The 401(k)'s 'Father' Wants to Hit Reset

The ‘father’ of the 401(k) says the system could use an overhaul.

401K portfolio next to calculator and financial newspaper
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I would also make it mandatory that employers automatically enroll employees, who would have to elect not to participate, rather than the reverse. And I would automatically increase contributions each year—with the opt-out option as well.

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Do you buy the argument that the 401(k) system amounts to a subsidy by average people, many of whom can't afford to maximize contributions, to high-income people who can?

That's a bit distorted. The group that really benefits from a 401(k) are those earning from $30,000 to $200,000. The top people will get taken care of regardless. The bottom group—a single mom earning $20,000 with two or three kids and no health insurance—a 401(k) isn't going to work for her. The reason an employee making $60,000 or $90,000 needs help is tied to Social Security. The way Social Security is structured, an employee making $30,000 a year will get somewhere around 50 percent of his income in benefits. The general wisdom is that you should have 70 percent of your working income or higher when you retire. If you already have 50 percent from Social Security, a lower-paid employee needs a lot less in retirement savings to get to 70 or 80 percent. Someone earning $100,000 only gets about 20 percent from Social Security. So that person, to get up to 70 percent, has to make up 50 percent someplace else. To talk about the tax inequity a bit further, most people don't know they pay federal income tax on their Social Security tax. If you earn $80,000, your Social Security tax is computed on $80,000. So is your income tax. It isn't computed based on $80,000 minus the Social Security tax you pay. It's on the gross. So you're getting hit twice. The significance of that is that lower-income employees are paying Social Security tax but most of them don't pay federal income tax. That's never talked about.

On the other side, you don't have to earn a lot today to pay a tax when you start to get your Social Security benefit. So those who are getting higher Social Security benefits are getting as much as 85 percent of it taxed. Social Security is a tax and social system that's designed to favor the lower-paid. OK, we can live with that. But this liberal gang who beats up on people making $60,000 to $100,000 for getting a tax break on the 401(k), it's a bit off the mark and unfair.

Couldn't you argue that people making $250,000 don't need help maximizing their contributions?

You certainly could argue that, yes, if they're making that much they could probably save it anyhow. I wouldn't quibble over that. But there aren't many people earning under $50,000 who are paying federal income tax. So the argument that they're helping to subsidize [tax breaks for the wealthy], well, most of them aren't.

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Would you also advocate strict caps on the fees that asset managers can charge for 401(k) plans? For that matter, are expense ratios capped by law already?

They aren't. I first proposed that about seven years ago. One of the structures I recommended was that if the employer structures its plan in a certain way, it got off the hook for fiduciary liability, which is a scary thing for some employers and a deterrent for small employers to offer 401(k)'s. One of the features of that was a limit on fees. They would have to fall within a certain range to get that type of safe-harbor protection. That's certainly a possibility. It would get a lot of pushback probably.

Do you think the Labor Department's new fee-disclosure rules help matters?

I think we need to give them time and see what they do. I think they will definitely help. There have been some providers who have just flatly refused to provide the information and will outright lie to participants. I've run into it. The folks who answer the phone, who probably don't know any better, are trained to say, "You don't pay anything." The half-truth of it is that there is nothing deducted from participant accounts that they see, or that they have to write a check for. But sure as heck it's deducted unseen to them. So getting this stuff out in the open hopefully will help. Also, the marketplace helps. There is plenty of competition in the marketplace.