Is your 401(k) Plan Going to Be Enough?

by Justin Weinger on September 20, 2013

401(k) savings plans have been around for a few decades and have always been touted as one of the best ways to save money for retirement.  The fact that many employers have matching programs that match the funds that a person puts into their 401(k) yearly is one of the big reasons that many people like them as well as the fact that the money deposited into 401(k) accounts is protected from taxes.

Recently however a new study was released showing that 401(k) savings plans are not only inadequate as far as putting together a substantial amount of retirement money is concerned but also that, as far as the nation’s growing wealth inequality is concerned, they’re actually adding to the problem.

The Economic Policy Institute released the report and it shows that the large shift from pension plans to 401(k) individual savings accounts has negatively affected many retirees. In effect, what the report shows is that only the wealthiest of workers can actually use a 401(k) to build enough retirement wealth because they are actually earning enough to put enough into their account while they are working. Conversely,  an employee that’s making just enough to survive is not going to be able to use their 401(k) to its full advantage and thus won’t get much (or any) advantage from it once retired.

The report’s co-author, economist Monique Morrissey, notes that 401(k)s were actually never designed as a replacement for pensions. She writes that, in effect, 401(k) plans are primarily used as tax shelters for employees who make the highest income. Ms. Morrissey also believes that the change to 401(k)s has actually been a disaster, even as many policymakers in Washington are calling for bigger cuts to Social Security. The combination of 401(k) plans that don’t provide enough money for retirement and the loss of Social Security is already affecting millions of retirees and, in the author’s opinion, is going to negatively affect millions more.

The report noted that, in 2010, the people who had  taken advantage of their 401(k) account by depositing the maximum amount allowed by law only accounted for the top 1/5 of households in the United States.  Also noted in the report was that one of the major contributing factors to retirement income inequality was that, as far as 401(k) plans are concerned, in order to really take advantage of  these plans the actual participants need to make contributions. Most don’t.  This isn’t so in the private sector where workers who are automatically enrolled in defined-benefit pension plans are not required to contribute to these plans to make them more valuable over time.

This being the case, what has happened is that higher income workers have started to participate in defined contribution plans in much higher numbers and, since they have higher amounts of disposable income as well as higher investment / risk tolerance, they are more likely to receive generous matching plans from their employers and thus receive larger tax breaks.

It’s a bit of a “catch 22” situation, to say the least. On the one hand a 401(k) plan is supposedly an excellent way to save money for retirement but, on the other hand, unless it’s actually used to the maximum that is allowed by law it still won’t grow unless the person actually is able to put money into it and, with most people barely able to pay their regular bills, that’s just not happening.

Of course if a person is extremely frugal, does their best to spend as little as possible and puts as much as they possibly can into their 401(k) during the working years, there certainly is a high chance that they’ll be able to put enough into their 401(k) to take care of them through retirement, barring any unforeseen emergencies or major health problems. In the end, it’s really a matter of deciding what’s most important, instant gratification and having everything  “now” or putting money aside for retirement so that, once you’re no longer working, there’s enough to live on.

Of course it’s  sometimes not as black and white as that and, if you have any questions about saving for retirement, 401K or IRA savings plans or financial questions in general, please let us know and will do our very best to answer your questions, give you advice and provide some solutions.

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