The 401(k): Welfare For Wall Street.

It is my belief that the 401(k) plan has devolved into little more than cleverly disguised tax designed to subsidize the bond and equity markets. In 2006, after significant lobbying, the financial services industry essentially purchased the Pension Protection Act of 2006 from Congress. Two of the more offensive aspects of the law are automatic enrollment and automatic escalation.

Automatic enrollment allows your employer to withhold 401(k) contributions from your pay without your consent and with no liability for loss. Prior to the first involuntary withholding, the employer is supposed to provide written notice 30 days in advance of the first involuntary contribution. Typically, the default investment, a.k.a. the qualified default investment alternative (QDIA) is a hybrid or target-date mutual fund, which
contains significant risk and have generally underperformed. It is very telling that the Department of Labor only allows money market or stable value funds as a QDIA for 120 days, demonstrating that this is a parasitic attempt to divert funds into the equities markets.

Automatic escalation is the practice of increasing an involuntary plan participant's contribution annually. The initial rate is 3% with a 1% increase in each subsequent plan year. The rationale given for automatic escalation is that 3% annual contributions will not generate sufficient retirement savings. In other words, since the involuntary participant has remained asleep the switch for a year, Wall Street might as well press the bet.

If nothing else, the PPA shows the dangers of being a passive participant in your retirement planning. For example, consider a
25 year old who was automatically enrolled on January 1, 2007. Assuming he was earning $45k/year, received a 5% raise annually, and was autoescalated in 1% increments in each subsequent year, his shares of his QDIA, the Fidelity Freedom 2040 Fund (FFFFX), would be worth $3,710 on June 1, 2009. Had he not been autoenrolled/autoescalated, he'd have $4372, which is about 15% more.

I have yet to see it proven that the 401(k) is the best means of retirement funding. Yet, the financial services industry and the government are willing to resort to deceptive and predatory practices to channel more of our discretionary income to Wall Street. Fidelity Investment's response to the PPA clearly indicates that deceit is intentional. In the response, Donna Hanlon suggests that the 30-day waiting period be replaced with a 5-day period because new hires might notice that their wages are being garnished:
Consequently, compliance with a thirty day advance notice advance notice requirement will require these plans to delay enrollment to the detriment of participants' retirement In automatic enrollment plans, this delay may highlight for participants the difference in net pay that participating in the plan entails, with the result that participants may be more motivated to opt out of participation, a consequence that is inconsistent with the policy choice underlying automatic enrollment.

The remainder of the comments provided by concerned parties are posted at the Department of Labor's site: http://www.dol.gov/ebsa/regs/cmt-defaultinvalt.html. I strongly encourage you to read them, since they provide a window into to actual motivations of the retirement fund industry. What I deduced is that nobody involved is terribly concerned with the welfare of the plan participants. If nobody is looking out for our best retirement interests, how long can we afford to remain oblivious?


  1. These are all great points. The pitiful choices for alternative investments--or even cash--in most 401(k) further supports your thesis.

    I also wonder what the withdrawal conditions will look like 10-20 yrs from now. Isn't there a good argument to be made that tax rates on retirement withdrawals will be much higher? I'm increasingly drawn to the idea of pulling retirement funds into the present. The 10% 'penalty' may pale in terms of future withdrawal taxes or just plain old dollar devaluation.

  2. The standard 401(k) "menu" leaves much to be desired, for certain. My 401(k) allows for a self-directed brokerage account, otherwise I'd be 100% in the stable value option, just to get the employer match.

    Each bailout makes higher taxes more likely, but missing the employer match is leaving money on the table. Most plans allow you to take a loan, so you pay interest to yourself. My plan charges 3% interest, so if I had any major debt, I'd take the loan.

  3. Good point about the employer match. Currently I'm contributing what's necessary to get the match, but no more.

    Sure wish my plan had a self-directed alternative...

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