Hard as it is to believe, the seemingly ubiquitous (at least for folks who work for large companies) 401(k) retirement plan got its start only in the 1970s. It turns out that the 401(k)’s early history is actually quite interesting and somewhat underreported, and forms the backdrop of a well thought-out article by Elizabeth O’Brien in MarketWatch titled “10 Things 401(k) Plans Won’t Tell You.”
First some background: The majority of workers prior to the 1970s had “defined-benefit pension” plans, where employers made all the decisions regarding what investments to make to ensure that future funds would be adequate to meet future pension payments. The benefit to employees was 1) it took the weight of those decisions out of their hands, and 2) under those plans, workers’ pension payments were virtually guaranteed.
Another lost point: The original objective of the 401(k) was to be a supplement to defined-benefit plans. The use of pre-tax money as an incentive to save was just some icing on the cake, particularly for high-wage earners.
The bad news for companies that had to fund their defined-benefit plans was that as the high interest rates of the 1980s went away, the obligations to make monthly payments to an ever-growing population of retirees didn’t go away, and the plans had an ever-harder time keeping up with payouts (this was long before the dreaded baby boom cohort started retiring).
That’s called an “unfunded” pension liability in financial statements, and looking at General Motors (NYSE:GM) just five years ago helps one understand the problem: Many pension plans were deeply under water.
The 401(k) took care of the problem by putting the onus on employees to invest their monies for retirement — and it lessened costs to employers.
The system as is exists today has its supporters and detractors, and O’Brien makes a pretty compelling case for the latter as investors struggle on their own toward retirement. Here are some statistics to ponder from her article:
- 401(k) plans now hold $3.5 trillion in retirement assets.
- In 1980, 62% of private sector employees had a defined-benefit pension; today that figure is 7%.
- Only 28% of employers offer projections to employees of how much their retirement plan might produce in income.
- 75% of large employers (1,000+ employees) offer 401 (k) plans.
- The average employee contributes 6.4% of his paycheck to a 401(k), much less than the 10% minimum suggested by most advisers.
- Fees (usually well hidden) can cost investors nearly 11 years in savings.
Unfortunately, the most distressing figure of all is that “The aggregate retirement income deficit for all Baby Boomers and Gen Xers — that is, the amount by which their savings, plus Social Security, fall short of what they’ll need — is $4.3 trillion, according to the Employee Benefit Research Institute.” Indeed, the shortfall is greater than that total of $3.5 trillion now held in all 401(k) plans.
It’s a decidedly interesting read, and while not necessarily “actionable” in advice, it offers great food for thought for retirement planning.
Marc Bastow is an Assistant Editor at InvestorPlace.com.