The 401(k) turns 30

Should you trust it with your retirement?

March 06, 2011|By Eileen Ambrose, The Baltimore Sun

American workers have had a love-hate relationship with the 401(k).

They were enamored with it during the 1990s, when the stock market only went up and created 401(k) millionaires. But bear markets since then have left many envying their peers with traditional pensions.

Now the 401(k) has turned 30, and the first generation that has largely relied on this savings plan is nearing retirement. And reviews are still mixed.

The average 401(k) account balance for those in their 60s, according to the Employee Benefit Research Institute, is $144,000 — not nearly enough to stop working or to maintain a comfortable standard of living in retirement. Yet the 401(k) remains the plan of choice among employers. Even some cash-strapped states with underfunded pensions, including Maryland, are toying with the idea of switching employees to 401(k)-style plans.

So just how well is the 401(k) working out? For answers, I turned to Ted Benna, a benefits consultant from Pennsylvania who is often credited with creating the first one.

Benna, who is 69 and semiretired, says he never anticipated that the 401(k) would replace traditional pensions and would design it differently if he were starting again from scratch today. Still, he defends the 401(k), saying it accomplishes what it was meant to do: help people save for retirement.

"The idea that in the last 30 years these plans eroded retirement security doesn't hold up," he says. "Individuals who are retired and have $150,000 or $200,000 in their 401(k) aren't saying, 'I wish I hadn't done it.'"

Benna happened upon his role in personal finance history. While reading a revision in the tax code — section 401(k) — Benna says he saw a way for workers to set aside money for retirement before taxes were taken out of pay and to receive an employer match.

"It was an 'aha' moment," he says. "I knew right away this is a big thing."

At the time, most large companies offered a pension along with a savings plan where workers could salt away money after paying taxes on it. Many workers were federally taxed at rates of 49 percent and higher. And plenty of them, Benna figured, would jump at the chance to save for retirement and lower their tax bill.

Benna proposed creating a 401(k) for a Pennsylvania bank, but the client wasn't interested in being a pioneer. So, he says, he established a 401(k) at his own firm in early 1981. The plan still exists, he says.

The 401(k) quickly caught on. Eventually it started replacing the traditional pension, also called a defined benefit plan. A pension is a lifetime commitment to the worker, and the cost is too unpredictable for many employers, Benna says.

"The reality is defined benefit plans would be dying off whether 401(k)s existed or not," Benna maintains.

And many workers like the 401(k), particularly those who don't stay with one employer long enough to get a pension. Employees can take the money with them when they switch jobs.

That's not to say the 401(k) doesn't have drawbacks. It's up to workers to decide whether to participate, how much to save and where to invest — and bad choices can leave them with a small nest egg.

And then, there are events such as the 2008 stock market crash. The average 401(k) account that year fell nearly 28 percent, according to the Employee Benefit Research Institute.

"They shifted all the risk from the employer to the employees," says Alicia H. Munnell, director of the Center for Retirement Research at Boston College. "We have just been through a period that dramatically exemplifies what that means."

Still, even more workers might be joining 401(k)s.

States with budget problems and underfunded pensions are discussing 401(k)-style plans for their workers, including Wisconsin, Nevada and Tennessee, according to the Center for Retirement Research. Critics argue that this doesn't necessarily save money, and it only worsens pension funding problems because workers no longer contribute to the pool.

Maryland lawmakers introduced bills last month that would move workers into a 401(k)-type plan, also called a defined contribution plan. A Senate bill would make such a plan available to new employees starting this summer. A House bill would freeze pensions for the bulk of state employees, including teachers, and going forward offer them and new workers a defined contribution plan.

Del. Andrew Serafini, a Republican and financial planner from Hagerstown, says, "We have to encourage people to be personally responsible." Serafini acknowledges, though, that in liberal-leaning Maryland, his legislation stands "not a chance" of passing.

Benna says he doesn't like seeing pensions disappear.

"It's not the right thing for national retirement security. We are better off having both types of plans," he says.

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