Financial Fellow

Written by J.P. Wicklein

     I read an article in Time last week advocating the death of the 401k.  Their rationale was that 401k’s are failing to prove themselves as an effective retirement savings vehicle for the masses.  In light of the recent financial meltdown the argument to replace the 401k with another retirement savings vehicle, such as a federally-controlled pension system, has gained attention.  Although there may be rationale for providing a government-controlled retirement savings option, beyond Social Security, eliminating the 401k would be a travesty.

Why 401k’s are awesome

     Through a 401k workers can save their pre-tax earnings in an individual retirement account.  All contributions, and earnings, are not subject to any tax until they are withdrawn.  (Note:  This applies to a traditional 401k, a Roth 401k offers separate, distinct advantages.)  Why is this that a good deal?  The primary advantage of a 401k is that it allows you to earn money on income taxes that you would’ve otherwise paid to the government.  In the end the ability to fund your 401k with pre-tax earnings, and avoid paying income taxes until withdrawal, can cause modest contributions to balloon into astounding sums.

     Consider this:  If someone contributed $5,000 every year to their 401k for 40 years they would have saved $200,000.  That savings, earning 10% annually (the historical long-term return for stocks) would balloon to over $2.2 million. 

     An additional benefit of the 401k is that you, not the government, controls the money in your 401k account.  You decide how much to contribute, what to invest in, and when to withdraw your funds.  Ironically, the ability to control that much of your 401k is exactly why some think it should be replaced with a government-controlled retirement system.

Why people think 401k’s suck

     The problem with the 401k is that people are ignorant.  A sizable number of people lack the commitment to regularly contribute enough money to their 401k and, the willpower to resist tapping into their funds until retirement age.  Further, lots of people don’t know what to invest their money in.  As a result, many Americans are reaching retirement age with nowhere near enough money to last them the rest of their lives.

     For example, during the financial meltdown that occurred last year many older Americans that were heavily invested in stocks saw their retirement accounts drop in value by as much as 50%.  As a result, many were forced back to work or had to cut back on their lifestyle.  Had they invested appropriately those same individuals would’ve only had a small portion of their portfolio in stocks. 

     Whether they were too ignorant to know better, or too greedy, the outcome was the same - they lost a lot of money.  (A good portion of their losses have been recovered as stocks bounced back during 2009.  Unless they got scared and sold when the market was abysmal, thereby missing out on the recovery – which many people did.)  That, among other reasons, is why some are advocating replacing the 401k with a government-controlled retirement system. 

Lowest common denominator retirement system

      As much as it disappoints me, I’m starting to accept the fact that many Americans are ignorant.  They lack the education and willpower to control their own financial future.  For these people it may be appropriate to cede control over their retirement funds to the government, like a helpless child submitting to the authority of their parent.  My concern, however, is that those that are intelligent and responsible enough to appropriately take advantage of the 401k, or other retirement vehicles, will be hurt by the ignorance of others.  If the 401k were to be taken away, and replaced by a mandatory, government-controlled retirement system, it would force the capable to be punished for the flaws of others. 

     Although it may be best to provide a government-controlled option, it would be wrong to deny other Americans the freedom to manage their own retirement savings in the process.

Photo by: A.M Kuchling (altered by J.P. Wicklein)