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With defined benefit pensions increasingly hard to find in the private sector and with 401(k)’s now having a track record spanning five decades, it might be surprising to some advisors and workers that there is considerable debate surrounding this retirement vehicle.
That’ll happen when the government is involved. Due the spending penchant of both parties, politicians think Uncle Sam needs revenue. That’s not accurate. What is needed are dramatic reductions in government spending, but since both parties are loath to embrace that, one element of the 401(k) debate involves eliminating some of the tax benefits associated with these plans to shore up Social Security.
Yes, the future solvency of Social Security is something Congress must address , but eliminating 401(k) tax benefits isn’t the way to get. Inevitably, elimination of those perks means workers will have less in retirement savings and that means less future revenue for the government.
There’s also been talk of rejuvenating defined benefit pensions, but that’s likely a nonstarter in the private sector where companies don’t want to carry long-term liabilities. Additionally, younger workers are highly portable, changing jobs every couple of years, meaning they’re unlikely to stick with an employer long enough to adequately vest in a defined benefit plan. All of that is to say some politicians may be compelled to fiddle with 401(k)’s, but some experts believe that could be the wrong approach.
401(k)’s Have Proven Their Mettle
As Melissa Kahn, retirement public policy strategist at State Street Global Advisors (SSGA), points out, there is some debate about whether or not 401(k) plans have been failures regarding retirement security. The answer she says is “no.”
“Retirement security is generally measured by determining the extent to which retirement income replaces pre-retirement income. An adequate replacement ratio is the goal of any retirement system,” she wrote. “A 2023 study by the Investment Company Institute found that the overall replacement ratio – based on all sources, including Social Security – through age 72 was over 90% and was over 100% for those in the bottom 25% by income. This is excellent by any standard.”
From a security standpoint, would it be nice if defined benefit plans were more prominent in the private sector? Sure, but that wouldn’t be a boon for all workers because small and mid-sized businesses would still be unlikely to offer those plans.
So no, the 401(k) isn’t perfect, but it has made saving for retirement easier for millions of workers and the SECURE 2.0 featured guidelines for bolstering 401(k)’s, including “the new Saver’s Match, which will dramatically improve retirement security for low and middle-income individuals,” adds Kahn.
There’s Room for Improvement
Like any other financial instrument, 401(k)’s aren’t perfect and there is room for improvement. Some of those improvements can be sourced at the state level, including automatic state IRAs. Those retirement accounts are targeted at employees that don’t have access to employer sponsored plans and have proven successful in the states offering them.
As is the case with a 401(k), the automatic state IRA isn’t perfect, but it gets workers into the retirement savings game, improving security along the way. Those plans could also serve as foundations for broader retirement plan improvement.
“First, we need a national solution that builds on the states’ success. Second, the objective of the state automatic IRAs is to establish a safety net for employers that cannot adopt their own plans, but the ultimate objective is plans, not IRAs, because state automatic IRAs are, for example, capped at IRA levels, and cannot allow for employer contributions,” concludes Kahn. “This makes the state automatic IRAs limited in terms of savings sufficiency.”
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