Is the 401k Broken?

5 Ways to Fix Our Retirement System

LAST WEEK I had a fascinating discussion with well-known podcaster Matt Theriault on Twitter about my recent post Bam! Jim Cramer Gets It Wrong. It seems that while I was busy raising eyebrows at Cramer telling everyone to ditch their 401k (and save instead into an IRA), Theriault questioned the value of saving money….at all.

Yeah…..

Matt’s a smart guy, so don’t scoff at his suggestion immediately. To defend his position, he quoted a Time magazine article showing that, in his words, using a 401k plan for retirement isn’t the way to go. He could also have just used his recent Ellory Wells podcast episode on the topic: Creating Streams of Cash not Piles of Money.

I read the article and didn’t arrive at the same conclusion as him or the author.

But is he right? Should you avoid saving into your 401k?

I think blaming the 401k plan for our problems is like saying:

– I’m not a fan of Justin Beiber so music is bad.

– Lots of people can’t clean so Windex isn’t working.

or

– I have lots of debt so we should scrap credit cards.

In some ways, the evidence suggests that 401ks are, in fact, broken. People aren’t using them well at all. We’re beginning to see the difference between a society that emphasized pensions to one that only provides a 401k plan. Nobody has any money saved anymore. Worthwhile? It appears not.

– During the 2008 market downturn the average 401k balance dropped 31%.

– 55 to 65 year olds lost a quarter more than 35 – 45 year olds.

– 45% of all 401k plans have less than $10,000 in them.

Here’s the real question: is 401k plan misusage the fault of the 401k tax code, education, or our innate human nature?

The case to blame humans:

Let’s be honest. We’re not built to save money. (See our podcast episode with the filmmakers from Broken Eggs for more on this). Our natural makeup is to want to survive TODAY, not the next fifty years. That’s why most people emphasize their grumbling stomach over putting an extra five dollars toward retirement.

…And Then There’s Education…..

On the education front, we aren’t doing well either. Most high schools have no personal finance program. The ones that have these programs categorize them as classes for people who aren’t going to college. I know….at my kid’s high school they have a personal finance class, but you’re dissuaded from taking it if you’re on the college track. Why? Too many other “priorities.”

We’re sending kids out of school with the ability to make money but not the ability to hang onto it.

Other Factors:

Matt references inflation as a problem in his tweets.

@AverageJoeMoney Overall, I’m against saving money. Money loses value daily. Invest in residual income and dividends that pay you now.

— Matt Theriault (@theDoOverGuy) June 26, 2014

I think he’s saying we shouldn’t save because we won’t beat inflation.

I agree,which is why I don’t understand why people insist on stuffing cash into investments which earn little to no interest. Inflation tears away at your money non-stop, making it worth less every day. If you aren’t beating inflation–I totally agree with Matt–you’re better off not saving at all.

But does that mean you shouldn’t save?

Does that mean you shouldn’t have an emergency fund?

Does that mean that you should put your money into only physical things that return a dividend?

Theriault thinks so. Of course, we have to remember that he’s selling real estate-based products, too. It doesn’t make him a bad guy….just gotta remember how much the beef guy loves a good hamburger.

BUT I think he’s right.

Our system is broken.

My feeling is NOT that 401k plans are broken. They aren’t (although don’t get me started on fees and ugly plan options that suit nobody but the provider…..). BUT while the tax code isn’t broken, usage of these products clearly isn’t working. What’s the solution? I’ll propose a couple:

Joe’s 401k Saving Ideas (which I can’t completely take credit for….)

• Change 401k plans from opt-in to opt-out. That preserves the freedom to save if you decide you want to. I do believe in your right to screw yourself out of your future if that’s what you really want. However, by changing plans so you automatically save into your 401k plan, you can be as lazy as you want and still have some retirement savings. Instead of having to stretch to sign up, now you have to stretch to get out.

• Change the default allocation from cash to a target-date fund. Many people have problems (and good ones) with target date funds. My goal isn’t to find the “perfect” solution, but to make sure that over long periods of time, your money grows. By using an age-based target date fund you’ll be much closer to your goal of beating inflation than if you save into cash.

• Allow people to move between a 401k plan to an IRA more easily. This will help people avoid being trapped in dead-end plans with high fees. As a financial advisor, I absolutely hated how some high-fee plans ripped people off by making you stay there.

• Build incentives to encourage companies to offer financial education classes. I know that ERISA rules already supposedly mandate education, but if you’ve ever worked in a company, you’ll know what a joke this is.

• Schools? If we’re “testing” kids, what are we “testing” them for? Shouldn’t we be testing their ability to hold onto money? I hate advocating more testing….but if we’re already there, shouldn’t we change the testing to focus on valuable life skills?

I look at these suggestions and see the incredible investment that it would take to implement them.  The testing requirements and financial education classes alone would require a level of enforcement that currently doesn’t exist.

But here’s the rub: if we continue to do nothing, we’ll get what we’ve gotten so far….a bunch of people who want to retire someday but who wake up too late to understand just how completely screwed they are. Then they throw long by getting too aggressive and lose WAY too much money when the market drops through the floor.

Financial education?

Welcome to the financial nightmare.  Broken 401k? I don’t think so. Broken retirement? Absolutely.

So, peeps….no answers, but only questions. Is the 401k broken? Should we throw it away?

Photo: PhotoSteve101