How equitable are 401(k) plans?

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If your employer offers a retirement savings plan, such as a 401(k), the prevailing advice is to invest in it as early and as much as possible.

But a new report out of the investment advisor Vanguard, which oversees a lot of retirement accounts, says these plans are inequitable. More than 40% of employer matches go to the richest 20% of workers — and it’s not just because they have the highest salaries.

A typical 401(k) plan might look like this: After you work somewhere for a year, your employer says, “Hey, if you contribute to this retirement plan we offer, we’ll match that dollar for dollar up to 5% of your salary.”

The report finds several problems with that model. Number one: “It’s all about how much you can afford to contribute and how much you choose to contribute,” said MIT finance professor Taha Choukhmane, who worked on the report.

The burden is on employees to opt in. White employees and those with well-off parents reap the biggest benefits, Choukhmane noted.

“Whereas those who are single parents of kids, those who are Black or Hispanic, those who have lower-income parents tend to contribute less and make less in these matching contributions,” he said.

That’s likely because they need that money for family care or living expenses. One answer to that is to enroll employees automatically and make saving the default, per Fiona Greig, who leads investment research at Vanguard.

“Those are much heavier hammers, if you will, that are causing people to save more, evidently, even more so than the match,” she said.

Problem number two: the delayed start to employer matches, which might take months or years of being on the payroll to kick in. “Eliminating an eligibility requirement, for example, can go a long way towards equity,” said Greig.

Because lower-paid, entry-level workers are more likely to switch jobs and miss out on matching dollars early in their career, when investing is most important.

Then, there’s problem number three: Most plans match a percentage of your salary. The higher the salary, the higher the contribution. And that means recipients get a higher tax break from the government.

Teresa Ghilarducci, an economics professor at The New School for Social Research, thinks those tax breaks should be capped. Her other proposal: Follow the lead of other countries and make retirement benefits close to mandatory.

“We’re not having a debate about whether or not social security should be opt in or opt out,” she said. “Because we know that people need some support in retirement, but social security is not enough. We know that people need a supplement.”

Ghilarducci is also a big fan of the proposed Retirement Savings for All Americans Act, which would provide federal contributions to the millions of workers who don’t have access to an employer benefit plan.

The inequity is not employees’ fault, she added. But while they wait for the system to improve, the best thing they can do is take advantage of every matching dollar they can, as early as possible.

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