A journalist asked me today whether I thought that the 401(k) system was going to be trusted for retirement planning now that so many people have lost such huge chunks of their investments in the market downturn. Would people still use 401(k)s, she wanted to know, and what might save them or make them better? How about mandatory financial education?
I was a little taken aback at the idea that 401(k) programs might be viewed this way. While certainly market investments of all kinds have taken a beating, the tax advantages of 401(k)s and the possibility of employer matching contributions make them very attractive structurally, even if not attractive at the moment. I wouldn’t want to throw out a system that largely serves to help people simply because of a bad year, or even a few bad years, in the market.
But her question made me think: what could we be doing better? I don’t agree with mandatory financial education as a real curative — I’d certainly be happy enough to have real, actual home economics (not just cake-baking, but money management skills) taught in high schools. I don’t think, though, that would suddenly cure retirement woes, any more than mandatory physical education has cured obesity.
I did have an idea that I blurted out and then warmed to after the call had ended. I believe that one of the big things people forget in their retirement planning is asset allocation — having a 401(k) fully invested in the stock market when you’re 60, say, is a very poor match of your risk profile and your asset distribution. I’ve always liked John Bogle’s advice that your bond holdings be roughly equal, in percentage terms, to your age. 60% or more bond holdings would protect a 60-year-old’s retirement funds to a much better degree than any allocation of stock mutual funds would.
So what in the tax code gives people incentive to properly allocate their assets as they get closer to retirement age? I’m a big believer that if you want people to act a certain way, don’t tell them to act that way in a high school class; instead, make it worth their while in the tax code. Is there a retirement plan model that would present a simple tax incentive for proper asset allocation? As a strawman: you can earn double tax credits for 401(k) or IRA contributions to bond holdings, up to a percentage of your overall retirement savings equal to your current age. (Not ideal, since what you really want is to distribute all holdings, not just current year contributions. Anyone have a better, simpler model?)
I do think that the effects this downturn has had on those in and near retirement have been brutal, in many cases devastating. The 401(k) and IRA programs have taught many Americans the value of retirement savings by giving them a tax incentive to learn. We certainly shouldn’t throw away those ideas, but maybe it’s worth improving them with a program — and incentive — for secure asset allocation.