The Problem with 401(k)s

A really nice post on the Vanguard corporate blog (really) about the problems with 401(k)s:

The film started with two misconceptions. The first is that most Americans aren’t prepared for retirement. That’s an over-exaggeration (see my previous post on this issue)..

The second misconception was about the old defined benefit (DB) pension system. The program suggested most workers had a generous DB pension, and that there were no risks to worry about. By comparison, 401(k) plans are a poor substitute—they’re too complex, too costly, and too risky for the average person.

All of this is equally untrue. About 4 in 10 private sector workers had pensions in their heyday, and the typical pension was modest. The system was full of risks. For example, you could spend your career at a company and find out at age 65 that the pension you were entitled to was inadequate. Or, if you changed jobs frequently, whether by choice or necessity, you often got little or nothing from the pension system. And few workers were aware of these risks.

I think that it is important to note how available defined benefit pensions really were, and that they were poorly suited for job mobility. But I think it is certainly true that the individuals who run those plans are far more able to make wise decisions than individuals. The 401(k) system really does force individuals to make decisions that they are poorly equipped to make.

That said, this point is critical:

- Savings. Strikingly, the documentary said nothing about savings habits and the culture of consumption in America. If only it had! The fundamental challenge facing all retirement investors, 401(k) or not, is saving adequately. Yes, low fees, better portfolios, and good legal regulation matter. But they are second-order concerns to the first-order problem of Americans consuming less today so they can have more tomorrow. We seem to have cultural amnesia about saving—and no one really wants to talk about it.

A friend of mine in the industry made the same point years ago. Picking the right stocks (or funds), taking care that fees are as low as possible, managing taxes well is all good, but the main thing you need to do is save enough, and people don't.

It may be better to lower taxes, make social security more generous, and abolish 401(ks) altogether. In fact, the tax advantaged nature of 401(k)s means you need to lower taxes (or increase spending) anyway to handle the demand drain that comes from the increased savings that those vehicles generate. Finally have social security without automatic COLA adjustments -- this should be another inflation control lever that is counter cyclical to the business cycle, not pro-cyclical the way COLA sets is up to be.