It’s been 40 years since Ted Benna, then a 36-year-old U.S.-based benefits consultant, noticed a new Internal Revenue Service section that had potential implications for cash-deferred savings plans.
The section, 401(k), meant that employees in these plans would have to leave their money in them until just shy of their 60th birthday if they wanted to make pre-tax contributions, with an exception for hardship withdrawals. It also limited the amount high-salary employees could contribute, tied to what lower-paid employers put in.
He wasn’t the only one to take note, but he was alone in the realization that the section 401(k) could be used for a purpose no one else had considered. That discovery led to the evolution of a model for accumulating income that has helped millions of Americans build retirement wealth.
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“The 401(k) has helped tens of millions accumulate probably between $10 and $15 trillion when you count the money that can roll out of these plans into [individual retirement accounts],” says Benna. “In that regard, it has obviously had a significant impact in helping people who have retired over the last 20 to 30 years. In terms of helping individuals accumulate funds for retirement, it has certainly succeeded in doing that.”
At the centre of the plan was a matching employer contribution and the ability for employees to make pre-tax contributions themselves. The company in which Benna was a partner, Pennsylvania-based Johnson Cos., became the first to launch a 401(k) retirement plan.
Despite its success in accumulating retirement savings, the model has its detractors, including Benna, who says the investment choices have become overly complicated and the fees too high. “These plans started with only two options . . . . It took less than two minutes for me to explain investment options to participants. It was simple and easy to understand.
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“Then it went to three to five to six, and then to 10 and 12, even far beyond that. That’s when it began to move into the realm of the financial communities . . . because with that added level of investment complexity you then got introduced to investment advisors to help employers pick funds, and try to provide enough education to the participants to make informed investment decisions.”
If he had to start all over again, Benna has said he’d keep the model but simplify the investment structure. Limiting investment choices and tying them to vehicles such as target maturity/retirement funds would produce “a portfolio that professionals would generally say makes sense for you in terms of appropriate diversification.”
The 401(k) is essentially a defined contribution plan, which is increasingly popular among global employers, including in Canada. Critics say these plans leave investment choices in the hands of members who aren’t qualified to make them. Proposed solutions include allowing members to leave their money in a company plan when they retire, a direction supported by Benna, who also likes auto-enrolment and auto-escalation measures, as well as payroll deduction to increase coverage and retirement income, although he suggests these should have an opt-out component.
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“Auto-enrolment results in higher levels of participation. I am a big supporter of that . . . . I would support employers offering some sort of payroll deduction, retirement savings program to help employees save for retirement. I would mandate it.”
Despite their flaws, and there are serious ones, according to Benna, DC-type plans like 401(k) are here to stay, and have helped many participants to a comfortable retirement.
“At this point in time there is no question that people who have retired over the last 40 years were in a better position than they would have been without the 401(k).”