Ted Benna joins us to talk about how he came up with the idea for 401(k) accounts, how he got Uncle Sam's seal of approval, and the ways that Wall Street has abused the 401(k). He also discusses his new book, 401(k)s and IRAs for Dummies, including why he thinks Roths are over-sold and his recommendations for retirement plans for small business and the self-employed.
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This video was recorded on Dec. 7, 2021.
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick, joined as always by Robert Brokamp, personal finance expert here at The Motley Fool. In this week's episode, Bro sits down with Ted Benna. He's the father the 401(k). They're going to talk about how he came up with the idea and even got the US government onboard. Benna also going to talk about his new book 401(k)s and IRAs for Dummies and why you thinks Roths are oversold, and his retirement planning advice for business owners. Because they had such a long chat, we figured all that, and nothing more on this week's episode of Motley Fool Answers.
Robert Brokamp: In 2020, 60 million Americans participated in a 401(k) plan, according to the investment company institute. As of June of this year, those plans held more than seven trillion dollars in assets. That doesn't include the additional trillions that were in 401(k)s, but have since been rolled over into IRAs. But when paragraph k was added to section 401 of the IRS code back in 1978, the purpose was not to create an account that would be the foundation of retirement savings for millions of Americans. In fact, story of how 401(k)s became so popular starts with one man. Ted Benna was considered the father of the 401(k). He's also the author of five books, including the recently published 401(k)s and IRAs for Dummies. Ted Benna, welcome to Motley Fool Answers.
Ted Benna: Robert, it's definite pleasure to be here with you, tonight. Thank you.
Robert Brokamp: Sure. Our pleasure as well. Let's set the scene. It's a Saturday in 1979 or 1980, I've read different accounts. You are in your office, you were a benefits consultant back then and you are working on a project for one of your clients, which was a bank in the Philadelphia area. What happened next?
Ted Benna: Well, I was working on that project and working through what they wanted to accomplish, without getting buried in details. I realized the best way to do that was to utilize Section 401(k) and as you mentioned here, that legislation was passed in 1978. It was only a page-and-a-half long Robert and it didn't become effective until January of 1980. Because it wasn't expected to be a big deal, there wasn't anyone running around the country setting up 401(k) plans in the fall of 1980. That I look at this and the two things actually that I brought to the forefront, included we're matching employer contribution, if you put money in, you could get a matching amount from your company, and as an employee, you will be able to put money in pre-tax yourself. There's section was really intended only for employer contributions, but there wasn't anything there saying that you couldn't do a match, or that employees couldn't put money in pre-tax, so I chose to take the more aggressive interpretation.
Robert Brokamp: The pre-tax part was important. Of course, everyone loves pre-tax, but back then the highest tax rate was 70 percent. That was very compelling. You almost had to have employees participate because by law, these plans could not overly benefit higher compensated employees. You had incentivize the lower-paid employees to participate?
Ted Benna: That's exactly. I realized when I was dealing with this bank client, that the lower-paid employees probably were not going to participate to the extent needed without having some additional incentive. That's when I layered the match on top and said, "Well, OK, now if you do this, you'll get a tax break, you're going to get some more money from the bank. If you do that." Hoping that might work, and just as a side note, the bank attorney turned it down. He didn't want them [...] that's never been done. We actually did the first plan in our own little consulting company, and that plan became effective January 1, '81. That was the first 401(k) savings plan in the country.
Robert Brokamp: Something I've read and you can tell me whether this is true or apocryphal. Is that something that helped get the government seal of approval was that one of your clients had a role in the then very new Reagan administration, who put you in contact with someone in the treasury department. Is that true?
Ted Benna: Yeah, that's definitely the case. We were able to get introduced to treasury professionals actually Drew Lewis. He was most famous for the old gray hairs know that for firing the traffic controllers.
Robert Brokamp: I remember that.
Ted Benna: He introduced this over at treasury. As a result of that, I was able to discuss with the person during the regulations at treasury is a key to this was, what were these regulations coming out treasury you are going to allow and I was able to get into good dialogue with this guy about the reasons this should be supported. I didn't get any indication what the regulations you would actually include. Fortunately, when they came out in the fall of '81, they supported both a matching contribution and employing pre-tax savings.
Robert Brokamp: From my research, it looks like that you were administering maybe about 50 plans by 1982 or so. How long did it take for 401(k) to really catch on?
Ted Benna: This is going to be amazing people today because you pick up bulks and you pick up ads and you hear people talking on TV or pastors preaching sermons or whatever, and they mention 401(k). Well, we couldn't get any attention for this thing. The idea of voice saving for retirement, was totally foreign and we worked hard. You're trying to get the Wall Street Journal and the New York Times and finally, The New York Times published an article that got things rolling in a big way.
Robert Brokamp: From what I read, the reaction to some of those early articles is that people were calling or sending emails, there wasn't email back then, sending letters to the journalist saying this is totally illegal and it's a loophole, it's going to be closed.
Ted Benna: Yeah. Actually, the first person that news paper writer did an article was Craig Stock for the Philadelphia Enquirer and he came out to interview me. He was just young new writer. He owned the financial bit. Ran the article over the weekend and his phone started ringing on Monday. Tell them this thing is in your legal and I got to know Craig pretty well over the years and said, "Well, I went back and checked with the IRS and they acknowledged that maybe possible." He figured at least he had done the work he needed to do.
Robert Brokamp: Despite being the father of the 401(k), you are also known to having somewhat mixed feelings about your creation, and you were quoted at a MarketWatch articles from several years ago as saying I would blow up the system and restart with something totally different. How did 401(k)s begin to deviate from your original vision and basically who's to blame?
Ted Benna: Let me mention the fact that that article either intentionally or unintentionally misquoted what I said.
Robert Brokamp: Fake news interesting. Got it?
Ted Benna: The writer was thrilled because, man, it caught a lot of attention. I was really talking about showing up the investment structure not to hold 401(k). Talking about current enough for two reasons. One, it had become much too complex, and the other is the costs of participants became much higher than what it should have been. I have another book that I wrote three years ago, 401(k) 40 Years Later. I detail on that what happened to fees and the story is pretty outgoing. What happened to fees?
Robert Brokamp: What's interesting to me, is you've pointed out in that book as well as previous interviews, that the whole mutual fund industry was, as you said, kind of a mom-and-pop industry. It was really their use of 401(k) that let them take off, and maybe you might say abusive 401(k).
Ted Benna: Well, exactly.
Ted Benna: What happened and this was the first stage of creating fee problem and all these suits that we're seeing today. I mentioned in the book AT&T as an example. I was interviewing their HR director from one of the early books I did and we got into what was called bundling. In the early days, participants only paid investment fees. The administrative and all the other fees were paid by the employer. When we got into bundling or really got bundled with the fees with participants paying them all. What happened was AT&T, the HR director was under pressure to cut money from his budget. He was able to shift the plan from institutional investing to one of the big mutual fund companies, pay us all of the fees off, to the participants, which took about $100,000 of expenses, off his budget. That was the first thing that happened. Then we had something else later on. That's another old story.
Robert Brokamp: Fees are obviously a big part of it. Let's move on actually from the history to your book. By the way, I have long recommended the dummies books when it comes to personal finance. You wrote a good book on 401(k)s back in 2002, your new one here is updated, include the IRAs. It's an excellent book, very thorough, very readable and you do talk about fees. How do people determine the fees they're paying in their 401(k)s?
Ted Benna: It took a long battle to get fee disclosure because the really abusive providers just totally fought and resisted it. But participants legally, are supposed to get a statement from their employers when they sign up for 401(k), explaining the fees. First of all, make sure you get that. Now the ones that have higher fees, it's not real transparent. It's pretty hard deal to figure those statements out. If you get one of those statements and you have trouble figuring it out, you might have somebody here to help you who is able to do that. But you have still some pretty ugly stories. I could give you one as example. I ran into Robert over the last three years, my focus has been primarily on helping the small employers that don't have a retirement plan, to find better ways to do that. For many of them, 401(k) is not the right answer and I include that in the book, that there are IRA models, your small employers can utilize. Here, I'm talking primarily about solo entrepreneurs and small businesses, probably where the owners earn less than 100,000. When I was working on this, I had a small business with eight employees. Contact mentioned, we have a 401(k), would you look at it? We're not probably pleased with it. Well, I found out the employer was paying 1,500 and fees every year plus additional when special things have been done. Robert, participants were paying 2.75 percent in fees. This was with one of the largest 401(k) providers, one of the top 10. They took one of the IRA base plan, shifted over, eliminated all the employer phase. Participants' costs went down to 0.15 from 2.75 percent. That's many years of additional retirement income yields being blown through phase. It's horrible. I'd go.
Robert Brokamp: Yeah. I can't imagine the impact of fees of 2.75 percent. You just look at the impact of fees of one and one-half percent compounded over a career, you're talking tens, if not hundreds of thousands of dollars.
Ted Benna: Yeah, you're talking over 20-30 year period, you're 50 percent more your accumulation. One thing I had mentioned in the book, otherwise. One way you can always improve your investment return is to reduce fees. [laughs] That's a guaranteed way of increasing your return.
Robert Brokamp: Yeah, absolutely.
Ted Benna: Yeah. The mini employer market is tremendously under-serviced. I mentioned in the book that there are four different types of 401(k)s now, three different types of IRAs. Figuring out what is best is extremely challenging, and during the right mix heck, a lot of difference. One of the services I've mentioned in the book is that for $200 one-time shot, you will all help a small employer work to make that decision, but there's a limit to how much of that I can do. As I was completing the dummies book, I was approached by new start-up entity, the name is Penelope, P-E-N-E-L-O-P-E, and that [inaudible 00:13:28] CEO is their website, they're going to take what I've learned over the last four years and their start-up is high-tech, very innovative, full platform administrating for 401(k)s but in the process, will take what I've learned and the focus will be helping these small employers to pick the right plan, not just a plain. The reason the financial community generally isn't interested in this segment of the market, there's not enough money. They can't make money on it. The advisors who are in it, typically, like the story I mentioned earlier, they're not appropriately selling 401(k) plans, when there may be a better alternative.
Robert Brokamp: In your book, you also discussed both traditional and Roth retirement accounts. Roths or other age these days, largely because many investors expect tax rates to be higher in the future. However, you believe Roths are oversold. Why do you think so?
Ted Benna: For a number of reasons. The first is for years ever since Roth was introduced decades ago, the approach and I won't mention any names would say, do you expect tax rates to go up or down? Well, then you will put your money in the Roth. Well, as I pointed out in the book, tax rates are actually lower today than when Roth started. People who fall on that advice over the last decade didn't work out for them. That's one slot. Another one is that most people when they retire have significantly less taxable income than they do when they're working. Those earning less than 100,000 certainly, they're going to, in all likelihood, to have significantly less taxable income. Tax rates will have to really escalate. Two other reasons too. My firm belief is it when you're starting in the workforce and saving to build a nest egg, it's very much to your benefit, built it faster rather than slower. Because life's unpredictable. When you're talking about what might happen 20-30 years ago, well, you might lose your job in your 50 age.
You may have major health issues, you may have a divorce or spouse that dies, you have [inaudible 00:15:54] the COVID, this for an option. If that happens and you're able to save more money if you're doing pre-tax and if you're doing that after-tax, so you're better off if you're in your 50s and those things happen, if you have a 40 or 50 percent bigger nest egg at that point in time. Really highest factors, political risks. I don't trust the politicians. Someday they're likely to tax this thing. I can very well [inaudible 00:16:24], you got too big of a deal, good-to-great a deal, your too big a tax rate. We were going to tax half of this tax-free buildup. The example I use is Social Security. For years Social Security was never taxable, your benefits. Now up to 85 percent of your Social Security is taxable. This was really funny. When I was writing the book, I went to IRS's website to just confirm what income levels you get hit for the tax. It says, only 85 percent of your social security benefits are taxable. People don't realize that when they're paying their Social Security tax, when they're working, they are already paying income tax on that Social Security tax or we're been double-tax upfront orders. Pretty interesting.
Robert Brokamp: Yes. On top of that, the amount of your Social Security that's tax is based on your income, so there's so straight taxation brackets. But unlike other tax brackets, they don't change every year. They don't go up with inflation. It doesn't take a whole lot of income to subject your Social Security to taxation these days.
Ted Benna: Correct.
Robert Brokamp: Let's say you were put in charge of all retirement savings in America, you are made the retirement savings, what would you change about the current system to enhance retirement security for Americans?
Ted Benna: Well, a couple of things. First of all, when I answer that type of question, I do it from a spectrum of what politically may be doable. Yeah, the idea of just scrap and everything's starting over from scratch isn't political reality. Things that have been promoting for a number of years now that are definitely politically
Ted Benna: One, requiring all employers that have a 401(k) to automatically enroll their employees, and to automatically bump up their contributions annually with the fact that employees can reverse that if they want. The next is to require all employers to set up a payroll deduction retirement program for their employees. It could be IRA based. We're very easy to do. The reason that I promote that, is I found over the years, biggest benefit of 401(k) is turning spenders in the savers by making that the first priority. For most of us, including me when I like you have four kids and a mortgage and all those expenses, I would've never done what I would have done without 401(k). You've that factor work up and there are two other things. One is putting a lock on when people change jobs to the money has to stay invested for retirement. That doesn't make sense for 30-year-old to get this paperwork when they change jobs and say, "Oh you could take to 10,000 now, buy a new car, take a vacation or whatever", it's too attempting. Then the last thing is most people who are retiring, you need to lock up some guaranteed income when they retire. One way to do that is with a fixed income guaranteed life annuity. I've recommended maybe providing the first 1,000 or 2,000 for the lifetime guaranteed annuity wouldn't be taxable. You're doing the retirement to include those who are retired or moving into retirement to get more serious about doing that.
Robert Brokamp: Now you pointed out in your book that, thanks to I think it's secure Act. It's going to be easier for foreign case to offer these annuities. You like the idea of annuities but you say the book that it's probably not the best choice to stick with the 401(k) annuity.
Ted Benna: Yeah. Frankly, I'm discretionary, that's crappy idea [laughs] promoted by insurance companies. My first job was in home office of insurance company. I used to calculate the rates that were built for making those type of annuity purchases and definitely in the favor of the insurance companies have really. Now the thing that's in that act that I strongly support is requiring the participants to be given [inaudible 00:20:56] its 2022 if I remember it. Something that says, based on what you've already saved, if you continue savings district, here's what's your income of retirement might be. The idea of a lump sum nest-egg, that doesn't really connect anything. These type of projections to convert and say, here's what you might get as an income certainly will be a lot more useful in helping individuals, maybe get on a little better track for retirement.
Robert Brokamp: Yeah. The other thing I like about that is they're calculating that income is if you retire at 67, which is higher than the current average retirement age. I personally think that we as a country have to just accept that people should be retiring later, not only for financial reasons, but I think there's a lot of questions about whether retirements actually healthy for people like you're going to spend the last 30 years of your life without a job.
Ted Benna: Fair. Created in credit suspend 20-30 years doing nothing. Actually, this is a problem. When social security first started back in that era of life expectancy reached 10-20 years. Now if you talk about 30-year retirement and you use three percent inflation rates, takes five times the amount of money rather than three times. That's why this is much more difficult when you're talking about maybe retiring in your mid 50s or late 50s or early 60s, and having a stream of income will lay the rest of your life.
Robert Brokamp: Yeah and I said point out that if you don't mind me saying you're almost 80-years-old and here you are publishing a new book, so good for you.
Ted Benna: Let me tell you. Guess what? It's today.
Robert Brokamp: Today? [laughs] Happy birthday to the father of the 401(k) [laughs] and your spending your talking to us, I feel so privileged. [laughs] For the final question let's go back to the beginning and you're creation for 401(k). I know you've been asked this before, but have you made money from the 401(k)? Did you try to patent it?
Ted Benna: We did. That was something we tried very early and we were told by our attorneys we couldn't. You always ask at one time on NPR and interview and [inaudible 00:23:16] it came from just off the top of my head, I said, well [inaudible 00:23:19] each participants send me a quarter.
Robert Brokamp: Did anyone do it?
Ted Benna: No, it's about 40 million, it's time [inaudible 00:23:27] participants. I went out and got some mail about a week later and it was heavier than normal. There were two envelopes with quarters and there's 125 cent check. [laughs] They tracked down my address somehow and send it. I still have the check somewhere, somebody's bank account or screwed up.
Robert Brokamp: That's so funny. At the end of the 2018 book that you mentioned previously, 401(k) 40 years later, you request that if anyone who's benefited from a 401(k) feel so inclined, they can make a contribution to compassion. That's an organization that helps with children in the developing world out of poverty. Sounds like a very worthy cause and I'll definitely be making a contribution. I hope that our listeners who have benefited from the tax advantages and employer match in a 401(k) will do the same to honor you for creating the 401(k) and now as a birthday gift as well.
Ted Benna: It would be great. I know a couple of board members who has been on the organization and they do a fantastic job. Over 80 percent of the funds are directly to those needs and supported child monthly here it's one possibility and then the others are just number of programs. They help women who have been abused, to be able to become productively engaged in all different projects, certainly a ton of them out there. They don't have to look hard to find opportunities. Clean water, all kinds of different projects. Yeah, that would be a [inaudible 00:25:07] definitely doing that.
Robert Brokamp: The website is compassion.com, if you'd like to go and make a donation in Ted's name. Let's wrap things up here. Our guest today has been Ted Benna, the author of the recently published 401(k)s and IRAs for Dummies which again, is very thorough, very readable. Ted, thanks so much for joining us for all the work you've done over your career. It's been such a privilege to speak with you.
Ted Benna: You're welcome.
Alison Southwick: That's the show. It's edited season's greetings lead by Rick Engdahl. Our email is [email protected] We have a pretty big announcement next week. Definitely I'll want to tune in. But until then, for Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody.