When Aaron Brown asserted in a recent opinion piece in Bloomberg that 401(k) plans today offer little or no tax benefits to savers, he ignited an uproar that the author says he didn't expect.
In the article, the former managing director and head of financial market research at AQR Capital Management argues that because taxes are much lower today than they were in 1980, savers have less incentive to participate in the plans, particularly if they're medium-wage earners. Mr. Brown estimates that in 1980 the marginal federal income tax rate for a median-income married couple with two children was 43%, while the likely retirement bracket tax rate was 15%. Today, that same couple would pay a marginal federal income tax of 12%, no different than their likely tax bracket rate in retirement, according to Mr. Brown's calculations.
"The 1980 version of the 401(k) tax deferral was equivalent to an additional investment return of 9.2% per year, an extraordinary incentive to save for retirement, even without an employer match," he writes. "Using today's numbers the benefit comes out to 0.6%, considerably less than the 1% to 2% in fees investors pay in typical 401(k) plans."
Mr. Brown also notes that retail investors today can easily buy low-cost investments outside a 401(k) given the availability of zero-cost, tax-efficient, well-diversified index funds. In 1980, investors paid 3.5% of assets in fees either in or out of a 401(k), but today they pay more for investments inside the plan, according to Mr. Brown. Investors today pay 1.5% in a typical 401(k), while paying just 0.5% outside, he says.
The industry reaction was swift.
"I give this article two great big thumbs down, way down," said David Blanchett, head of retirement research at Morningstar, in a LinkedIn comment. Mr. Blanchett took issue with the author's statements on fees, saying that most participants are in large plans with "incredibly low investment cost" and "excellent overall quality."
"It's true that there are some really expensive 401(k) plans. There's also a lot of really expensive IRAs out there, too," he said.
Jason Grantz, director of institutional retirement consulting for Unified Trust, also bristled at the author's comments on fees. "There's been non-stop downward pressure on fees across the industry for all plan sizes," Mr. Grantz said in an interview. "I doubt very seriously you'll find a plan with any kind of sizable assets that's paying 1.5% or more in fees."
Critics also faulted the author for placing an overly narrow focus on the tax benefits of 401(k) plans, saying the plans offer much more than tax advantages.
"While I understand the logic behind the diminished tax benefits now in comparison to 1980, the fact remains that there is still the need to save for retirement," said Nathan Gage, retirement plan adviser at Chemung Canal Trust, in a LinkedIn discussion. "We all know that, lacking a convenient workplace retirement plan, the reality is that far too few people would actually save on their own."
Others made the point that tax rates could swing in the other direction in the future, making the tax-deferred benefits of 401(k) plans stronger than they are now.
Criticism aside, Mr. Brown stands by his arguments, saying that tax benefits for 401(k) plans have eroded significantly since 1980, and for median and low-wage young workers those tax benefits are now sometimes less than the additional costs of the plans.
"I don't mind people calling me names. No one should write opinion columns if they don't want people yelling at them," he said in an interview. "The whole point of the article is really, 'hey look at the tax rate, look at the inflation rate' before you just recycle financial advice that's been around for 40 years and may no longer be valid."
