Teresa Ghilarducci: The 401(k) Retirement System Has Failed

Americans lost over $1 trillion in their 401(k)s in 2008. Ouch! Evidence, says Teresa Ghilarducci, a New School for Social Research economist, that America needs to radically alter how workers save. She proposes eliminating the tax breaks for 401(k)s and replacing them with guaranteed retirement accounts. Under Ghilarducci's plan, outlined in her book When I'm Sixty-Four: The Plot Against Pensions and the Plan to Save Them, all workers who don't have a traditional pension would be required to contribute 2.5 percent of their income to a government account with a 2.5 percent employer match. A 3 percent return above inflation would be guaranteed by the government. U.S. News asked Ghilarducci about her controversial retirement plans. Excerpts:

What's wrong with the 401(k) retirement system?

The biggest problem with the 401(k) retirement system is the people who need them the most don't get the biggest benefit from the government subsidy. The people who get the biggest subsidy are in the highest tax bracket. The biggest problem with 401(k)s in general is that the contributions into the 401(k) are voluntary on the part of the employee. Sometimes, the employee gets help from the employer match, but it's not guaranteed. Because the employee puts the money in it, employees think of it as a savings account for hardships and for retirement. Because of the ability to take money out before you retire, it's not enough when you retire. The employee also has to make investment decisions. Most workers are not well suited to make those decisions. And they can't spread the risk over time. Basically, a pooled fund can pool it over many life spans, but a worker has only an individual time span to plan for. There is also market risk, and there is very little they can do to hedge against that risk.

If 401(k)s are serving investors so badly, why do people like them?

What they wrongly say is that the stock market does better than the government would. But your 401(k) is not in the stock market. Your 401(k) is in mutual funds, and you have to pay a fee for that. Because of fees and because of common mistakes that people make in managing their own money, the average returns have been about 3 percent without an inflation adjustment. They also see high-profile plans being terminated. When there are no other better options that are available, it's the best they have.

How will GRAs fix the retirement system?

After 30 years of experience with voluntary participation in the 401(k) system, in my opinion, it has failed. The only retirement system that all people have is Social Security and Social Security isn’t enough. We need a universal supplement to Social security so that everyone can retire. Personal savings and employer pensions were supposed to fill in that role. I expect that the government will spend a considerable about of time figuring out a way to have a supplement to Social Security. It might not be my plan, which is mandatory and pays for the subsidy by scaling back the 401(k) system. I see a more gradual introduction of a GRA.

Is a 3 percent interest rate above inflation enough to get people to a secure retirement?

Barely. It is the minimum that the government can guarantee and itself not run the risk of not being able to pay it. If you save 5 percent of your earnings, it is enough to get middle-income workers 70 percent of their preretirement earnings in retirement. Without that supplemental guarantee, they are getting about 40 percent from the Social Security system.

What should retirement savers with depleted 401(k)s do now, under the current system?

My best advice is to keep saving in your 401(k) account, but look very carefully at where you are investing. Invest in low-fee index funds. If you can't tolerate the stock market going up and down, then you should probably buy index bonds. In my 401(k), I have a balance between stocks and bonds, and I have the lowest fees possible. I don't try to time the market. People should not sell their assets low.