401(k) Plans No Longer Make Much Sense for Savers

Robert Powell, CFP®

Aaron Brown, a former managing director and head of financial market research at AQR Capital Management and author of "The Poker Face of Wall Street," recently opined that 401(k) plans no longer make much sense for savers. Read https://www.bloomberg.com/opinion/articles/2020-07-21/401-k-plans-no-longer-make-much-sense-for-savers.

Not surprisingly, many experts are disagreeing with Brown’s opinion. Below are some comments I received from various retirement experts. I'll add to this thread as more arrive in my inbox. And don't forget to share thoughts and comments as well.

The article seems overblown to me, at least on the face of it. Fees for 401(k) plans have dropped a lot and continue to (if still too slowly). The no capital gains assumption seems problematic (at the least). The author ignores Roth 401(k)s, and neglects the benefits of automatic withdrawal. Lastly, things change. If the polls hold, taxes will surely go up (and probably will either way). I'd focus on making 401(k) plans better -- lower costs, more portability (his rollover at any time proposal is interesting), and better guaranteed income options, for starters.

Bob Seawright, author of the Above the Market blog (https://rpseawright.wordpress.com/), publisher of The Better Letter (http://BetterLetter.substack.com), and chief investment and information officer for Madison Avenue Securities. Follow him on Twitter @RPSeawright.

401(k)s have been very successful in building retirement savings for Americans.
One of the primary reasons is that workers automatically save on a regular basis and most keep their money invested for their retirement years. Also the match that is typically offered is a significant boost to savings.

Plans do differ in terms of buying power with larger plans having the advantage of scale to buy investments and services at a lower price. They also differ in oversight as some plan sponsors and hired fiduciaries may be more skilled than others.

Stacy L. Schaus, CFP®, is the founder and CEO of Schaus Group.

I’m not sure I’d go as far to say that 401(k)s don’t offer any benefit compared to a taxable account on a tax/fee perspective, I’d have to see the details of the analysis they did. But yes, I agree with the notion that relative to when tax rates were much, much higher than they are now, the benefits of pre-tax savings and tax-deferred growth were greater.

I like brokerage windows in 401(k)s. It’s a good way to give plan participants access to low-cost investment options and quality funds. That said, unless someone is working with a financial advisor, I don’t think we’d see widespread adoption. A recent Vanguard study showed 52% of retirement plan participants were 100% invested in just one target-date fund. It’s the easy-button and requires little investment acumen.
In my view, the greatest benefits of 401(k) plans were not even mentioned in the piece: automatic ‘forced’ savings and relative inaccessibility of the money before retirement.

Saving isn’t fun; spending is. If there is no 401(k), then with every paycheck, you’re asking someone to make the right choice and save for their future. But if they make the ‘right’ decision once, and never see the money in their bank, there’s no temptation to spend it. Keeping the money just out of reach and attaching rules to 401(k) withdrawals with penalties also helps keep investors from self-sabotaging their retirement.

If kept in a taxable account, the investor is reminded of this fact annually when they have to pay tax on reinvested dividends and gains. It will feel much more burdensome and perhaps encourage investors to draw down the account on lifestyle expenses.

Obviously, things are still changing with 401(k)s with the increased number of lawsuits and average expense ratios have been steadily dropping. Tax rates are also very low after the TCJA which is set to expire at the end of 2025 if not sooner. Given the ballooning deficit from the pandemic stimulus, it’s hard to imagine the government won’t need to find a way to raise additional revenues to pay for it.

Kristin McKenna, CFP®, is a managing director and wealth advisor at Darrow Wealth. Follow her at @KristinInvests.

I think this article is mostly one big piece of clickbait and that it jumps to some incorrect conclusions.

Yes, fees in many 401(k) plans are high. Too high in my opinion and experience, but that doesn't eliminate the value in having a savings plan that can automatically be deducted from a paycheck (so people will "pay themselves first") and that it grows tax-deferred until the money is distributed.

Maybe the author, a former hedgie, has a skewed perspective, but I believe the 401(k) is still a great retirement savings tool for the average American. And it is even more beneficial to higher earners to help with current year taxes.

Add in the Roth 401(k) option which is increasingly becoming available, and I think the 401(k) is still one of the best retirement savings options available.
And if taxes are higher or lower in retirement, which no one can know today, I think the current tax benefits and tax-deferred growth are still attractive. Add in company matching and it amounts to additional compensation for the employee. Finally, as pensions become less available, the responsibility of retirement savings falls on each person's shoulders. I didn't see the author suggest a better alternative either.

Russ Thornton is a financial adviser focused on retirement planning for women in their 50s and 60s. He is author of the Wealthcare for Women blog (https://wealthcareforwomen.com/blog/). Follow him @RussThornton.

And Barry Ritholtz, co-founder, chairman, and chief investment officer of Ritholtz Wealth Management, penned this reaction on his website, https://ritholtz.com/2020/07/the-myth-of-democratized-investing/. You can follow Barry at @ritholtz.

Some of what they say is true for people who are on the lower end of the income spectrum, but certainly not true for all people. Whether a 401(k) is viable depends on your income, tax rate today, and your tax rate when you retired and start taking distributions. For many of my clients, this tax arbitrage is still a viable long-term strategy. And where a pre-tax 401(k) doesn't work, a Roth 401(k) does work.

Rick Ferri is an investment analyst and author with Ferri Investment Solutions. Follow Rick at @Rick_Ferri.

There is an advantage to 401(k) plans that Aaron Brown did not mention: they can offer stable value funds that offer higher yields than money market funds. Many 401(k) participants use stable value funds… they are a clever investment unique to the 401(k).

Now, that aside, Aaron Brown makes some good points. But there is a different way to take them.

  • It would be reasonable to regulate 401(k) all in fee levels to 1% or even 0.5%. This has been a growing problem since the ‘90s. Sponsors pushed more and more costs onto participants. A change like this would spur greater indexing.

  • Require that 401(k)s be platform-independent. If a participant can find a better deal elsewhere, that is where the money goes.

  • Require that all-in fees be disclosed to participants in a simple way.

What this says to 401(k) participants is this:

· If fees are high, reduce participation.

· If matches are low, reduce participation.

One thing that was not mentioned is that taxable assets are flexible. They can be used for consumption if needed with no tax penalty. That said, saving in a 401(k), an IRA, or any other tax-favored form of investing limits the ability of investors to remove cash. That is a good thing for most people, as it puts up a barrier against consumption. Most people need to save more, and 401(k)s put up a barrier against pre-retirement consumption.

David Merkel is author of The Aleph Blog https://alephblog.com/. Follow him at @AlephBlog.

Even though as the author says, tax rates are lower than when the 401(k) plan came into being, the ability to invest and have funds grow tax-free until retirement is still powerful.

He fails to mention the advantages of a Roth 401(k) when offered.

He fails to take into account that the current tax rates my change into the future. While nobody can predict the future, with the size of the deficit in the wake of the pandemic it would surprise nobody of today’s current tax rates were to increase.

He advocates for the ability to be able to roll over 401(k) balances to an IRA, how does this improve the tax situation he describes?

While some 401(k) plans are pricey, the general trend in 401(k) expenses has been declining in recent years.

Many plan participants like the ability to choose from an investment menu and are uncomfortable choosing their own funds. This can be an advantage for the 401(k).

The salary deferral nature of the 401(k) is helpful to many participants in that it is a painless way to save for their retirement.

Where offered, the 401(k) match offers essentially “free money.”

I’m also not sure what he is suggesting as an alternative.

Roger Wohlner is a financial writer and advisor based in Arlington Heights, IL. Follow him at @rwohlner.

I don't think some of the recommendations suggested are terrible, but I also don't agree that 401(k) plans no longer make much sense for savers.

I think the forced savings component of a 401(k) is a big positive being overlooked. Many folks simply won't save if it's made much more complicated than being auto-enrolled into a workplace plan. While tax benefits and plan costs vary case by case, the fact of making saving simple cannot be overstated and 401(k)s are great for that.

Brendan Mullooly is a Certified Financial Planner® and Investment Adviser Representative with Mullooly Asset Management, Inc. Follow him at @BrendanMullooly.


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