401(k)s Are Failing; Here's What We Need Instead, Professor Says

Clearly, the 401(k) plan doesn't help most Americans save for retirement because "most people have nothing or very little" in their 401(k) accounts, Daniel Hemel, an assistant professor at the University of Chicago Law School, argues in an interview with ThinkAdvisor.

Hemel contends that since 401(k)s have failed to advance broad-based retirement saving, and given the nation's rapidly aging population, there is an urgent need to rethink the plan.

One major issue is 401(k)s' high annual fees, which erode the very reserves employees are trying to build.

What's Hemel's solution? A public option in the form of the Thrift Savings Plan, currently offered to members of Congress and other federal employees. Its fees total only 3 basis points per year.

As a way to expand "access to low-cost, tax-deferred savings vehicles," the TSP is what William Birdthistle, a professor at Chicago-Kent College of Law, and Hemel proposed in a Time magazine opinion piece on Nov. 2.

Indeed, the two sounded an alarm that the 40-year-old Section 401(k) tax code provision is "facing something of a midlife crisis."

Birdthistle, author of "Empire of the Fund: The Way we Save Now" (Oxford University Press 2016), researches investment funds, executive compensation and corporate governance.

Hemel's areas of research are taxation, nonprofit organizations, administrative law and federal courts.

In a ThinkAdvisor interview with this reporter published on Nov. 29, Louis Harvey, president and CEO of Dalbar, a leading Boston-based financial services market research company, challenged the professors' view of the 401(k) and disputed the accuracy of their article.

Hemel insists that "the facts we put forward in the op-ed are incontrovertible. One could disagree with it, but it wasn't factually wrong."

ThinkAdvisor recently interviewed Hemel by phone to learn more about why the 401(k) has been what the two academics call "ineffective" and what they're recommending to remedy the situation.

Here are excerpts from our conversation:

THINKADVISOR: Professor Birdthistle and you write that Section 401(k) is "facing something of a midlife crisis." Why is that? And how urgently does something need to be done about it?

DANIEL HEMEL: It's a midlife crisis in the sense that it's not accomplishing what we, as a society, should want it to accomplish. How urgent is it? We have a fast-aging population. So, yes, it's urgent that we deal with this. It's been urgent for a while. Do I think that Section 401(k) will be repealed tomorrow? No. That's not the claim we're making.

The 401(k) is "ineffective at helping most American workers save for retirement," you write. On what do you and Professor Birdthistle base that statement?

Most people have nothing or very little in their 401(k)s. So Section 401(k) can't have done all that much. Section 401(k) does help rich people save for retirement. It doesn't help most Americans save for retirement. The U.S. Department of Treasury's Office of Tax Analysis data show that most Americans don't benefit from Section 401(k). That's factually true.

You write also that the 401(k) is inefficient. "In particular… high administrative and management fees are eating up too much of Americans' nest eggs." How much are employees paying in fees?

We cite a [2016] study that says the average fee is 97 basis points. There's no reason why people should be paying close to 100 basis points.

What could be done to lower fees?

That's the most controversial part of our op-ed. We thought the most obvious solution was for members of Congress to look at their own retirement plan — the Thrift Savings Plan — which has fees of 3 basis points. So in the op-ed, we suggested it as a public option.

The TSP certainly has lower fees. Why else did you suggest it?

We think it's a politically attainable approach that would make the world a better place.

Can employees transfer their TSP when they leave government?

Yes, you can roll your Thrift Savings Plan account into something else. I was a federal employee for three years [law clerk]. But I have no desire to roll over my TSP account.

Why not?

Because I think: Wow! A 3 basis-point retirement savings account that allows me to invest in diversified index funds. Why would I want to take my money out of that before I'm 70-1/2?

Would the TSP public option that you envision be available to all employees?

[Among the possibilities], we could make it available to everyone, or only to low- and middle-income workers, or only to workers whose salaries are the same as or less than members of Congress.

How do you think that option would go over with workers?

Lots of people wouldn't choose it because they like the plan that their workplace offers. But it would inject a degree of competition that we think would [lower] fees and make 401(k)-like vehicles available to workers whose employers don't offer them.

You write that you're not expecting Section 401(K) to be repealed in the near future. But to what extent are you suggesting that the country's retirement plans get a makeover?

We're saying: If you were to sit down and write from scratch how we should incentivize Americans to save for retirement, I don't think anyone would say, "We should have a 401(k) arrangement for some private-sector workers and then 403(b) plans for certain non-profit employees who might also have access to a 457 plan; and solo-401(k)s; and SEP IRAs. The degree of complexity that we have today certainly isn't optimal. It evolved for historical and political reasons. If we could go back to the drawing board, no, this isn't how we — society — would write it.

How would society write it?

[American workers] would want something simple. What we have is really complicated. But we don't expect Congress to abolish Section 401(k) anytime soon and replace it with an entirely new regime.

The government loses "more than $120 billion a year" in tax revenue "associated with Section 401(k) and similar defined contribution plans," Professor Birdthistle and you write. In the interview with Dalbar's Louis Harvey, he stated that "The whole issue of the government losing revenue is bogus." What's your response?

I don't understand how it could be "bogus." It's pretty uncontroversial that the government loses revenue as a result of Section 401(k).

In your article, you suggest that an answer to revenue loss could be to impose "a modest excise tax for 401(k) and IRA contributions and withdrawals for high-income taxpayers…" Mr. Harvey said if that were to happen, the wealthy would simply "move their money into another area." What are your thoughts?

William [Birdthistle] and I were imagining, say, a 1% tax on withdrawals from 401(k)s and IRAs for taxpayers above some high-income threshold. If a 1% tax on a withdrawal would move people to stop using 401(k)s and IRAs, then quite clearly 401(k)s and IRAs aren't doing all that Mr. Harvey seems to think they're doing. If a small tax would lead people to say the benefits aren't worth it to them, then those benefits can't be all that great.

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401(k)s Are Failing; Here's What We Need Instead, Professor Says

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