The failure of the 401(k)


As President-elect Barack Obama and lawmakers attempt to reach agreement on what sort of stimulus package has the best chance of arresting America’s economic free fall, the enormity of the immediate crisis naturally pushes any issue that can be deferred to the margin.

As a consequence, there’s been little discussion of the way in which this economic implosion has exposed the utter failure of the now-ubiquitous 401(k) retirement accounts. In fact, the entire 401(k) system looks increasingly like the sort of bait-and-switch con relished by the Bernie Madoff’s of the world.

As Robyn Credico, a leading consultant on pensions, told the Wall Street Journal this week, “This is the biggest test that the 401(k) plan has seen to date, and it has failed.”


Here’s the problem: In 1978, when Congress amended the Internal Revenue Code to include Section 401(k), it envisioned the provision mainly as a way for workers to supplement their companies’ traditional defined-benefit pension plans and Social Security. (Secondarily, it also was a nifty hideaway where highly paid executives could shelter income from taxes.)

Nobody at the time envisioned the 401(k) as something on which people would rely for their retirement.

But in the years that followed, more and more employers began to look for ways to get out of funding the pension and health plans that, up to then, had been regarded as part of the responsible capitalist social contract. Two innovations in political ideology -- one on the left and one on the right -- provided superb cover for the companies’ greed.

For the Democrats, “choice” became a mantra, and the 401(k) suddenly became a mechanism through which working people could “choose” how to fund and manage their own retirement. On the Republican side, the notion of “an ownership society” came into vogue. There, the theory was that giving working people an ownership interest in the equities market would promote greater personal responsibility and make people better citizens.

Nobody bothered to ask employees whether they wanted to swap their pensions for choice or ownership, nor did anybody stop to notice that very few people are suited by background, ability or temperament to actively manage investments.

If there is such a thing as lethal social poison, it is avarice cloaked in political piety.


Companies seized the opportunity to abandon their defined-benefit pension plans. Today, more than 60% of all U.S. workers rely on 401(k)s as their primary retirement fund. They’re not eager to “choose” their own retirement program, nor are they enthusiastic “owners” of American business. They’re draftees. Essentially, millions of us have been conscripted into the equities markets, where we have helped fuel stock prices and provided a bonanza for the financial services companies that manage and sell investment funds.

The problem is that, since the markets’ peak in October 2007, our 401(k)s have lost a collective $1 trillion in value. That’s fully a third of the value of all 401(k)s. The picture is actually worse than that because another $1 trillion has been stripped from people who lost or changed jobs and rolled their 401(k)s into individual retirement accounts.

Those are the most obvious losses. Look a little closer and the picture is even bleaker: According to a study by the American Assn. of Retired People, 20% of American workers have been forced to stop contributing to their 401(k)s and individual retirement accounts by economic hardship.

Millions of others have been forced to make early, so-called hardship withdrawals from their accounts because they’ve lost their jobs or healthcare or are facing foreclosure. The 10% early withdrawal penalty is a catastrophic expense in such a context. Millions more have taken loans from their 401(k)s to meet pressing debts or expenses, like college tuitions. Not only are those workers missing out on any available appreciation in their investment, but -- in a time of rising unemployment -- they’re running a terrible risk. If you lose your job, you must immediately repay the entire balance on any outstanding loan from your 401(k). If you can’t, you’re liable not only for income tax on the unpaid balance but also the additional 10% penalty for early withdrawal from the 401(k).

With many economists predicting unemployment at 9% to 10% by the end of 2009 -- welcome to hard times.

Finally, consider this: The collapse of the 401(k) experiment is occurring just as the baby boom generation begins to retire in significant numbers. Welcome to hard times, indeed.