Is it Time to do Away with 401k Plans?

Let’s answer that question by first asking what employees really get in exchange for their 401k deferrals, other than the promise of tax deferral:

• The employees may be deferring themselves into a higher tax bracket when their accounts are distributed (does anyone honestly think there is a chance that tax rates will go down in the future?).
  
• The employees may pay penalty taxes if withdrawals are taken prior to age 59 1/2
  
• The employees are converting dividend income earned on their investments into an ordinary income tax rate when their accounts are distributed.
  
• The employees are converting capital gains income earned on their investments into an ordinary income tax rate when their accounts are distributed.
  
• In many cases 401k record keeping, fees and commissions are exorbitant – and rarely are they transparent.

In addition, when the 401k plan is the retirement plan there are three significant structural weaknesses to it:

• All of the investment risk has been transferred to the employees (as millions of 401k participants have learned to their recent sorrow).
  
• All of the longevity risk –the risk of outliving the retirement income- has been transferred to the employees.
  
• All of the disability risk has been transferred to the employees – the fact that when they become disabled their 401k contributions stop, with potentially catastrophic results to their planned accumulations.

An astute person might ask, “Why are employers sponsoring an employee benefit plan that has so many employee disadvantages?”

A very good question – particularly when it would be possible to provide a cost and tax-effective retirement program for employees that eliminates many of these flaws. For example, instead of the 401k-employee deferral plan the employer could offer:

• A menu of after-tax investment options for the employees such as:
  -A Roth 401k
  -Institutionally priced variable and fixed annuities
  -Institutionally priced fixed and variable life insurance policies
  
  
• Group or individual disability insurance that will continue contributions into employees’ investment accounts when they became disabled so their retirement assets would grow just as if they were working.
  
• A guaranteed investment account for employer pre-tax 401k contributions.
  

Further, such a program will relieve employers of many of the costs of record keeping, discrimination testing and other compliance and administrative chores.

Hmm, maybe it is time to scrap the 401k plan!