By Thomas Kostigen
They are the way the majority of Americans gain exposure to the stock market. And 401(k)s are hugely popular retirement vehicles. They have been for decades. But tax laws, interest rates, and more competitive fee structures may have made the 401(k) retirement plan structure obsolete.
A recent analysis by Bloomberg News reveals that the pre-tax savings benefits offered by 401(k) plans no longer hold water. “There is no tax advantage remaining to the 401(k),” according to the Bloomberg report. “Making some reasonable assumptions about a worker with 30 years to retirement, the 1980 version of the 401(k) tax deferral was equivalent to an additional investment return of 9.2% per year, an extraordinary incentive to save for retirement, even without an employer match. Using today’s numbers, the benefit comes out to 0.6%, considerably less than the 1% to 2% in fees investors pay in typical 401(k) plans.”
Lower fees and capital gains rates that benefit investors today didn’t exist 40 years ago, when 401(k)s came into effect. Then, as Bloomberg notes, the marginal federal income tax rate was 43%; the capital gains tax rate was 28%; the likely retirement bracket tax rate was 15%; and interest rates were around 15%.
The big benefit for 401(k) plans has always been employers matching investment dollars. And that still holds. But the 401(k) structure itself can’t compete with tax-efficient investments in taxable accounts.
Moreover, 401(k)s can hamstring investors in a number of ways. Fund selection within plans is often lacking. As just one example, many 401(k)s don’t offer funds that adhere to environmental, social, and governance (ESG) guidelines—something that the great majority of 401(k) investors would like as options in which invest. Indeed, recent Department of Labor guidance prohibits 401(k) plans from offering ESG fund options.
CFA Institute CEO Marg Franklin described the final DOL rule as a “disservice to fiduciary stewardship and contrary to investor protection. ESG factors have become increasingly significant components of professional financial analysis and a risk-adjusted return strategy,” she stated. “This rule places ERISA (Employee Retirement Income Security Act) retirement savers at a disadvantage.”
And then there is the baked-in fee factor of 401(k)s.
“In 1980, a typical investor might have paid 3.5% of assets in fees either in or out of a 401(k). In 2000, that’s shrunk to perhaps 1.5% in a typical 401(k), and 0.5% outside. Some employers offer 401(k) with fees equal to or even lower than taxable alternatives, but others are stuck around the 3.5% level,” according to Bloomberg’s analysis.
The number of investment products and tax-efficient strategies have mushroomed over the last 40 years, as well, allowing investors access to more sophisticated retirement planning. A financial advisor can recommend whether a 401(k) structure, or perhaps some other constructed portfolio, is best for investors.
The first 401(k) savings plan was officially begun in 1981. It spun out of changes that had been made to the Employee Retirement Income Security Act. A lot more has changed since then, with high tech, efficient products, and low or no-fee trading.
Investors should look ahead for retirement planning that not only suits their wants, hopes, and dreams, but takes into account best- in-class products and service offerings. The 401(k) plan may not optimally fit into a 21st Century retirement. In our next column we’ll look at some retirement planning alternatives.
Thomas Kostigen is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Thomas is a best-selling author and longtime journalist who writes about environmental, social, and governance issues.
