40 Years Of 401(k)

Last year, 401(k) employee retirement savings plans hit a venerable milestone — the 40th anniversary of their creation.  401(k) plans were born during the Carter presidency, with the passage of the Revenue Act of 1978, which established Section 401 of the Internal Revenue Code.

stk27434sigThe language of the statute is the dense, definition-filled content that tax lawyers love, but the concept of the 401(k) is simple:  workers can salt pre-tax money away in protected funds and invest it, thereby enjoying some tax savings and having a vehicle to save for retirement.  Many employers offer 401(k) plans as a part of their benefit package and facilitate the program through payroll deductions.  According to the Investment Company Institute, in 2016 there were almost 555,000 401(k) plans in the U.S. and more than 55 million Americans were active participants.  The ICI also reports that, as of the end of the third quarter of 2018, 401(k) plans held $5.6 trillion in assets — up from $2.2 trillion in 2008 — and represented 19 percent of the total amount of U.S. retirement assets.

Some people raise questions about the 401(k) option, arguing that its availability has helped to produce the virtual disappearance of employer-funded pension plans, in which the employer totally funded the plan and, in many instance, provided the employee with a guaranteed retirement benefit.  I think that’s wishful thinking.  Even at the time the 1978 legislation was passed, many American companies were looking to cut costs, and guaranteed pension plans were disappearing into the mists of history.  Most of us have never worked for an employer that offered a true pension plan.  To be sure, 401(k) plans are based primarily on employee contributions, not employer largesse — although in many cases employers offer some kind of match to employee contributions.

Unless you’re an investment advisor who pines for the long-lost days of funded pension plans, though, you’re probably grateful that Congress was far-sighted enough to create the 401(k) option 40 years ago.  And it’s not hard to argue that 401(k) plans are, in some respects, superior to pension plans.  The 401(k) option gets the worker directly involved in her own retirement planning; employees have to elect to participate in the plan, after all, determine how their contributions will be invested, and then have their contribution withheld from their paychecks.  The 401(k) mechanism makes that as painless, relatively speaking, as withholding for federal and state taxes and Social Security contributions — because it comes out automatically, most people don’t notice it.  And then, after a few years, workers realize that they’ve actually made progress in starting to save for retirement, and for many people that realization opens the door to additional efforts to save, invest, and get ready for the retirement years.  The 401(k) option has made many Americans take personal responsibility for their own financial affairs, rather than relying on a company pension plan to do the trick.

And you can argue that 401(k)s have had a broader benefit, too.  So much automatic saving has to be invested somewhere — principally in the U.S. stock market.  In 1978 the Dow was well below 1,000; now it stands above 25,000.  No one would argue that 401(k) plans have been solely responsible for that run up, but there is no doubt that they have contributed to buy-side pressure that has helped to move the stock market averages upward, which has the incidental benefit of helping all of those 401(k) participants who’ve put their retirement savings into the market in the first place.

Happy anniversary, 401(k)!  Beneath that Tax Code jargon lurks an idea that has been helpful to millions of Americans.  I’d say we need to give credit where credit is due:  the 401(k) is one time when Congress did the job right.

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529’d

State of the Union policy proposals come, often in rapid-fire fashion, and go.  President Obama’s proposal to tax “529” college savings accounts, announced only last week and withdrawn this week, may have set a record for the quickest skedaddle.

IMG_0746The “529” plans, named for the section of the Internal Revenue Code that addresses their tax treatment, allow people to squirrel away money to pay for a family member’s college tuition.  The money gets invested, taxes on any gains are deferred, and the money that accumulates in the account can later be used to pay for a beneficiary’s college, tax-free.  That’s why savingforcollege.com says that 529 plans offer “unsurpassed income tax breaks.”

The 529 plans are such a good deal that more than 7 million of them have been created.  President and Mrs. Obama have them for their daughters, for example, and put $240,000 into those plans back in 2007.  And while the Obama Administration argues that the tax benefits for those plans predominantly favor “the rich,” it all depends on how you define “middle class” in modern America.  As the New York Times points out, 10 percent of 529 plans have been established by people with incomes below $50,000, and 70 percent of the total number of 529 accounts are owned by households with annual income below $150,000.  Is a two wage-earner family that makes $140,000 really wealthy?  My guess is that most families in that category don’t look at things that way.

The President’s 529 tax plan was a trial balloon that quickly was shown to be a lead balloon, opposed not only by the people who set up the 529 accounts, and the entities that hold and manage those accounts, but by Democrats and Republicans alike.  House Minority Leader Nancy Pelosi reportedly personally lobbied President Obama to ditch the 529 tax plan on a recent plane flight.  And the optics of the proposal aren’t that great, either.  For generations, a cornerstone of American policy has been to help citizens get their kids to college — and now we’re going to tax those industrious folks who plan ahead and save for college for their kids and grandchildren, rather than letting them be saddled with crushing student loan debt as they go forward into their adult lives?  Of all of the tax breaks available in the endless Internal Revenue Code, this is the one we’re attacking?

You can argue, I suppose, about whether the 529 tax plan was good policy, but there’s no doubt that it was bad politics.  I’m guessing that “529’d” might become part of the dictionary of political slang, to be used in the future whenever an ill-conceived proposal gets raised, quickly torpedoed, and then flushed forever down the memory hole.