Retirement experts estimate that a worker will typically need to save at least $1 million to maintain their standard of living in retirement. However, many are far from meeting that goal. According to the Federal Reserve, 25% of U.S. adults don’t have any retirement savings, and only 36% of working Americans believe their retirement savings are on the right track. How did the U.S. retirement landscape reach this point?
A new special on Netflix, called “Money, Explained,” identifies the rise of defined-contribution accounts, like 401(k)s, as one primary reason why it is becoming more challenging for workers to retire with security.
During the decades immediately following World War II, if a private-sector employer offered a workplace retirement plan, that plan usually included a defined-benefit pension. In 1978, however, Congress passed the Revenue Act, which included a section known as the 401(k) that drastically changed the practice of retirement planning.
The 401(k) initially benefited wealthy executives who could defer a portion of their compensation into a savings account, tax-free. But a man named Ted Benna, who is widely credited with popularizing the 401(k) as a retirement savings vehicle, theorized that the provision could be used for workers to contribute part of their salary pre-tax into a plan as well to try and save for their retirement.
While this idea may sound attractive in theory, in practice, the 401(k) has been a disaster for workers’ retirement security. As we wrote recently, the 401(k), unlike defined-benefit pensions, “places all the investment and longevity risk on an individual worker. Since the investments in a 401(k) are not collectively pooled, an economic downturn could threaten one’s retirement savings. And since there is no guaranteed retirement benefit, workers could also risk outliving their savings.”
The damaging results of the shift from defined-benefit pensions to 401(k)s can be seen for themselves. The median 401(k) balance in one of the largest 401(k) providers, Fidelity Investments, is only $24,500 (far from the amount of saving at least $1 million for retirement). And Benna himself has spoken out against his creation, saying in the Netflix series that “[the] 401(k) was never intended to be our national retirement system.”
It’s time for America to abandon its unrealistic obsession with 401(k)s. Pension plans guarantee a secure retirement that workers can count on in their golden years.
