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March 02, 2005

Why 401(k)s Can Suck

Matt rightly suggests that before we talk too much about new "private accounts", maybe we should pay more attention to the ones we already have, namely 401(k) plans.

But before we embrace Matt's plan to automatically enroll workers in 401(k)s, we should make sure it's a good deal for them. If there's a decent employer match for contributions, that might make sense, but 401(k)s are not necessarily a good deal. Take this Bureau of National Affairs study:

we find that low- and moderate-income households actually raise their lifetime taxes and lower their lifetime expenditures by saving in a 401(k) plan.
Why this bad result for lower-income 401(k) savers? Because social security benefits are taxed for higher-income seniors, so if you save too much income for retirement, you actually can end up losing more social security benefits to taxation than you gain in tax savings from using a 401(k). Higher-income savers (who can expect to have their social security fully taxed whether they use 401(k)s or not) unambiguously gain tax advantages from 401(k)s.

So the workers refusing to use 401(k)s in favor of spending their money today may actually be smarter than a lot of people give them credit for.

The implication of this study is that almost all the revenue costs of 401(k)s go for the benefit of high-income savers, something to remember before liberals sign onto to creating any other tax-subsidized system of "private accounts," even if it's on top of social security rather than a replacement.

Posted by Nathan at March 2, 2005 09:38 PM