The 401(k) Plan: Retirement Made…Complicated.

Retirement planning

The adoption by many companies of a 401(k) plan was a revolutionary turning point for the United States in the late 1970s and offered a transition from pensions which had less utility to workers that were staying at jobs for shorter amounts of time. Interestingly, the 401(k) was not a tax plan designed for retirement, but a loophole that was discovered by an accountant that enticed employers. The plans had value because workers were staying with employers for less time, leading to less pension vesting, but they still wanted to save for retirement. Derived from Federal Internal Revenue Code Section 401(k), 401(k) plans serve as an employer-sponsored retirement savings plan that allows employees to allocate a percentage of their salary into an investment account. Often, employers are allowed to and will match the amount deposited (up to a certain percentage) by the employee, boosting retirement savings. Additionally, these contributions are often invested in stock to help them to grow over time. The Employee Retirement Income Security Act (ERISA) protects the rights of employees participating in retirement plans, ensuring the right to disclosure of important plan information and a timely and fair process for benefit claims. [1]

On paper, the 401(k) has significant merits and was seen by some as an ideal method of saving for retirement. For example, a major benefit of the 401(k) is that contributions are made with pre-tax dollars, so an employee is not paying income tax until the money is withdrawn after a certain age. This allows whatever amount of money in the account to maximize its growth. Some other benefits include employer matching and investment options, as previously mentioned, and automatic savings, which insures that an employee is consistently setting aside money for their retirement.

The truth is, however, that the 401(k) is not required to be offered by employers and has not really served employees in this country that well. According to U.S. Census data from 2017, 49% of Americans between the ages of 55 and 66 do not have personal retirement savings at all. It has been further observed that many employees in lower income brackets have had to tap into their 401(k) accounts prematurely because of financial distress or the need for emergency funds. [2] If an employee withdraws funds from their 401(k) account before the age of 59-1/2, they are subject to a 10% penalty of the amount of money removed from the account. The financial security of many Americans is still quite tenuous, with 44% of US adults reporting that they could not afford to pay an emergency expense of $1,000 or more from their savings. [3] In that sense, even those Americans that did take advantage of a 401(k) might have lost the benefit of savings because they dipped into their account in a time of need.

Hoping to combat the painful truth that the U.S. has some of the highest rates of poverty among the elderly population compared to other developed countries,[4] new ideas have been proposed in congress to rectify the concern of retirement poverty in the United States. Policy makers have analyzed other countries with successful programs in efforts to improve the US system. For example, Australia’s “Superannuation Guarantee” requires companies to contribute the equivalent of 11 percent of an employee’s monthly pay to an investment account that is controlled by the worker, who can also put in additional money.[5] This plan differs from the 401(k) because it forces employers to contribute to an employee’s 401(k) plan and enforces a higher rate compared to the current optional contribution that exists in the United States. In Norway, moreover, a person is entitled to enroll in the Norwegian National Insurance scheme, a free-of-charge retirement plan for residents. Individuals who have resided in Norway for at least five years between age 16 and 66 (inclusive) are entitled to the guaranteed pension in the new system. A full guaranteed pension is granted after forty years of residence, and it is reduced proportionally for shorter periods. [6] Each year a person’s pension entitlement is marked at 18.1% of their pensionable income. [6] For example, a person who earns $100,000 annually will have approximately an additional $18,000 set aside for retirement by the government.

A recent plan that’s been proposed by our congress, known as the Thrift Savings Plan and the basis for the Retirement Savings for Americans bill, would function as a government-sponsored retirement program for federal employees. This plan would include automatic enrollment and matching contributions from the government, distinguishing it from Social Security. [7] It would, however, only help with employees working for the government, a small percentage of Americans. Since new ideas and decisions revolving around the existing 401(k) plan are emerging every day, we hope new and further initiatives will be considered to protect the happy retirement of workers in the future.

Newer companies, with stock options and promises of “going public” are likely unable to protect the future retirement of generations of workers, though the dream of such lucrative transactions is often proposed to workers in contract discussions. It is important to understand the complex language of any employment contract and to consider any provisions relating to a retirement savings plan such as a 401(k) when considering a job offer. Too often clients do not consider retirement choices when considering a job. We look forward to new and better legal ideas and laws in this area and will continue to report them as they evolve. Hopefully, some initiatives will help to provide more retirement-based compensation options for workers. At end, we hope a modest consideration of this point will make for better success for you, our clients, as we continue to help “take the worry out of your work.”