By William Birdthistle and Daniel Hemel
November 2, 2018
IDEAS
William Birdthistle is a professor at Chicago-Kent College of Law and the author of Empire of the Fund: The Way We Save Now (Oxford University Press, 2016).
Hemel is an assistant professor at the University of Chicago Law School.

The provision that gives the name of America’s most popular retirement savings plan, section 401(k), will turn 40 this Tuesday. And in its first four decades, the 401(k) has lived an unexpectedly glamorous life. At the time of its enactment, lawmakers anticipated that it would exist in obscurity, affecting only a small number of corporate executives. Forty years later, 401(k) has become possibly the most famous section of the Internal Revenue Code, with well over 90 million Americans personally participating in 401(k)s or similar defined contribution plans.

Section 401(k)’s rise from obscurity to ubiquity might suggest that its 40th birthday should be an occasion for celebration. But this is no time for popping corks. The provision has proven to be enormously expensive while also ineffective at helping most American workers save for retirement. In short, section 401(k) is facing something of a mid-life crisis.

To be fair to section 401(k)’s framers, the provision was never intended to be a broad-based saving incentive that would serve as a foundation for financial stability in retirement. Instead, it marked a truce between the IRS and firms that wanted to let employees plow their year-end bonuses into pension plans. The IRS sought to tax employees immediately on those amounts, on the theory that the pension plan contributions were equivalent to cash. Congress struck a compromise, which it tucked away in a provision of the 1978 Revenue Act that garnered little notice at the time: employees could delay taxes until they withdrew cash from the plans, as long as the plans satisfied certain statutory criteria (including a requirement that the plans not discriminate in favor of the firm’s highly compensated employees).

There are at least three reasons why lawmakers should reconsider that hastily crafted compromise. The first is its sheer cost. At the time that section 401(k) was enacted, Congress’s Joint Committee on Taxation projected that section 401(k) would have a “negligible effect upon budget receipts.” Today, the Joint Committee estimates that the tax expenditure associated with section 401(k) and similar defined contribution plans is more than $120 billion a year. That’s almost four times the tax expenditure associated with the much-debated mortgage interest deduction. Surely a program of this magnitude should not be allowed to operate on auto-pilot.

A second reason to rethink section 401(k) is its distributional effect. President Trump loves to ask—at least when the stock market has a good day—“how’s your 401(k)?” The answer for most American workers is: “I don’t have one.” Most of the provision’s benefits flow to households in the top fifth of all earners, while households in the bottom half of the income distribution capture less than 4% of the benefits generated by section 401(k) and other defined contribution plans. In other words, section 401(k) delivers the most aid to the taxpayers who need it least, while a wide swath of the American working class is left out entirely.

A third reason to revisit section 401(k) is its inefficiency—and, in particular, the fact that high administrative and management fees are eating up too much of Americans’ nest eggs. According to a 2016 study, 401(k) participants pay an average fee equal to 0.97% of assets—well above the average expense ratio for mutual funds overall. Put another way, plan administrators and investment managers are taking one cent out of every dollar that Americans hold in their 401(k)s each year. That might not seem like a lot on first glance, but over time, it adds up, particularly when compounded over the decades of a working career.

So what to do about it? Ideally lawmakers would go back to the drawing board and overhaul America’s labyrinthine system of tax-preferred retirement savings. What we have today is an alphabet soup of savings options—401(k)s, traditional and Roth IRAs, SEP IRAs for small business owners and the self-employed, 403(b)s for employees of nonprofit organizations, and more—all of which have extraordinarily complicated criteria for contributions, plan management, and withdrawals. A bold and visionary Congress would streamline all of these programs into a single retirement savings vehicle that all workers could access, with tax benefits targeted at lower-income households and with Social Security still providing a safety net for all retirees in their twilight years.

A more modest—and perhaps more politically plausible–proposal would be to maintain section 401(k) and its counterparts while expanding access to low-cost, tax-deferred savings vehicles. Perhaps the most promising means of accomplishing that end involves the Thrift Savings Plan, a defined contribution plan already available to members of Congress and millions of other federal government employees. TSP participants can choose among a short menu of diversified index and target date funds. The federal agency that oversees the plan selects a manager for the funds through an open-bid process (Investment manager BlackRock won the most recent round). The net expense ratio for plan participants is 0.033% of assets, or 3.3 basis points—a tiny fraction of what the average private-sector employee must pay.

Congress should grant all workers access to the Thrift Savings Plan platform. Call it “TSP for All,” or—harkening back to the Obamacare debates—a “public option” for retirement savings. The upshot would be that tens of millions of Americans—from Uber drivers to construction workers to retail clerks—could choose from the same menu of investment options already available to their elected representatives.

Whichever route Congress chooses will, concededly, cost money. Allowing individuals to defer taxes on savings plan contributions almost certainly reduces revenue in the long run. One way to plug that gap would be to impose a modest excise tax on 401(k) and IRA contributions and withdrawals for high-income taxpayers—say, households earning more than $200,000 a year.

All of these ideas would require careful vetting before implementation. But if we are serious about ensuring retirement security for American workers, then the status quo is not a viable option. Let’s use this anniversary as an opportunity for creative reappraisal and—ultimately—a catalyst for action. And by the time of section 401(k)’s 50th birthday, hopefully we’ll actually have something to celebrate.

Contact us at editors@time.com.

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