” Benna recalled thinking at the time in a later interview. “Immediately, I jumped to, ‘Wow, this is a big deal!’” The section of the tax code he found?

Section 401(k).

Benna was right. His discovery was a big deal. And employers quickly realized that this retirement vehicle offered them an additional benefit: it shifted the burden and risk of providing for retirement from employers to employees. And employees didn’t fully appreciate what they were losing. As a result, 401(k)s took off. In 1985, there were just 30,000 401(k) plans in existence.

Today, there are 638,000.19

Not bad for a glorified tax loophole. But here’s the problem: it doesn’t work for most savers. Benna recently spoke out about how the 401(k) system is overwhelmingly complex for average workers without backgrounds in finance and investing, at one point going so far as to call his creation a “monster.”

“I knew it was going to be big,” he said, “but I was certainly not anticipating that it would be the primary way that people would be accumulating money for retirement 30 plus years later.”
From the very beginning, savings vehicles like 401(k)s had some fundamental problems. Individual retirement savings accounts depend on voluntary individual contributions, which people may or may not make throughout their lives. That’s a problem, because in order to be effective, these contributions must be made steadily throughout a worker’s career, starting in their mid-twenties. Often, but not consistently, these contributions are matched by the employer.

Just as important, 401(k)s also earn subpar returns on these insufficient savings as a result of poor investment strategies. In short, we have a retirement crisis because the 35-year experiment with a do-it-yourself 401(k) system has failed. The voluntary burdensome, commercial system doesn’t adequately help employers and workers accumulate retirement assets, doesn’t invest them long-term and securely with low fees, and doesn’t arrange pensions for life. Average 401(k) participants simply will not have enough saved to maintain their standard of living in retirement.

Why 401(k)s fail savers

To understand why 401(k) plans so often leave workers with insufficient retirement savings, consider the most common ways they fail the savers who need them the most.

  • They don’t accumulate enough savings. Across America, the median 401(k) account balance is just $18,433. Less than
  • 50 percent of 401(k) holders actually have enough to retire.
  • They’re not even close to universal. Forty-five percent of private sector workers don’t have access to any workplace retirement plan. Among those who work at companies with fewer than 100 employees, only half have a 401(k) plan.
  • They leave low-income and middle-income families behind. Families in the top 20 percent of income distribution are ten times more likely to have a retirement savings account than families in the lowest 20 percent. These affluent savers benefit from tax incentives that the majority of Americans cannot access.
  • Low-income families don’t have the ability to save even if they want to. Forty-seven percent of Americans couldn’t come up with $400 if they needed it in case of an emergency.
  • 401(k)s and IRAs are built to deliver lower returns. Because of a structural requirement for short-term investments (savers are able to withdraw from 401(k)s
  • at any time), defined contribution portfolios deliver much lower returns—sometimes by as much as half—compared to defined benefit portfolios.
  • They place the burden of saving, planning, and administering onto the worker. Workers with a 401(k) must figure out how much they need to save, how that money should be invested, and—once they reach retirement—how to manage their assets so they don’t outlive their savings. This would be challenge enough for a savvy professional investor. It’s an almost impossible burden for the average person—or even a famous surgeon.
  • They ignore what motivates savings at the expense of those who need it most. As human beings, we’re poorly wired to plan for the long term. For most families, if the choice is between replacing a leaky roof and preserving compound interest, most will choose fixing the leaky roof. That’s what makes 401(k)s such poor savings vehicles. Not only are they opt-in savings systems, but they allow savers to liquidate their savings at any time in exchange for high fees.
  • Yet 401(k)s are often a savers’ only option. Despite workers’ overwhelming preference for defined benefit pension plans, these retirement options have virtually evaporated in the private sector. Three decades ago, nearly two thirds of workers had a defined benefit pension. Today that number is just 15 percent, virtually all of whom are government workers.

Given all of these shortcomings, why is the 401(k) still the primary retirement vehicle for many Americans today? The answer is simple. A 401(k) isn’t the best option; in most cases, it’s the only option.