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401(k)s Blasted as ‘Poorly Designed’: Study

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A new report from the Economic Policy Institute, a left-leaning think tank, takes aim at 401(k)s, claiming their poor design was an “accident of history” and that it exacerbates income inequality in retirement.

“Though assets in individual and pooled retirement funds have grown faster than income in recent decades, aggregates and averages can be misleading,” the report says.

Calling it “retirement insecurity,” the institute argues it’s worsened for most Americans as retirement wealth has become more unequal. For many groups, the median household has no savings in retirement accounts, and balances are low even when focusing only on households with savings.

“In 1980, a benefit consultant working on revamping a bank’s cash bonus plan had the idea of adding an employer matching contribution and taking advantage of an obscure provision in the tax code passed two years earlier clarifying the tax treatment of deferred compensation,” the report explains. “Though 401(k)s took off in the early 1980s, Congress did not intend for them to replace traditional pensions as a primary retirement vehicle, and 401(k)s are poorly designed for this role.”

It notes that the shift from traditional defined-benefit pensions to 401(k)-style defined-contribution plans, in theory, could have broadened access to retirement benefits by making it easier and cheaper for employers to offer benefits. However, participation in any employer-based retirement plan declined over the past decade even as defined-contribution plans became prevalent in the private sector.

The reason is the employee match — those that can most afford to contribute do so, skewing savings toward higher-income individuals.

It then offers a number of areas in which income inequality is especially pronounced.

  1. Households in the top income quintile accounted for 72% of total savings in retirement accounts in 2010 and were the only income group that had more than their annual income saved in these accounts.
  2. Participation in employer-based retirement plans by workers age 25 to 61 declined over the past decade, from 52% in 2000 to 45% in 2010.
  3. For many demographic groups, including black and Hispanic households, households headed by someone without a college degree, and single people, the typical (median) household has no savings at all in retirement accounts.
  4. On average, white households have more than six times as much saved in retirement accounts as Hispanic or black households.
  5. College-educated households have nearly six times as much saved on average as high school-educated households.

“Retirement disparities have grown because tax preferences favor high-income families and because many 401(k) participants cannot afford to contribute enough to their plans. By contrast, most workers in defined benefit pensions are automatically enrolled and, in the private sector, are not required to contribute to these plans.”

The situation only seems to be getting worse, the report concludes. Though younger workers should be saving more to make up for the loss in pension and Social Security benefits, the retirement savings of younger households have stayed flat or declined in recent years. 

Check out Olivia Mitchell: You Might Live to 100. Will Your Money? on ThinkAdvisor.