What Will Replace the 401(k)?

The venerable 401(k) has been under fire since the recession. Here's what could replace it.

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We’ve come full circle on retirement saving. Just 15 years ago 401(k) plans were widely embraced. Workers enjoyed managing their own money, believing that 10% annual returns for life would be a layup. Employers were happy to match contributions, giving them cover to shift away from costly traditional pension plans. Policymakers thought they had found an answer to the fraying social safety net.

Today it all looks like a big mistake. Numerous reports in places like the Los Angeles Times and Wall Street Journal have chronicled the 401(k)’s shortcomings. They are legion. Too many people don’t contribute enough, don’t diversify and don’t repay loans from the plans; too many take early distributions and try to time the market.

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There are structural problems too. 401(k) plans don’t readily provide guaranteed retirement income and because you don’t know low long you’ll live you have to err on the conservative side and save like crazy. Meanwhile, in the recent downturn a lot of cash-strapped companies eliminated the matching contributions element of their plan. Many—but not all—have reinstated the match since the recession officially lifted.

Despite all this, though, 401(k) plans would still be in our good graces if only the stock market hadn’t gone dead for the past dozen years. With little or no return for more than a decade—and just as baby boomers begin to retire—the savings crisis has pushed us to new levels of despair. More than half the population has less than $25,000 saved for retirement, according to the Employee Benefits Research Institute. This, as much as anything, has caused the 401(k) backlash.

Interestingly, this backlash is reaching a fever pitch just as the economy shows signs of picking up momentum and the stock market, anticipating a stronger recovery, has been moving higher. Yet even if stocks start delivering again, the 401(k)’s flaws probably mean change is coming.

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In an op-ed in The New York Times, Teresa Ghilarducci, a professor of economics at the New School and author of When I’m Sixty-Four, argues that the time has come to allow private sector workers to enroll in cost-efficient and professionally managed state-operated retirement programs. The private money would be pooled and invested alongside the public money—at virtually no cost to taxpayers. Ghilarducci writes:

“This is a vital step: public pension plans usually outperform 401(k) plans and individual retirement accounts, because instead of a single worker managing a single account, large institutional plans pool workers of all ages, diversify the portfolio over longer time periods, use the best professional managers that aren’t available for retail accounts and have the bargaining power to lower fees and prioritize long-term investment. By some estimates, costs for public pensions are over 45 percent lower than for individual 401(k) plans.”

It’s not clear if such a plan would augment or replace the 401(k), and it wouldn’t overcome all obstacles. Workers would still need to choose to contribute. They would still have to decide how to convert their next egg to an income stream. But market risks would be less and with lower investment costs returns would be higher. That’s a start.

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