Ted Benna is not happy with what became of his creation.
Benna was working for an insurance firm outside Philadelphia about 40 years ago when he figured out how to use an obscure provision of a 1978 tax law-section “401(k)”-and turn it into an employee retirement account for contributions from both employees and employers. He designed it as a fringe benefit for banks that wanted to save taxes when they transferred bonuses to employees. In the years since, however, it’s grown into much more-it’s now the dominant way that Americans save for retirement, helping them collectively amass trillions.
Today, he’s proud that his invention has helped millions of people prepare for retirement. But the plain-spoken Pennsylvanian now says that the accounts have an “ugly” side-primarily that they have made mutual fund companies and investment managers rich off fees that grew way too high. He’s now on a crusade to design simpler plans with lower fees that put money in the pockets of future retirees, not money managers.
He’s also got lots of ideas for how to fix the American retirement crisis more broadly. He wants a requirement that employers above a certain size offer a payroll deduction plan. He wants to fix the “leakage” problem in which money drains out of 401(k) plans when people leave jobs. The answer? “Block the door,” says Benna. Make people keep 401(k) money locked up for retirement.
He also wants a massive education program aimed at younger workers to get them started saving for retirement early and taking advantage of corporate matching programs. He doesn’t much care if he gets painted as an old curmudgeon shaking his cane at young folks and telling them they could have a decent retirement if they just started socking some money away instead of buying $5 lattes.
“I mean, my grandkids, I see it, I say, ‘Holy crap. Don’t buy four- or five-dollar drinks!'”
Here’s a slightly condensed version of my hourlong conversation with Ted Benna, father of the 401(k), from his farm in northern Pennsylannia.
Ben White: You’re known as the father of the 401(k) plan. Tell us about how you first came up with the idea of using the tax code in this way. Give us a little history lesson.
Ted Benna: The short version is that article 401(k) was added into the tax law in the fall of 1978, which will be 40 years ago this fall. It was only a page and a half long. That’s all there was. And it was intended for a totally different purpose-for what were known then as cash-deferred profit sharing plans that primarily existed at banks. In the fall of 1980, I had a consulting assignment for a Philadelphia-area bank that was looking to get rid of their cash bonus plan. I was sitting in my office on a quiet Saturday afternoon pondering how to come up with something that was going to be workable. The cash bonus was going to be replaced by putting the money into one of these qualified retirement programs instead, and I had the unpleasant job of explaining to bank employees as the outside consultant why the bank was doing this, “looking out for their long-term welfare.” You know, not everybody stood up and cheered about that. They had been used to getting a cash bonus for years.
For this to work for the higher-paid employees, there had to be a sufficient buy-in for what was the bottom two-thirds of the employees. And I knew bank tellers at that time. They weren’t getting paid that much money, that giving up a $500 cash bonus in exchange for maybe a $50 or $75 tax break wasn’t going to do it. And that was when I came up with the idea of, “Well, let’s add a match to this.” I felt the match had the potential of making this thing fly. And that was the big ‘aha!’ moment.
It’s often asked, “Did you expect this thing to get big?” And I thought, “Well, yeah. Holy crap.” I knew we could go out to corporate America, to senior execs and say, “Hey, you know, this $20,000 or $30,000 you’re putting in this savings plan after tax at a 70 percent marginal federal tax rate? This is a way you can do that pre-tax.” That probably would get their attention.
White: It originally went by a different name that was not quite as attractive to people. It took a while to get the branding on it right?
Benna: We packaged it under something called “cash-ops” for “cash options.”
White: This is 1980 we’re talking about. And it quickly takes flight as a popular option. But at the time you certainly didn’t view it as a replacement for traditional pension plans at companies, the traditional way for people to have retirement security. It was kind of an add-on way to save money. Is that the way you viewed it?
Benna: When we talk about the history of the private retirement system, there’s a very distorted picture out there today. I’m not political. OK? During the last presidential election, Bernie Sanders and President Obama both stated, “We need to get back to what we used to have where everybody had a pension and it was wonderful and blah, blah, blah, and everybody had a pension.”
Well, a couple of facts; there was never more than 30 percent of the private-sector workforce that had a traditional defined-benefit pension. I started on that side of the business. I sold them. It was never above 30 percent. My first employer had a pension plan. To become a participant you had to wait until you were 30 if you were male and 35 if you were female. And you had to stay until you were aged 60 before you got any benefit. That was pretty standard. If you left before that, you got zippo.
White: These are the vesting requirements that we’re talking about here?
Benna: Yeah. And when employers went out of business in those days, retirees and workers who had spent years working in underfunded plans lost a large piece or a major part of their pension. So, you know, the good old days weren’t-
White: Weren’t that good?
Benna: Weren’t any better than they are now. I mean, that’s reality. So now, given that, let me get to what has happened since 401(k). The large companies that had thrift saving plans made the conversion [to 401(k)s]. The [thrift] plans they had in place were glorified Christmas clubs. You put 6 percent of your pay in, you got it matched dollar-for-dollar in a lot of companies. Well, at the end of the year, you’re allowed to take your money back out. And most employees did.
So what happened in the big companies-and you see the remnant of it today-is they simply added the ability for employees to put their money in pre-tax if they wanted to, but they still left the after-tax. So you can do either, or you can mix or whatever. So what happened is you now forced the employees in those companies to say, “Well, do we want to continue playing the short-term game or switch to the long-term and get the tax break.” The give-up was, the money is going to get invested, and we’re not going to be able to get our hands on it other than for these hardship withdrawal rules. So, what happened is employees in those plans began to fairly rapidly shift over to the pre-tax.
I have family members and friends, you know, lots of folks who have retired over the last 10, 15 years or so, who have been greatly benefitted by 401(k) because they got their pensions; they got Social Security; and they accumulated six-figure 401(k) accounts. I’m talking about average people, not senior execs. They’re living better in their retirement than they would have otherwise.
There now are over half a million 401(k) plans. And over 90 percent of them cover employers with less than 100 employees, over 90 percent. Those employers, most of them-I mean, not all, but maybe as many as 90 percent – would never have had a traditional pension plan. You know, they just wouldn’t make that financial commitment. I mean, it’s reality. And even in those plans at that time you had to stay around 10 years or more to be vested. And so, those plans, you know, the amount going in from the employer wasn’t enough to build an adequate retirement. So gradually, what happened with all of those plans is they got converted into combination 401(k)-profit-sharing plans. So, I would argue, as of today, that generally we have a much better situation than would have been the case without 401(k).
Going forward, we have a much bigger problem because employers have jettisoned the traditional pension plan. That happened. And that would have happened whether 401(k) was ever around or not.
White: So you’re saying that it is not fair or correct to blame the rise of the 401(k) and defined-contribution plans for the reduction in defined-benefit plans?
Benna: I mean, I don’t care if people crap on 401(k). It doesn’t keep me awake at night. But, you know, it’s just not reality. There’s another piece of this that needs to be understood. The ideal is that employees have both. That’s the perfect system-you have a properly funded employer defined-benefit plan and a 401(k) plan. Okay? And a financially solvent Social Security.
White: That would be the ideal world to live in. We don’t happen to live in that world.
Benna: Exactly. But let me just make one point here. Defined-benefit plans are great if you spend most of your career at one place and have a final pay plan, where your benefit is calculated on your average income the last five years or whatever. If you move from job to job, they’re pretty crappy, because I don’t know if you’re familiar, if you’ve ever seen the actuarial curve of how value builds in a defined-benefit plan, but it’s very much back-end loaded. So, if you work from age 25 to 32 at some place covered by defined benefit and you leave, you get cashed out with less than $5,000.
White: Exactly, because you weren’t making that much money at that point.
Benna: Plus, the actuarial amount needed to fund what is in fact a lifetime annuity when you’re 25, isn’t that big. You’ve got 40 years it’s going to be invested. So now, when you’re 60 and obviously your pay is a lot higher, now you’re talking about a benefit that’s going to become payable in five years. Well, you’re going to crank a lot more money in to fund that thing.
White: OK, so let’s not blame the 401(k) for the fall of defined-benefit plans. But that doesn’t mean that you’re not critical of what happened with 401(k)s, particularly fees and Wall Street.
Benna: You know, 401(k) at its root is nothing more than a vehicle for people to save for retirement, pure and simple. And it’s the best vehicle out there for doing that that exists today because it converts spenders into savers, and we’re all spenders, and there are very few of us that have the discipline to do what happens in a 401(k) plan every pay period on our own, including me.
White: Including me. One hundred percent. I would not have the amount I have saved for retirement without it. No question at all.
Benna: It’s helped millions of people accumulate trillions of dollars. I have no regret about that. It’s probably between $10 [trillion] and $15 trillion, I figure, when you count the rollovers. So, I have no regret about that. Where I have my regrets is, frankly, what the money-fee people have done. And it’s ugly.
White: So what have they done? I guess we’re talking Wall Street here.
Benna: Yeah, we sure are. Well, for starters, you know, 401(k) made the mutual fund industry. I mean, it was a ma-and-pop business before that.
White: How did the investment management industry get so big and wealthy off of this in ways that might have diverted from your initial vision and purpose?
Benna: Well, my initial vision and purpose was humbly making money because I had a family. [LAUGHS]
White: Well, sure. I mean, we’re in a capitalist system here. But, I mean, I don’t think you invented the 401(k) with the idea of creating these mutual fund giants who charge high fees to people.
Benna: Exactly. The mutual funds and the advisers. When this thing started, all the expenses of operating a 401(k) were paid by the employer except the investment fee. The record keeping, the legal, everything was paid by the employer. And at that point the investment fees were pretty straightforward because you only had one share class of funds. You didn’t have 15 of them or whatever American Funds might have now. So that part was pretty simple and straightforward.
The next piece that is key here is you only had two investment choices-stocks and bonds. You only had two funds. And you split in multiples of 25 percent. So you had five potential portfolios, you know, 0-25, 50-50, 75-25, 100-0. It took me one minute to explain the investment options to participants. And then we went to three. The third one that was added typically was a balance fund, which was pretty goofy because when you had option A that was fixed [bonds] and option B that was equity [stocks], well, you got balance by mixing those two so you didn’t need to stick a balanced in. But, anyhow, that’s what happened. And then it went to four, to five, and, you know, 10, to 12, to 20. So it got a lot more complicated for participants.
White: So let’s get into your ideas for making the 401(k) plan better. How do we do that?
Benna: On the coverage front, you know, the fact that half the workforce out there doesn’t have access to use this type of vehicle, the answer is to do something that I hesitate to recommend but don’t see an alternative. I know a lot of people will jump on me on this one. And that is to require employers, at least above a certain size-five employees, 10 employees, whatever-to offer a payroll deduction program.
White: The dreaded mandate?
Benna: Yeah. I mean, I don’t see anything else getting there. The mandate that you have to make a payroll deduction program of some type available.
The other problem that 401(k) continues to get beaten up over, rightly so and can be fixed pretty easily, is the leakage problem. Money escapes when people leave jobs or plans are terminated, and the easy answer to that one is you block the door. People change jobs, they’ve got to keep the money in a retirement lockup, the next employer’s plan, IRA, or whatever. Not hard. So those are, you know, they are two biggies.
White: All right. So the employer mandate, fixing the leakage problem. What you’re talking about is a fairly significant piece of legislation or individual pieces of legislation that would get at these issues. And that gets us into the political realm of how challenging some of this stuff is and the interests that fight against it. But you’ve also talked about how some of these fund managers are getting very rich off the fees, and the fees are too high.
Benna: I have put out and published a guide that’s geared for the bottom end of the market, you know, the little guys that don’t have a plan. It’s titled How to Set Up Your Own 401k, with the subtitle of And Save a Lot of Money. What I have put out are three designs for tiny businesses that enable them to provide benefits similar to what you get with a 401(k) plan without the cost complexity or liability exposure. And they can be set up and operated for no employer fee and cost as little as five basis points (0.05 percent) to participants. I mean, pretty incredible.
White: So you’re not paying money to Vanguard or Fidelity or anybody else?
Benna: These are driven off Individual Retirement Accounts. One of the big challenges is finding the home for the money. I started with Vanguard, but the problem is Vanguard has a $1,000 minimum to open an IRA account. So I’ve got to do a workaround. I went to some others, and I didn’t find anything easy there to work with any place else.
White: Let’s just pull the lens back a little bit, if we could, and look at the entirety of the retirement situation in the United States and particularly for the younger generation of workers who are simply not saving enough through a 401(k) or don’t have access to 401(k)s. What do we need to do to increase retirement security among Americans?
Benna: The best thing we could throw at them is massive education and having folks-you know, parents, grandparents-stepping up and telling their kids, “Hey, look. you need to get this going early.” Get them in the game. The approach I take with folks is to say, “Start at 1 percent. I mean, it’s not much. It’s not going to hurt you. Think about what discretionary spending do you do.” You know? “Do you stop at Starbucks?” I mean, my grandkids, I see it, I say, “Holy crap. Don’t buy four- or five-dollar drinks!”
White: Do people get mad when you say, “You could have a good retirement if you don’t have that latte and avocado toast”? Then everybody yells at you for being an old guy shaking your stick at the kids? But, I mean, there is truth there that if you cut just a tiny bit of discretionary spending and started your 401(k) plan at 1 percent plus the match and then had an auto-accelerate, you would be doing a lot better. I mean, we’re not going back, I don’t think, to the paternalistic model of the corporation with a very generous defined-benefit plan.
Benna: It’s not going to happen.
White: Retirement is going to be largely self-directed with, as you mentioned, these accelerators put in and auto-enrollments put in so there is some nudging along the way from the corporation. And then, God willing, we fully fund Social Security, and you have that little extra piece. It’s not going to fund your retirement, but it’s something. So it’s a better 401(k), or whatever we wind up calling it, plan, perhaps with lower fees with more strictures on auto-enrollment and getting rid of leakage, plus funded Social Security. I mean, this is kind of what it’s going to look like. Right?
Benna: You know, all these systems are manmade, and they’ve got their positives and negatives. For years in my presentations, I’ve said, “Look. Every retirement system out there whether it’s public, private, defined-benefit, or defined-contribution is dependent over the next 20, 30 years on a strong economy and a robust stock market.” The perception that you do not have investment risks with a defined-benefit plan is a bunch of malarkey.
White: Oh, of course. I mean, what is this stuff invested in?
Benna: You have the risk, you just don’t know it.
White: Right. If the pension goes down, it goes down. If it collapses, it collapses.
Benna: A fundamental problem on the defined-benefit side that isn’t being acknowledged, both on the public and private sector, is legally employers have been allowed to promise benefits that they don’t properly fund. It’s been a systemic problem.
White: Yeah, clearly, which is an enormous conversation we can have another hour or two to talk about. But let’s leave it there. Ted, thank you so much for taking the time.
Ben White is POLITICO’s chief economics correspondent.