In a Wall Street Journal article entitled "How Well Do You Know…Your 401(k) Plan?" Leslie Scism and Jennifer Levitz quiz readers on the history and latest developments of 401(k) plans.
In the 1970s, some corporations asked the government if they could put aside retirement money, tax-free, for their executives. Officials gave permission, provided the companies offered the opportunity to all workers, never expecting the plans to take off….The 401(k) plan slipped in "under the radar," says Teresa Ghilarducci, and economist at the New School for Social Research in New York. The idea was that this new plan–in which workers set aside pretax earnings in investment accounts–would supplement the rank-and-file's old fashioned pension plan, the type that sends out a monthly check.
But as companies sought to hold down costs, more and more froze the old-fashioned plan and went solely with a 401(k). "What [the government] didn't anticipate was the erosion of well-defined benefit plans," she says. "They never conceived that the 401(k) would be the only retirement plan that companies provided. That's what we economists call 'unintended consequences' of a law."
The 401(k) is replacing pension plans. And it's easy to see why. Pension plans are a real albatross around the neck of companies. Pension plans support people who don't work for these employers anymore.
The employer-sponsored pension plan was a market driven phenomenon to begin with. It appears that railroads were some of the first to provide the pension in America, to attract good workers and keep them. It was the free market at work. The free market inspired companies to add pensions to wages and motivate workers to start working and stay working for them.
So what did that mean? Mr. Railroad Worker would put up with crap in what we today might call a dead-end job. If he put up with crap he would have a pension at the end, and he'd have money after he was too old to work. His wife and kids would be taken care of. "Career path" wasn't part of his vocabulary.
But suppose his buddy down the street had an idea for a new business they could start and Mr. Railroad Worker would be in charge. Mr. Railroad Worker would say, "What are you kidding? I only have 15 more years before I get my pension. I can't quit and start a new venture with you!"
The system put a damper on innovation and job creation.
Now, with this new portable pension, each worker has ownership of his or her retirement money. All of us are able to change careers and start any kind of business we want.
HOORAY! The individual is in charge!
OH NO! the individual is in charge!
Most 401(k) plans require that the individual actually put some money in. The employer will match funds, but you have to ante up. It's your own fault if your 401(k) is empty. And you are free to screw it up.
Old-style pensions were managed by the employer and doled out a set amount each month. Pension plans could go under if the company went under, and the individual is powerless to do anything.
Pensions and 401(k) plans are both subject to the market. But the employer swallowed the risk in pension plans. With the 401(k), the risk and the reward is on the individual. The individual has the power with a 401(k).
It started out that the muckity-mucks in large companies wanted a way to feather their own nests. But in the end, all of us are more free to move around, improve ourselves and our careers, and maybe even find our own path to muckity-muckhood.
It just shows how it's best not to over-regulate market forces. If the government gets out of the way, things can shake down in positive ways. No one predicted how this would happen, but it's resulted in a lot more freedom for everybody.