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Money Talks

By Dr. Gregg Dimkoff
Professor, Grand Valley State University
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This year marks the 30th anniversary of 401k plans. We owe their development to Ted Benna, a retirement benefits consultant who created the plan for one of his clients: a bank. The bank’s attorney advised against implementing the plan because of the risk — the risk the IRS or Congress would rule against the bank. The bank followed its attorney’s advice and said no. Similarly, Benna’s other clients refused to be the guinea pig.

Undaunted, Benna implemented the nation’s first 401k plan for The Johnson Companies, a suburban Philadelphia group of several small companies he co-owned with others. At the time, Section 401k of the Tax Code allowed employees to defer non-salaried compensation into tax-deferred profit sharing plans. Benna’s stroke of genius was setting up a plan where workers could contribute directly from their earnings with employers providing a matching contribution. Soon thereafter, the IRS issued regulations sanctioning 401k plans as we now know them. Within 10 years, the majority of large U.S. corporations offered 401k plans to its employees.

Most employees loved the idea of managing their own retirement money, and the majority believed their nest eggs would achieve high rates of growth during employment, generating huge balances upon retirement. Back in the 1980s and 1990s, employees, their financial advisors and even finance columnists used annual compound rates of return of 8-10 percent or even more to project future balances.

Ahhh, life seemed good. Employers were relieved of the burden of funding more and more lavish pensions, and employees potentially could accumulate huge retirement war chests. In fact, the first three Johnson Companies employees who enrolled in the company’s 401k had plan balances of $1 million after only 20 years of participation.

Now that 30 years have passed since the first 401k plan, researchers are checking to see how well they’ve worked. Their findings aren’t pretty. In short, too many workers have not participated in their employer’s retirement plans; too many have contributed insufficient amounts; too many have not contributed enough to receive their company’s match (leaving free money on the table); too many have misallocated their investment choices, thereby failing to be adequately diversified; too many have churned their investments, foolishly trying to time the market or chase the hottest trends and too many have borrowed money from their retirement plans and not repaid it, incurring early withdrawal penalties and subjecting withdrawals to income taxes.

Here are two ugly facts from the Benefits Research Institute’s most recent annual Retirement Confidence Survey. About 29 percent of workers have less than $1,000 available for retirement. Another 27 percent have more than $1,000, but less than $25,000. It’s clear as a bell most of these people won’t be able to retire or will live in poverty during retirement. It’s also clear 401k plans have not achieved their potential, nor have they achieved the hyped returns many workers expected. For the majority of workers, they have failed as retirement plans.

It’s not the fault of the plans, however. They work well for many workers, perhaps as many as 20-25 percent of employees. But those employees share a common trait: They appear to have a genetic saver’s gene. They contribute up to the specified legal limits. They do so year after year, and they diversify their plan investments over several asset classes.

Except for these super disciplined employees, everyone else needs help. If our children lacked the necessary discipline, knowledge or were too paralyzed by fear to act, we would help them. To not do so would be abdicating our responsibilities as parents. The same goes for employees who need help with their qualified plans and retirement planning. Employers must provide the help. And advising employees to seek the help of financial advisors is not too helpful. Instead, it’s refusing to deal with the problem.

I suspect most employees would love it if their fringe benefits departments offered a continuing series of workshops offering advice about how many years a worker can expect to live while retired, how much money will be required to support those years, how to diversify across asset classes and how that changes as retirement approaches, and the dangers of churning. In other words, how to avoid the problems turning a great concept — 401k plans — into a failure.

It’s becoming obvious that pensions eventually drive most employers out of existence. On the other hand, 401k plans are a poor alternative for the majority of employees. But that can change. Doing so requires employers take the lead educating employees. Sure, it will cost money, but it’s the right thing to do and far less expensive than pension plans.

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