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401(k) Plans Still Make Sense: Jeff Levine

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A Bloomberg Opinion piece on 401(k) plans by Aaron Brown that’s been making the rounds on Twitter and in financial media is filled with factual errors that undercut the arguments it tries to make.

Brown, an author and former head of risk management at AQR Capital Management, argues that 401(k) plans today don’t have the tax advantages they had when first introduced in 1980, based on comparisons of tax and interest rates. 

“In 2020, there is no tax advantage remaining to the 401(k),” writes Brown, who suggests that investors would be better off with low-cost tax-efficient investments in a taxable account. 401(k) fees have fallen sharply since 1980, but now retail investors can invest in tax-efficient diversified index funds for little or no cost, explains Brown.

His argument, however, is based on erroneous data.

Brown says the marginal federal income tax rate for a median-income married couple with two children was 43% in 1980 and 12% today.

Not true. The 43% marginal tax rate applied to income of $35,200 to $45,800 in 1980 when the actual median income for a family of four was $24,410, according to the Census Bureau. After the standard deduction and exemptions for a married couple and two children, the taxable income would be subject to a 24% marginal tax rate, according to Jeff Levine, director of Advanced Planning at Buckingham Wealth Partners.

Levine discussed the column in a video posted to Twitter and in an interview with ThinkAdvisor.

Brown tells ThinkAdvisor that the median income figures he used are from the IRS, not the Census, and that they are more reliable since they’re based on actual tax returns, rather than what people tell the Census Bureau.

Brown also errs when comparing the capital gains tax rate of 1980 with today. He uses the 28% maximum capital gains rate in 1980 and compares it to the lowest capital gains tax rate today (0%).

He’s “not comparing apples and oranges but apples and gorillas,” Levine told ThinkAdvisor. “You can’t say ‘I base my opinion on these facts’ and then be wrong. You have to be right on the facts first.”

Brown probably doesn’t understand the origin of the 28% 1980 capital gains tax rate, Levine says. “Back then you excluded 60% of capital gains from income, keeping 40%, and that times 70% [the highest tax bracket] gets to 28%.”

Brown concludes that 401(k) today offers “little or no tax benefit” other than an employer match, when available, but that the match “has nothing to do with the 401(k) structure.”

He suggests that workers be allowed to roll over 401(k) funds into self-directed IRAs while they’re still working — not just when they leave a job — which would force 401(k) platforms to compete in an open market, encouraging them to lower fees.

Brown also recommends that below-median income households be able to withdraw 401(k) funds tax-free and that their plan contributions exclude FICA payroll deductions — only income taxes are excluded now. 

Fewer FICA tax collections, however, mean less money for the Social Security program, which “disproportionately benefits” lower income taxpayers, Levine says. 

Even if one accepts Brown’s ideas that 401(k) plans don’t offer as much tax benefit these days as they did 40 years ago and that fees are often too high, the solution is not to eliminate the 401(k) or discourage participation in 401(k) plans. There are Roth 401(k) plans funded with after-tax, rather than before-tax contributions, and employees can usually to choose lower cost funds in their plans, says Levine.

Brown’s argument is “not just a bad opinion. It’s a bad opinion based on incorrect facts,” he says.

Brown admits “there is a lot of room for disagreement about what the median working married taxpayer paid on the last dollar of taxable income in 1980 and 2020,” but the point remains that “marginal tax rates and capital gains tax rates are way down for middle-income people” and “the decline is significant.”

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