There’s A Big Problem With The 401(k) Plan

At the beginning of the year — believe it or not, nearly six months ago now — we did an installment of The Juice with a similar title.  We discussed some problems we have with retirement plans, such as 401(k)s and IRAs. 

Now, of course, retirement investing in tax-advantageous accounts works out for millions of people. However, as is often the case in personal finance and investing, something that works out for lots of people can become one-size-fits-all dogma. And, sometimes, it gets to the point where you’re branded as insane for not taking the blanket advice. 

Show us a money article about how to invest that doesn’t start with “max out” your 401(k) and/or IRA contributions. 

Great advice. Until it isn’t. 

One of The Juice’s general concerns is that if you have to stretch to do something financially, it probably isn’t a great idea. Whether that’s buying a house or saving for retirement, what’s the point of crunching your budget to the point where you have to backtrack?

If you have to turn to credit cards to make ends meet? 

If, as we outlined in that aforementioned Juice, you have to take a hardship or otherwise early withdrawal from a retirement plan to cover expenses. 

Some people are simply better off in taxable accounts where they get their hands on their money with no or relatively fewer tax consequences. We don’t talk about these people enough. 

As we also noted in that previous Juice:

The news isn’t all bad. BofA also noted that 21.3% of Generation Z and 10.4% of millennials have increased their 401(k) contribution rates. Less than 3% have decreased the money they’re taking out of their paychecks.

But, as we considered when we wrote that, we wondered if that’s yet another facet of our haves and have nots economy. It seems intuitive that retirement plans, particularly 401(k)s, benefit people with jobs (obviously!) and really benefit high earners. 

Because, without doubt, there are people who don’t contribute at all or don’t make out their contributions because they can’t afford it. They need cash flow to cover the cost of doing life. 

Vanguard recently released an assessment of 401(k) plans with a focus on the employer match. Among the findings, directly from the Vanguard report:

• In two-thirds of plans, employer contributions exacerbate pay inequity.
• Employer contributions are highly concentrated, with 44% of dollars accruing to the top 20% of earners. Many common formulas, including safe harbor designs, disproportionately benefit higher-income employees.
• The majority (59%) of employer contributions accrue to the 41% of employees who save more than the match cap, suggesting they would have saved just as much without the match.
• The bottom 20% (of earners) receives just 6% (of employer contributions). 

As with many things in America, benefits are tied to employment. Most notable, health insurance. However, how much you earn also matters. 

Vanguard proposes some ideas to deal with the inequities:

… we find that a dollar cap on matching contributions correlates with greater equity and lower costs. Employers could prioritize plan features that promote savings for lower-income workers, such as autoenrollment, a higher default savings rate, or immediate eligibility and vesting. Dollar caps are a promising (and currently underused) tool that could free up employer resources to pay for such features.

Vanguard profits from the 401(k) business. So, good on it for highlighting the inequity. At the same time, Vanguard has a vested interest in proposing solutions to the current system.

To be clear, we’re not saying there necessarily needs to be a policy change. 

The Juice doesn’t think we’re going to see this reality change. People who earn more money can save more money and, subsequently, stand to benefit from perks such as employer matches. 

What we are saying is that the one-size-fits-all narrative needs to change. We have created an investment culture that makes it seem as if you’re failing if you don’t max out retirement plan contributions you have available to you. And the reality is that this isn’t the only way to build wealth and save for retirement. 

If a taxable strategy or something that doesn’t involve 401(k)s (and IRAs) works for you, go for it. If you lose sleep because too much of your paycheck is going into your 401(k) because you’re essentially being shamed into contributing to it, that’s not good. Plenty of worthwhile options exist to help you better balance your current needs alongside your financial future. 

The Bottom Line: Yes, we absolutely do have a ton of options. More than ever. So, next week in The Juice, we’ll focus on them. 

We’ll start the week looking at alternative investments, such as private equity and the platforms you can use to enter the broad space. We’ll finish it with a comparison between investing in taxable versus tax-deferred or otherwise tax-advantageous accounts that goes beyond the A+B math and takes real life into account. 

So, if you haven’t already, please forward today’s Juice to a friend and suggest they subscribe for free.

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