Why 401(k)’s Are Not a Plan, But a Giant Misunderstanding

Whether an individual or a small business owner, if you are confused about what to do with your 401(k), you are not alone. There is about $5 trillion of savings and confusion inside them. And, it all started unintentionally.

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The Unintentional History of 401(k) Plans

One day, a benefits consultant named Ted Benna noticed this little paragraph “k” in IRS code 401, written in 1978. It allowed a tax break for companies to let workers save a little extra cash on the side. This provision allowed employees to shelter a portion of their pre-tax earnings into a savings account to later supplement their defined benefit pension.

Never intended to become a retirement plan -- and never able to replace a pension’s insured income stream -- the 401(k) was ignored at first. It was not until two years later that Ted Benna pitched the idea to a bank client who did not take his advice.

So, Benna set the first 401(k) savings plan up for his own company instead. His idea eventually caught on.

  • Employers realized they could save a lot of money by offering a 401(k) instead of a pension.

  • Employees, excited by an emerging bull market, thought they could make more money picking their own funds.

Who needs the conservative math of a pension check every month if a hot fund could make more than that in a week?!

The Original Intent of the 401(k) Plan

Ted Benna has tried to explain that his original idea was to use the 401(k) code for a savings account, NOT to replace the pension plan. “It has transformed what’s happening with retirement…but it wasn’t intended, it was a fluke,” he said.

Today, just 13 percent of Americans have corporate pension plans, down from 76 percent in the mid-1980’s, according to data from the Bureau of Labor Statistics.

More than 55 million individuals now have 401(k) accounts. Unfortunately, their retirement dreams are based on a misunderstanding that they have a retirement plan.

Ted Benna said about the confusion in 401(k)’s: “Now this monster is out of control. We went to three options, then to six, then to seven, then to 15. It is far beyond what most participants were able to deal with...I helped open the door for Wall Street to make even more money than they were already making. That is one thing I do regret.”

According to the Investment Company Institute and Brightscope, the average 401(k) plan has 29 fund choices. This explosion in complexity gave rise to an army of consultants needed to create and monitor the growing menu of choices.

“That’s when the investment community took over the 401(k) business,” said Benna, who added that total costs increased from roughly 0.1 percent for the earliest plans to 1.0 to 2.5 percent today. “The bottom line is there was money to be made,” he said.

There are stewardship expenses, transactional expenses, legal expenses, trustee expenses, administrative expenses, bookkeeping expenses, communication expenses, and investment expenses.

Dozens of class action lawsuits have been filed around all this expensive confusion. Notably, several by employees of the largest providers of mutual funds and 401(k) services on their own plans internally. If they cannot even get a good deal, imagine what is going on inside a non-financial company for the participants of those plans. And, all this is during a good stock market! Imagine what happens when returns are not there to mask some of these problems.

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Confusion About 401(k) Plans Compounds the Problem

Make no mistake, anything this big for this long must be a co-conspiracy. Our animal spirits spiked by more choices make American consumers particularly ill-equipped to perform the role of longevity planning. Then, mix in the inevitable confusion.

  • One survey revealed that 92 percent of Americans “have no clue” what they are paying inside 401(k)s.

  • Another survey revealed that 72 percent think they are paying nothing.

A bull market that lasted almost two decades starting in 1982 was the perfect accomplice for that greed and apathy.

Nobody knows how this experiment -- based on a misunderstanding -- will end. That first generation of 401(k) accounts is just now retiring. They saved for more than three decades and will soon be handed the steering wheel to land it themselves.

To Solve the 401(k) Problem Requires a Plan

There are two things we think you should consider in place of chasing down the 401(k) dream.

1. If you are nearing retirement, you can still find the same good old-fashioned pension income streams that have been around longer than 401(k)’s for many time-tested reasons – in your own accounts.

2. If you are a small business owner providing a 401(k) to employees -- or a participant in one -- you may have a plan option that allows self-directed accounts. We have done both for ourselves, personally, and for our company.

As always, we offer the same help for others that want to be treated the same way. Learn more by joining our Financial Freedom community through the email sign-up form below, or reach out to us when you are ready for help with a 401(k) alternative.