Revolutions often begin with drama, a powerful upheaval that seizes everyone's attention. The assault on the Bastille in 1789. The armed insurrection in Petrograd in 1917. Yet sometimes an historic divide is crossed with little fanfare. Only much later is it widely recognized that the world has been fundamentally transformed.
That's the case with the U.S.'s main corporate pension plan, the 401(k). The Revenue Act of 1978 contained a provision that become Section 401(k) of the Internal Revenue Code and it went into effect on Jan. 1, 1980. Subsequent regulations issued by the federal government in 1981 gave benefit specialists the guidance they needed to set up the pension plans. The 401(k) has since evolved into the largest private-sector employer-sponsored retirement plan in the U.S.
The latest comprehensive data (as of the end of 2008) compiled by the Employee Benefits Research Institute and the Investment Company Institute (EBRI) shows that some 50 million U.S. workers are participating in 401(k) plans, with $2.3 trillion salted away—accounting for 16% of all retirement assets.
The impact of the 401(k) goes far beyond a particular pension plan. It changed society and for a long time was closely tied with advancing the American Dream. Like civic associations at the turn of the 20th century and homeownership following the Second World War, investing in the capital markets took on the characteristics of a powerful mass social movement, especially in the '80s and '90s. Millions of people flocked to Wall Street through their 401(k)s, IRAs, and similar retirement savings plans to invest for the future. Nest eggs swelled as equities soared and corporations kicked in matching amounts. (The most common match is 50¢ for every dollar an employee contributes, up to the first 6% of pay.) Stock market twists and interest rate turns became headline news and the media increasingly devoted resources toward helping folks manage their retirement savings.
The 401(k) is a major reason why the mutual fund industry mushroomed from a sleepy corner of the investing world, with 654 funds and assets totaling $135 billion, into a financial behemoth, with more than 8,000 funds managing about $11 trillion.
Yet 30 years after its official launch, enthusiasm for the 401(k) appears to be waning. The rise of the 401(k) largely coincided with one of the great secular bull markets in history—the years 1982 to 2000. Memories of those halcyon years, which fostered a cult of equity, are fading. Savers have watched their portfolios crumble through two bear markets in less than a decade.
A number of corporations during the recession early in the decade—and many more in the Great Recession—reduced or even eliminated the company match into the 401(k). Morbid jokes among workers about their "201(k)s" highlight how the pension plan has stoked everyday worker insecurity. Although the big-picture 401(k) numbers are impressive, the micro figures are dismayingly small. The average 401(k) account balance, for instance, is almost $46,000 and the median value is a mere $12,655, according to the EBRI. These amounts would certainly not be enough in themselves to carry a person through even a half-decade of retirement.
The biggest problem with the 401(k) itself is how it evolved, with all the responsibility borne by workers. Companies embraced the 401(k) as part of an overall campaign to rein in benefit costs. Management retreated from offering expensive traditional "defined benefit" pension plans in favor of low-cost "defined contribution" plans such as 401(k)s. In essence, with a defined benefit plan, the employer bears all the investment risk and commits to a fixed payout of money, typically based on a salary and years-of-service formula. In sharp contrast, a 401(k) puts all the risk upon employees, who must decide how much to invest and where to invest it.
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