401(k)s are an accident of history

401(k)s were never intended to replace pensions, so it should be no surprise that they aren’t up to the task. This has been pointed out before, but it’s nice to be reminded that even the people who came up with the 401(k) concept now “lament the revolution they started,” to quote an excellent article by the Wall Street Journal’s Timothy W. Martin.

This is the kind of negative coverage that keeps the folks at the Investment Company Institute busy. Students of spin may want to check out the industry lobby’s latest effort, which obscures the dismal record of 401(k) plans by lumping them in with traditional pensions. It also focuses on retired seniors, ignoring the growing number who can’t afford to stop working.

Careful readers will note that even the ICI’s rosy report shows that decades into the 401(k) revolution seniors received $105 billion dollars in pension income and only $29 billion from 401(k)-style plans in 2014. Admittedly, this is based on somewhat unreliable household survey data and ignores the fact that many well-off 401(k) and IRA participants treat retirement savings plans as tax shelters and avoid withdrawing money from them as long as possible. Still, it’s a stretch to suggest that the looming retirement crisis is a mirage caused by poor data (see also here and here).

The failures of the current system are clear, but that doesn’t mean all proposed reforms are good ones. While it’s refreshing to see the idea of employer or employee mandates floated in a mainstream news article and attention paid to reform efforts advanced by state and city governments, it’s critical that mandatory and government-sponsored plans be lower-cost as well as lower-risk than current 401(k)s and IRAs.

The simplest solution to the looming retirement crisis would be expanding Social Security, though that’s unlikely in a Republican-controlled Congress. Among the alternatives mentioned in the Journal article, Republican Senator Marco Rubio’s proposal to give private-sector workers access to the federal Thrift Savings Plan has some support from progressives, though it does more to address the cost than the risk problem (the TSP’s lifecycle funds are fairly risky, especially for low-income workers).

California and other states, meanwhile, are considering ways to reduce investment risk, including smoothing investment returns across generations of retirees using a reserve fund—an idea EPI helped popularize in 2008 with Teresa Ghilarducci’s Guaranteed Retirement Account plan. Ghilarducci and Blackstone Group President Tony James have collaborated on a version of the GRA plan that emphasizes the role of professional investment managers and actively-managed investment portfolios, in contrast to Senator Rubio’s plan and others that rely on passive investment strategies. Though other countries have used actively-managed funds to tailor long-term investments to pension liabilities, success depends on a good governance structure to counter the temptation to engage in “pay to play” and other practices that don’t serve the public good.

One thing all these plans have in common is pooled investments. It’s rare these days to hear the claim that individuals are best equipped to manage their own retirement savings—a free-market gloss on a regressive tax break that morphed into a way for employers to shed pension responsibilities. Not incidentally, of course, 401(k)s were a boon to the financial sector, which may be why there’s still talk of cutting Social Security while expanding savings in individual accounts.

How do you defend a system that has failed so spectacularly? You change the definition of success. Social Security is treated as broken when it’s just overdue for a tune-up, while 401(k)s promise nothing, which is easy to achieve. If that’s not a convincing argument, 401(k) apologists point to research showing that people spend less as they age, normalizing the fact that Americans increasingly face a sharply declining standard of living in retirement. But Americans who have been made to feel ashamed for not saving enough for retirement are unlikely to feel better when told that they’re exhibiting optimizing behavior by discounting consumption in years when they may or may not be alive.