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.
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.
– 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.
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.
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?
John S @ Frugal Rules
Good post Joe and even better questions! This is such a cluster that it can be hard to know where “you” really need to start. I agree that the 401k, save for crappy ones that are bloated with fees, aren’t broken but that the system itself is much closer to that situation. From how I see it, we moved from the pension era were, for the most part, things were handled for us and could count on it…relatively speaking to one where it places a large burden on us as individuals. Then you throw in crappy education on investing/finance and it just makes it even worse. That said, I would think changing the default allocation to a TD fund and offering real education through employers would be a good start.
Great question and I think you summed it up pretty well. I don’t think the 401k system is broken, it is just a tool for saving for retirement which provides a tax benefit. Yes, I agree about plans with high fees though…don’t like those. Definitely need to be opt out because people are too lazy to opt in. I work in government and a co-worker said that pensions are better than 401ks because 401ks rely on the stock market. Well so does the pension!! It’s just that the pension “guarantees” a certain amount of income at retirement regardless of the stock market performance and if it performs badly…tax payers make up the difference.
Done by Forty
Your first bullet re: the opt-out would have truly dramatic results. It’s simple, it costs nothing, taps into the power of activation energy, and, most importantly, sets people up for a positive habit loop. (A few, actually: the first is saving money & getting some positive feelings at the end of each pay period for doing so; the second is learning to learn more within their means.)
Setting the defaults to be in society’s overall favor (401k opt outs, organ donor set as the default option, etc.) is usually the right choice.
Sadly, I know a few people who don’t save for retirement because they think their 401k is a “scam.” I also know a few people in their late 30’s and early 40’s that don’t save at all. I wonder what is going to happen to all the people who fail to save. Who is going to take care of them?
I don’t know if the 401K is broken or not. Part of the problem is that people just aren’t disciplined enough to put money away voluntarily. The 401K would probably be working a lot better if people made it a priority!
Mrs PoP @ PlantingOurPennies
I actually really like the 401K that the small company I work for provides. The fees aren’t insanely low, but not crazy high, and no front loads. A decent balance considering the size of our plan’s assets. We get solid matching funds that are no-nonsense and have nothing to do with your salary – so the CEO is eligible for just as much in matching funds as is the secretary – 25% match on whatever you put in. And to top it all off, they take their fiduciary duty seriously and pay for a fee only planner to come in for 1-1 meetings quarterly for anyone who wants to sign up. The planner can help make sure you’re in funds that meet your goals, and talk about other more complicated matters – I tested him with some early retirement questions during our meetings! From my perspective, I feel like 401Ks work way better for us than pensions ever could!
Stefanie @ brokeandbeau
Almost all of my retirement savings are in a ROTH IRA, but that’s not by choice. I have to be working a union job to get 401k contributions and those jobs are very hard to come by and typically short term :/