If you are a long time reader of Defined Benefit, then you know that we are no fan of 401(k)s here. As 401(k)s have increasingly replaced defined benefit pensions, the retirement security of many Americans has eroded. A new report from the GAO offers new evidence that 401(k)s are failing many American working families.
The 401(k) was never supposed to be the primary retirement savings tool for American workers. When it was created in the late 1970s, the 401(k) was a minor provision in the tax code intended to help wealthy corporate executives save more of their wealth in tax-advantaged savings accounts. And that is what it has been most successful at doing. According to the new GAO report, among working households, 81 percent of high-income households have savings in a defined contribution 401(k)-style plan. For these high-income households, the median account savings in a 401(k)-style plan is $201,500.
For low-income households, only 25 percent had any savings in a 401(k)-style plan and the median account balance is only $10,400. There are a number of reasons for this. One is access. Only 35 percent of low-income households even had access to a workplace 401(k)-style retirement plan compared to 80 percent of high-income households. When they have access to a workplace retirement plan, though, low-income workers participate at lower rates than high-income workers: 64 percent to 95 percent. There could be several reasons for the lack of participation. One of the most obvious is a lack of disposable income. Research has shown that low-income households spend a greater proportion of their income on basic necessities such as food, housing, and clothing. When these households are barely making ends meet, they don’t have extra money to put aside for retirement. Other explanations include a lack of financial literacy and a greater propensity to cash out rather than roll over savings in a 401(k)-style plan.
401(k)s have a number of flaws compared to pensions and each of these flaws contributes to the failure of the 401(k). Unlike pensions, enrollment in a 401(k) is typically not automatic. Also unlike pensions, employers are not required to contribute to an employee’s 401(k) plan (although they may do so). Pensions are also professionally managed and earn higher investment returns than 401(k)s, which individual workers must invest, even if they have no knowledge of investment strategy. Finally, the default option for a pension is a monthly benefit guaranteed for life, whereas with a 401(k), it is easier for employees to take a lump sum and spend through it quickly in retirement.
The evidence at this point is almost overwhelming: 401(k)s have failed the majority of American working families. The move away from pensions to 401(k)s in the private sector has harmed the retirement security of many Americans. Advocates of eliminating pensions in the public sector- pensions for teachers, firefighters, and other public servants- would be repeating the same mistake. It’s time for our political leaders to wake up and realize that there is a retirement security crisis here and 401(k)s are making it worse.