Welcome back to the Deep Dive, where we extract
the most vital insights from the stack of sources
you need to master. Today, we are wrestling with
a giant, the retirement savings vehicle that
really defines modern American finance, the 401k.
It really is. It's absolutely central to the
financial lives of millions. And yet, for something
holding, what, around $6 .4 trillion in assets?
A staggering number. Yeah, the complexity and
the jargon are just... They're staggering. Our
goal today is to take you beyond that acronym.
We want to give you not just the rules and the
limits, but the strategy and really the philosophy
behind them. Exactly. And we've pulled together
everything we could find. We've got the historical
records, the detailed IRS rules, and some surprisingly
sharp criticism. Including one from the man who
basically created the modern version of the plan.
Right. So our mission for you, the listener,
is pretty simple. We want to demystify the structure,
help you understand the mechanics, and really
evaluate the tradeoffs of this powerful, but
let's be honest, very complicated savings vehicle.
And the deeper you look, the more striking the
history becomes. I mean, this cornerstone of
national retirement savings. It was never designed
to be a national system. No, not at all. And
this is where it gets really interesting. The
401k was an unexpected legislative accident.
It came out of the Revenue Act of 1978, and it
started as a loophole. A niche tax strategy.
Exactly. A niche strategy to help highly compensated
executives minimize their tax exposure. And this
is the key part. This was during a period when
the top marginal income tax rate was a jaw -dropping
70%. We will definitely come back to how that
context shaped the system we have today. Hashtag
I, the unexpected history and core definition.
OK, let's unpack this from the very beginning.
We hear the term 401k all the time. But what
exactly I mean, what does that specific subsection
of the U .S. Internal Revenue Code officially
define it as? Well, at its heart, it's an employer
sponsored defined contribution plan. OK, defined
contribution. Break that down. That phrase is
absolutely key. It means the benefit you get
in retirement is defined only by how much is
put in by you and your employer. And how well
those investments do over time. So it's not a
guarantee? No, not at all. It's a personal retirement
savings account that is tethered to your job.
And the main mechanism is that employees make
these periodic contributions, either pre -tax
or post -tax, straight from their paychecks,
right? Straight from the paycheck, often supplemented
by an employer match. And from the employer's
side, from a bookkeeping perspective, which you
as the employee never see, those funds are handled
in a very specific way. Oh, so? The second that
money is withheld, the employer's obligation
to send it to the plan administrator is immediately
classified on their books, on the general ledger,
as a payroll liability account. So it's money
they legally owe. Instantly. And they have to
transfer it, usually within a few business days.
It's a highly regulated, very current liability.
Now let's get back to that unexpected history.
You mentioned this kind of plan was actually
banned for a while. What was going on in the
70s? Yeah. So before 1974, some employers offered
this choice, a cash or deferred option. You could
take the money as taxable cash now or you could
have the employer put it into a retirement plan
for you. OK. But Congress got worried. They saw
that these were being used maybe a little too
aggressively by. High -paid people, mostly for
tax sheltering, so they just put a stop to it.
They put a moratorium on any new plans while
they studied how to regulate them. And that study
led to the Revenue Act of 1978. Exactly. The
new legislation got wrapped into that massive
act, specifically in Section 401K, which reauthorized
these cash or deferred plans, but only if they
met these new... much stricter non -discrimination
tests. And companies jumped on it pretty fast.
Incredibly fast. I mean, that reauthorization
was enacted in November of 78. And the records
we have show that a company like Hughes Aircraft
was among the very first to implement a plan
just weeks later. Wow. It shows they were already
thinking about how to transition their existing
savings plans into this new, you know, tax -advantaged
framework. But the real name to know here is
Ted Benna. He's the one who gets credit for creating
the first truly functioning 401k plan at his
employer, the Johnson Companies. And his goal
wasn't to, you know, save America's retirement.
No, his motivation was purely tactical. It was
all about cutting the current tax bill for executives.
Right. Benna was working with these bank executives
who were getting deferred compensation bonuses
and they were just desperate for a way to shelter
that income. And you have to put yourself in
their shoes, a high earner in the late 70s, early
80s, looking at a marginal tax rate of 70%. I
mean, that's a massive financial incentive. You're
going to find any legal way you can to push that
income into a structure where it's not taxed
immediately. 70%. That context just changes everything
about why this was created. The whole point of
the original 401k was about minimizing a huge
current tax bill. It wasn't about, say, long
-term compound interest for the middle class.
Precisely. Benner realized the new 401k language
let employees defer salary on a pre -tax basis
and that it could apply to current income, not
just profit sharing. His first plan let people
contribute up to 25 % of their salary capped
at $30 ,000 a year. Those are huge numbers for
back then. They are. And they clearly show the
initial focus was on high earner tax mitigation.
That niche idea just... It exploded and it morphed
into the mass retirement vehicle we have today,
almost completely by accident. So this accidental
history brings us right to the most fundamental
decision you face when you open a new 401k. The
big one. Traditional or Roth. This choice is
all about when you pay the tax bill. And, you
know, tax experts have these models for it. E
.T. and T. Right. The traditional plan follows
the exempt, exempt, taxed or E .T. model. And
the Roth's follows the taxed, exempt, exempt
or two model. And the critical thing to see here
is that in both models, that middle E, the middle
exempt, refers to the growth. The growth of your
investments is permanently tax -free. You never,
ever pay tax on the profits your money generates.
Okay, so let's start with the classic, the traditional
or pre -tax 401k, the classic deferral. So when
you contribute to a traditional account, that
money gets deducted from your taxable income
for this year. So you get an immediate tax break.
an immediate and if you're in a high tax bracket
a powerful break it's a very substantial benefit
but and this is important the deferral only applies
to your income tax what about payroll taxes you
still pay them crucially you still pay the full
7 .65 percent for social security and medicare
on that contribution that tax is not deferred
it doesn't matter if you choose traditional or
raw and the income tax bill just It comes due
later. It comes due when you take the money out
in retirement. So if you're a listener, you're
essentially making a bet. That's a great way
to put it. You're betting that your personal
income tax rate, your marginal rate, is going
to be lower when you retire than it is right
now in your prime earning years. That is the
core calculation. If you contribute while you're
in a 35 % bracket and you retire into a 15 %
bracket, you win that bet. Big time. But what
if you lose? required minimum distributions force
you to withdraw a lot of money, and that pushes
your retirement income into a higher tax bracket
than when you contributed, then the deferral
actually backfires. It becomes a penalty. Okay,
now let's flip that for the Roth 401k. With the
Roth, the pain is all up front. Exactly. Roth
contributions are made with post -tax money.
You don't get a tax deduction now, so you feel
that tax hit immediately. But the monumental
benefit is on the back end. Tax -free. Qualified
distributions in retirement are completely 100
% tax -free. Right. You will never owe the government
another dime on that money. Not the principal,
not the growth. So let's be very clear about
the rules for qualified distributions. They're
strict. Very strict. We looked into the code
and two things have to be true at the same time.
First, the distribution has to happen more than
five years after your very first Roth contribution
to that specific plan. The five -year clock.
Right. And second, the withdrawal can't be made
before you turn 59 and a half unless a very specific
exception applies, which are detailed in IRS
code section 72T. And there's a key administrative
difference here from an IRA. A Roth 401k contribution,
once you make it, it's set in stone. It's irrevocable.
You can't later convert it back to a pre -tax
traditional contribution. With a Roth IRA, you
can do that. Not so with a 401k. So this brings
us to what you said is the profound insight connecting
both accounts. The permanently tax -free profits
on your after -tax savings. This is the real
A -plus advantage. It's not the deferral itself.
Okay, this is a nuanced point, and I think we
really need to spend a minute on it because it
forces you to think about the traditional account
in a totally different way. It really does. So
let's use a conceptual model. Think of it as
the government co -owner. When you contribute
pre -tax to a traditional account, you get that
immediate tax reduction. Conceptually, that tax
reduction is the government investing its share
right alongside yours. They are essentially lending
you that money to invest tax -free. So if I contribute
$1 ,000 and my tax rate is, say, 25%, the government
basically owns $250 of that amount, but I get
to invest and manage the whole $1 ,000. Exactly
right. And that full $1 ,000... grows tax -free
for decades. When you finally take a distribution
in retirement, the tax you pay on that withdrawal
is just the government reclaiming its $250 share
of the principal. Okay. Plus the profits that
its $250 share generated, all calculated at whatever
your tax rate is in retirement. So the withdrawal
tax isn't a tax on my growth. It's just the government
taking back its loan plus its share of the profits.
The money I actually saved, my original $750,
that part grew tax -free forever. That is the
crucial synthesis. The only real difference between
traditional and Roth is who gets to benefit from
the leverage on the government's portion. Right.
If you bet correctly on a lower tax rate in retirement,
you win because the government takes less back.
But the tax -free growth is the core feature
of the whole vehicle no matter when you pay the
tax. To boil that all down, the only true benefit
in both systems is tax -free growth, and the
timing of the tax is just a bet on future tax
rates. Is that the simplest way to say it? That
is the most accurate assessment. And one last
point on eligibility that we have to mention.
The Roth 401k has a really big advantage over
the Roth IRA for some people. You're talking
about high earners. Yes. The Roth IRA has a strict
upper income limit. If you earn too much, you
just can't contribute, period. The Roth 401k,
on the other hand, has no income restriction
at all. This makes it an incredibly valuable
tool for what the IRS calls highly compensated
employees, or HCEs, who are locked out of the
Roth IRA. It gives them a way to get that permanently
tax -free growth that's otherwise unavailable
to them. OK, so shifting from that philosophical
choice to the hard reality of compliance, the
annual contribution limits. And these are absolutely
unforgiving. If you get this wrong, the penalties
can be devastating. So we need to break down
two separate limits. The first one is the one
most people know about, and it limits what you,
the employee, can put in from your salary. That's
the employee elective deferral limit, or if you
want the code, the 402G limit. For the latest
year we have in our sources, that limit was $23
,000 for 2024. And that's a combined total, right,
for both your traditional pre -tax and any Roth
post -tax contributions you make. It all goes
in one bucket against that limit. And these limits
aren't static. No, they're indexed for inflation.
They usually go up in $500 increments. And Congress
also created a special provision for older workers,
the catch -up contribution. This is for employees
who are age 50 or older at any point during the
year. For 2024, that catch -up limit was an extra
$7 ,500. So an older employee could contribute
up to $30 ,500 in total. And our sources pointed
out a very specific temporary increase to that
catch -up limit coming in 2025 and 2026, specifically
for people aged 60 through 63. So that's a targeted
effort to let people who are really close to
retirement save even more right at the end. Exactly.
It's a government push to facilitate that late
-stage saving. Okay, so that's just the employees
part. The second limit is much, much higher.
It's the total amount that can go into the account
from all sources, employee and employer. That's
the Section 415 limit. This is the absolute ceiling.
It includes your deferrals, your catch -up, any
employer match, and any profit sharing. And the
limit is? It's the lesser of 100 % of your compensation
or a statutory dollar amount. For 2024, that
was $69 ,000. plus your catch -up if you're eligible.
We should probably clarify how the employer match
works with the Roth choice because that can be
confusing. It can. Employer matching funds are
great, but they always have to be made on a pre
-tax traditional basis. Always. Always. So if
you contribute $10 ,000 to your Roth 401k and
your employer puts in a $5 ,000 match, that $5
,000 from them is traditional money, you'll pay
tax on it when you withdraw it down the road.
And some companies also do profit -sharing contributions.
Yes. And those are separate from your own contributions.
But just like the match, those profit sharing
dollars are pre -tax and they count toward that
big aggregate Section 415 limit. Before we get
into penalties. There's a specific group of workers
who are sort of left out here, government employees.
Right. Federal, state, and local governments
are generally barred from offering 401K plans
if the plan was established after May of 1986.
They usually offer something called a Section
457B plan. Which is similar but not identical.
Similar limits but different rules, especially
around when you can get your money after you
leave your job. Okay. Let's talk about the danger
zone. Over -contribution. This happens a lot
when someone switches jobs mid -year, right?
Oh, it's a huge risk. The new company's payroll
system has no idea what you contributed at your
old job. But the limits apply to you, personally,
across all the plans you participate in for the
year. And if you go over that 402G limit... You
have to fix it. The excess contribution, plus
any earnings it generated, has to be distributed
back to you by April 15th of the following year.
And if you miss that deadline, you fall into
the double taxation drought. How does the IRS
manage to tax you twice on the same money? It's
brutal. The initial excess contribution was never
a valid deferral, so it's taxable income in the
year you earned it. That's tax number one. But
if you make the correction late, the distribution
of that excess money is also reported as income
in the year you take it out. That's tax number
two. You get taxed twice on the principal amount
you contributed by mistake. that is just a punishing
outcome for what could be a simple mistake okay
finally let's quickly hit the contribution deadlines
they're different depending on the business they
are for a standard corporation or an llc taxed
as one contributions generally have to be in
by the end of the calendar year but for unincorporated
businesses Sole proprietorships, partnerships,
the deadline is much better. How so? It's extended
all the way to your personal tax filing deadline.
So April 15th or even September 15th, if you
file an extension. The 401k is designed for long
term saving and the IRS uses some pretty heavy
financial incentives to make sure it stays that
way. Absolutely. So we need to get into the rules
around early access, starting with the big one,
the general penalty age. The magic number is
59 and a half. If you take any money out before
then. you get hit twice. First, you pay ordinary
income tax on the amount. And second, you pay
a separate, very painful 10 % penalty excise
tax. So it's designed to make you think twice
or three times. It is. It's there to ensure the
money stays invested for its intended purpose,
which is retirement. OK, but there are emergency
exits. The one people ask about most is the hardship
withdrawal. The IRS has a very narrow definition
of a real hardship. Very narrow. The code lays
out six specific reasons. Things like unreimbursed
medical expenses, costs for buying your primary
home, some educational costs for the next 12
months. Things to prevent foreclosure or eviction.
Right. Funeral expenses or repairs for damage
to your main home. It's a specific list. But
then this is the crucial part for you, the listener.
IRS says it's okay, your employer can still say
no. That's the critical footnote. The employer
is the final gatekeeper. The specific plan document
determines what's allowed. An employer can, and
often does, choose to disallow some or even all
of those hardship reasons. And we should probably
mention, you know, the CARES Act in 2020 was
a temporary exception to all this. It was. It
allowed penalty -free withdrawals. of up to $100
,000 for people dealing with pandemic -related
issues. But that was a very specific, temporary
measure. So beyond hardship, what are the other
common ways to get your money early without that
10 % penalty? Well, the sources list a few key
exceptions. If you leave your job in or after
the year you turn 55, that's called the age 55
rule, you avoid the penalty. You also avoid it
in cases of death or total and permanent disability,
distributions that are part of a divorce settlement,
a QDRO. Also avoid it. And then there's a complex
one called substantially equal periodic payments
or 72T payments. Let's talk about 401K loans.
A lot of people see this as borrowing from yourself.
You know, no big deal. But there's a hidden tax
flaw. There is. On the surface, it seems great.
The interest you pay on the loan goes right back
into your own 401K account. So you're kind of
paying yourself interest. Right. The problem,
the tax complexity, comes from the fact that
you make those loan repayments, including the
interest, using after -tax money. So you pay
tax on your salary and then you use what's left
to pay the interest on the loan. Exactly. But
that interest you pay back doesn't increase your
actor tax basis in the 401k. So when you eventually
withdraw all the funds in retirement, that interest
money, which you already pay tax on once, gets
taxed again as ordinary income. Double taxation
on the interest. It is. It makes the real financial
benefit of the loan very questionable. And the
risk if you default is huge. Immense. The code
says you have to pay the loan back in five years
max, unless it's for buying your main home. If
you default on that or if you leave your job
and can't pay it back. What happens? The entire
outstanding loan balance is immediately treated
as a taxable distribution. So you're paying ordinary
income tax on the whole amount, plus the 10 percent
early withdrawal penalty if you're under 59 and
a half. It's a tax torpedo. It can be financially
devastating. So the government lets you defer
taxes for decades. But eventually, they want
to get paid. They want their share. And that
brings us to the mandatory drawdown rules. Required
minimum distributions or RMDs. RMDs are just
the government's way of forcing you to finally
recognize that deferred income so they can tax
it. Generally, you have to start taking distributions
by April 1st of the year after the year you turn
72. Is there any way to delay that if you're
still working? Yes. There's a vital working exception.
The RMD isn't required if you are still employed
by the company sponsoring the 401k plan for the
whole year and you own less than 5 % of that
business. But once you retire, the clock starts
ticking. The clock starts. The RMDs have to begin.
And the penalty for not taking an RMD seems,
well, it's draconian. 50%. Why is the IRS so
aggressive on this? Because if they don't force
you to take the money out. The whole tax deferral
system breaks down. They let you defer tax for
decades, so they have to ensure they eventually
collect it. The penalty is 50 % of the amount
you should have taken out. It's designed to make
you comply. And just to be clear, RMDs apply
to both traditional and Roth money inside a 401k,
right? They do, which is a key difference from
a Roth IRA, which has no RMDs for the original
owner. In a 401k... You have to take them from
both sides. The moment an employer decides to
offer a 401k, they walk into this very complex
world of compliance, specifically non -discrimination
testing or NDT. And the whole point of NDT is
to stop the plan from just becoming a tax shelter
for the company's top earners. It's about fairness.
It's about ensuring the lower paid employees
actually benefit, which in turn puts strict limits
on how much the highly compensated employees,
the HCEs. can contribute. So let's define an
HCE clearly. What is it? It's based on two things.
Either your compensation is over a certain amount
for 2025, that's $160 ,000, or you own more than
5 % of the business. Either one makes you an
HCE. And the main test they have to pass is the
actual deferral percentage test, the ADP test.
Explain the 2 % rule. The ADP test compares the
average contribution rate of the HCEs to the
average rate of the non -highly compensated employees,
the NHCEs. And the rule is simple but powerful.
The HCE average cannot be more than 2 percentage
points higher than the NHCE average. Let's use
a real example. Say the regular employees, the
NHCEs, only contribute an average of 1 .5 % of
their salary. But the executives are putting
in 10%. The plan fails badly. Fails badly, correct.
If the NHCE averages 1 .5%, the HCE average can't
be higher than 3 .5%. So if the plan fails, the
employer has a big problem to fix. And what are
their options? The most common solution is they
do a return of excess. They literally have to
send taxable refund checks back to the HCEs to
get their average contribution rate down. Or
they can do a QNEC. A qualified non -elective
contribution. This is the more expensive option
for the company. They make an immediate 100 %
vested contribution to all the NHCEs to artificially
raise their average deferral rate. up to a passing
level. So they give the lower -paid employees
more money to make the test work. Exactly. If
they boost that NHCE average from 1 .5 % up to,
say, 4%, then the HCEs would be allowed to defer
up to 6%. And that cost is what pushes a lot
of companies toward a safe harbor plan. It is.
A safe harbor plan is designed specifically to
get out of that ADP testing altogether. The company
agrees to make a guaranteed, 100 % vested contribution
to all eligible employees, either as a match
or as a flat contribution. And in exchange for
that guaranteed cost, they don't have to worry
about the testing anymore. The compliance headache
just goes away. Okay, shifting gears to fees.
This is often called the silent killer of retirement
growth. What should you as a listener be looking
for? You have to look past the performance numbers
and dig into the expense ratios and administrative
costs. Fees cover everything, record keeping,
administration, investment management. And they
add up. They do. Back in 2011, the average total
fee was around 0 .78 % of assets. That's about
$250 a year per participant. But for small businesses,
those fees can be way higher, sometimes double
the average. And the whole issue of excessive
fees led to that landmark 2015 Supreme Court
case, Tibble v. Edison International. That case
was so important. The court ruled that plant
administrators could be sued for excessive fees,
and it established they have a strict, ongoing
fiduciary duty to monitor those fees. What was
the specific issue in that case? The court called
out the use of more expensive retail class mutual
funds when cheaper, identical institutional class
shares were available. Plan sponsors now have
to prove they are constantly monitoring fees
to make sure they are reasonable. Okay, so to
fight low participation, especially among the
NHCEs, we've seen this big push for automatic
enrollment. Right, where you're in the plan unless
you actively opt out. And to protect the employer
in that scenario, they created the QDIA. The
Qualified Default Investment Alternative. This
came out of the Pension Protection Act of 2006.
If an employee gets auto -enrolled but never
chooses their investments, the money has to go
into a QDIA. And what are typical QDIAs? They're
usually professionally managed funds that are
designed to be risk appropriate. So things like
target date funds, balance funds, or managed
accounts. And by using one, the employer is protected.
They get fiduciary relief. If the investments
lose money, they're protected because they follow
the legal mandate for a suitable default option.
So when you leave a job, you face the rollover
decision. There's a right way and a very risky
way to do it. The right way is the direct rollover.
The money moves straight from the old plan to
a new plan or an IRA. No taxes, no penalties.
It's clean. The risky way is taking the check
yourself. Right. If you take possession of the
funds, you have to complete the rollover into
a new account within 60 days. And if you miss
that 60 -day window... The entire distribution
becomes taxable as ordinary income, and if you're
under 59 .5, that 10 % penalty applies. And there's
another catch, right? Withholding. Yeah, the
employer is legally required to withhold 20 %
of the distribution for taxes. Which means if
you want to roll over the full amount, you have
to come up with that 20 percent out of your own
pocket to complete the rollover and then wait
to get it back from the IRS when you file your
taxes. It's a mess. What about converting traditional
funds to Roth inside your company's plan? Can
you do that? The IRS does allow what's called
an in -plan Roth conversion, but there's a huge
caveat. What's that? The company plan has to
offer both a traditional and a Roth option, and
the plan documents have to explicitly say that
these conversions are allowed. If they do, you
can do it. You pay the income tax on the converted
amount that year, and then it grows tax -free
forever. Okay, finally, let's touch on plans
for small businesses and the self -employed because
the rules there really loosened up about two
decades ago. Yeah, EGTRA in 2001 was the key
legislation. It raised the maximum employer profit
-sharing contribution from 15 % all the way up
to 25 % of eligible pay. Which was a huge deal
for business owners. A massive deal. It drastically
increased their savings capacity. So an incorporated
person can put in their maximum employee deferral
plus that huge 25 % profit sharing contribution
all the way up to the total Section 415 limit.
But there's a critical difference for unincorporated
people, like a sole proprietor. The math gets
a little tricky. It does. For someone running
a Schedule C business, the profit sharing is
calculated as 25 % of their net self -employment
income. And because the contribution itself is
deductible, it reduces the net income you use
for the calculation. So the actual rate ends
up being a little less than 25%. So for a sole
proprietor with $100 ,000 in gross income, the
actual contribution would be more like $20 ,000,
not $25 ,000, because that $20 ,000 contribution
lowers their income before the calculation is
even applied. Exactly. You need precise accounting
for that. It's a circular calculation. And one
last complex maneuver we should define, ROBS
rollovers as business startups. Right. Using
retirement money to fund a new business, is that
right? actually legal? It is if you follow the
very specific IRS rules. It lets you use your
existing 401k funds to buy stock in a new C corporation
that you're starting. And you don't pay taxes
or penalties. Correct. It's a way to get startup
capital through a tax -free transaction. The
IRS watches these plans very closely, but they
are a valid, if very complex, financing option.
Contact 6, global context, critiques, and the
future. So while the 401k is uniquely American
in its name and origin, the idea of a defined
contribution system is global. Oh, yeah. The
term 401k has almost become generic worldwide.
Japan, for example, adopted what they call a
Japan version 401k back in 2001. Other countries
have had their own schemes for a long time. Like
in the UK or Canada? Right. The UK has personal
pension schemes. Canada has RSPS registered retirement
savings plans, which are a little different because
they're individual vehicles, not strictly tied
to an employer. How is Australia's system fundamentally
different from the U .S. model? Australia's superannuation
funds are really interesting because of the mandatory
employer contribution. Yeah. Australian employers
are legally required to contribute a certain
percentage of an employee's salary into their
fund. This ensures a baseline level of savings
that isn't dependent on whether the employee
chooses to participate or not. That mandatory
piece is what's missing in the U .S. And what
about in Asia? What models do we see there? Well,
India's national pension system, the NPS, works
a lot like the 401k for government and corporate
workers. Similar rules for investing in taxes.
And in Malaysia, you have the Employees' Provident
Fund, or EPF. It was established way back in
1951. It's mandatory for private sector workers,
and it ensures huge savings and broad participation.
Okay, now we have to turn to the system's deep
structural flaws. Flaws so severe that the inventor
himself, Ted Benna, once said he felt like he
had created a monster. And the first, most basic
criticism is just the risk of loss. It's inherent
in any defined contribution plan. Right. There
is no government guarantee. Absolutely none.
Unlike a pension or an FDIC -insured bank account,
the assets in your 401k can go to zero. And even
if you diversify and shift your risk as you get
older, you're still exposed to huge market declines
like what we saw in the Great Recession. And
that risk is compounded by the hitter costs,
the fees. A plan sponsor going bankrupt won't
lose your assets, but those excessive fees from
providers act like a constant silent drag on
your returns year after year. The second major
critique is the incredible burden of choice that's
placed on the employee. Why is our entire national
retirement system built on the assumption that
non -experts can choose and manage complex investments?
It's a huge and I think unfair assumption. The
complexity of picking funds, rebalancing, updating
your choices for 40 years. It's a major bill
here. It's why a lot of people, especially lower
income workers, just don't sign up at all. Target
date funds were supposed to fix that. They were
intent to mitigate it, sure. But even those require
a certain level of trust and a basic understanding
of risk. The third critique, and maybe the most
politically charged one, is inequality. The tax
breaks just overwhelmingly benefit people who
can afford to save the most. Precisely. If you're
a high earner, that tax deduction is worth a
ton of money. If you're a low income earner,
the deduction is negligible or even zero. And
the stats are pretty stark. They are. Our sources
cited data showing the highest earning groups
save enough to get about 11 times more in retirement
income than the lowest earning groups. It directly
widens the wealth gap. And beyond that, there's
just the participation gap. Not every employer
even has to offer a plan. It's totally voluntary.
Millions of workers have no access to the system's
tax advantages at all. And this is something
Ted Benna himself has proposed fixing. He suggested
mandating that companies over a certain size
have to offer a 401k to ensure wider access.
And all of this leads directly to the core problem.
Are people saving enough? And the answer seems
to be no. This reliance on defined contribution
plans means retirement income is just wildly
unpredictable. What was that statistic? It was
a deeply concerning one. In 2017, 49 percent
of Americans between the ages of 55 and 66 had
no personal retirement savings. None. Zero. That
huge gap means a massive part of our population
is facing either working into old age or living
in poverty, relying only on Social Security.
So given all these really severe criticisms.
There are now some pretty big proposals on the
table to fundamentally change how we do retirement
in the U .S. Yeah. One bipartisan idea is to
open up the federal government's thrift savings
plan, the TSP to all employees, not just federal
workers. And that would provide a more stable,
defined. income structure. And it would leverage
the massive scale and the super low cost of the
TSP. And then there's the most provocative proposal,
which is to just end the 401k tax break entirely.
What's the economic thinking there? The researchers
behind that argue that the tax break doesn't
actually create new savings on a national level.
It just encourages high earners to shift money
they were already going to save from a taxable
account into a 401k to get the break. They say
the subsidy is ineffective. And if they got rid
of the break, what would they do with all that
new tax revenue? They estimate it would bring
in about $200 billion a year in additional revenue.
And they propose using those massive funds to
directly support and shore up Social Security.
So shifting the focus back to a universal guaranteed
safety net. Exactly. It completely challenges
the philosophical foundation of American retirement.
It asks, you know, if the current system is failing
almost half of all near retirees, should we keep
prioritizing tax breaks for individuals? Or should
we shift our resources back to a guaranteed benefit
program for everyone? Hashtag Chag Outro. We
have covered a vast amount of ground today. From
the accidental birth of the 401k as a tax dodge
for executives facing a 70 % rate. All the way
to its current, very complex structure that's
struggling with these huge questions of equity
and sufficiency. So the key takeaways for you,
the listener, are really critical. First, master
that tax duality. Right. Traditional, or EET,
means you pay tax later. Roth or TEE made you
pay tax now. But remember, in both cases, the
real prize is the permanently tax -free profits.
Second, be hypey vigilant about compliance. Know
your personal contribution cap, that 402G limit,
and understand that brutal double taxation penalty
if you go over, especially when you switch jobs.
And you have to understand the immense burden
that's placed on you, the burden of choosing
investments, of monitoring fees. It's all on
your shoulders. And finally, just remember where
the system's flaws come from. 401k was designed
as a niche tax dodge for the highly compensated,
and it just sort of accidentally became the default
retirement vehicle for the entire country. So
that leaves us with a final provocative thought.
Given its inherent market risks, the complex
burden of choice it puts on the average person,
and its very real contribution to inequality.
Should the U .S. government continue to prioritize
these massive tax breaks for individual savings?
Or should the focus shift back toward universal,
government -funded, defined benefit security?
What are you willing to trade for that tax deferral?
Thank you for joining us for the Deep Dive.