Are 401(k)s a Bad Idea?

A reader named Trent pointed me to a story that 60 Minutes did last week, Retirement Dreams Disappear With 401(k)s.  It’s not their best work, and I’m not one who thinks much of their best work.

Helpfully, the CBS website gives a near transcript of it, so I can easily quoteSocialSecurityposter2 the way over-the-top copy read by the reporter, Steve Kroft.

It was a gray, chilly morning in midtown Manhattan and a line of unemployed, mostly white-collar workers, stretched for blocks around the Radisson Hotel. More than 1,000 middle managers, stockbrokers, consultants, secretaries and receptionists had come hoping to find a job.

It was called a career fair, but there was no merriment – only a whiff of desperation.

Many of the people at the career fair have been out of work for months and burned through their liquid assets; their future, even bleaker than the present.


At the non-merry career fair Kroft interviews some late middle age folks with bleak futures.  (Something I can really sympathize with.)  Kroft does get a few moments of moving video when an executive assistant with 30 years of experience pleads for somebody in the television audience to hire her.  But that’s not the fallout of the Wall Street implosion on which 60 Minutes wants to report.  This story is on 401(k)s.

Helpfully, these New Yorkers with bleak futures have brought their 401(k) statements with them to the career fair.   And naturally, one of them has brought it unopened so CBS can share the drama of him opening it with America.

The poor guy is 60 years old, planned to retire at 62, and "nearly half of his life savings” have been lost.  His 401(k) is off $140,000.  Ouch.  Was that all his savings? 60 Minutes doesn’t mention anything else.  So he was three years from retirement and had only $280,000?  In New York?  I’m thinking (and hoping) there was more money in other accounts, but CBS is focused on 401(k)s and nothing will throw them off the scent.

For example, they pass up the story of how a guy in the final years before retirement could allocate his assets in a way that he could lose half his assets.  It could be smugly assumed that he was foolishly aggressive in his choices, but I bet he didn’t know any better.  He didn’t understand how aggressive he was being and how dangerous his situation was.  How that could happen would have made a good story, but, alas, I digress.

This 60 Minutes story is on how 401(k)s are a failure, and possibly a bad idea.  According to them, 401(k)s “were never designed to be retirement plans in the first place.”  Or, to be more precise, it was just a part of a larger retirement plan, most of which was to be provided by government and paternal companies. “It was supposed to supplement the two traditional income streams for retirees – Social Security and pensions.”

This is hogwash.  First, it was Social Security that was meant as a supplemental source of retirement income when it started.  Second, corporate pensions were never as universal as nostalgia suggests.  At their peak, which was a while ago now, less than half of American workers were covered by them.  And third, although I don’t know what was in the minds of legislators when the 401(k) law was enacted, in practice it is very explicitly thought of as a substitute for a pension plan and as far as I know this has always been the case in the corporate world.

People in the investment business call pensions defined benefit, or DB, plans and 401(k)s, IRAs, and the like, defined contribution, or DC, plans.  For decades now, there has been a movement away from DB to DC.  It may have been underreported by the media and under-debated as a policy issue, but it has been massive and almost universal.

Companies don’t like running DB plans for two big reasons.  First, they are hard and expensive to run.  The company is forced into a sideline of being an insurance company and investment manager in addition to whatever it is that they do for a living.  If the investments do poorly, or if retirees live longer than expected, then the company has to take more money out of the business to make up the shortfall.

But the other, and at least as significant, reason that companies don’t like DB plans is that their employees don’t like them very much either.  Obviously, if given the choice between having a pension and not, everybody would choose to have one.  But on a perceived-benefit-per-dollar basis, DB plans are a poor way to compensate your employees.  From a worker’s point of view, the pension benefit they accrue in a given year is often very abstract and uncertain.  If they work some number of years, they will get some percentage of their (not yet known) final salary.  If they leave the company after only a few years, which is statistically likely, they often get nothing.

In contrast, the benefits from a DC plan are immediately obvious to the worker.  They get paid countable dollars that they can save in tax-deferred vehicle. Often the company matches some of their contributions.  Although those company matches sometimes have a vesting schedule, in general DC plans are completely portable, meaning that workers can take their savings with them when they leave the company.

The 60 Minutes piece does all it can to portray the DB to DC conversion as another example of evil big business shortchanging the little guys.  It may be that the little guy may was indeed shortchanged by this, but what CBS is talking about is a huge demographic shift, not some small accounting trick.  It would make as much sense to bemoan the decline in classified advertising in newspapers or the shrinking pay-phone industry.

And those little guys who are now worse off were willing accomplices in their own downfall.  They were enthusiastic about having control of their own money, rather than trusting somebody else to take care of their retirement savings.  But like a teenager desperate for a driver’s license, craved freedom sometimes has tragic consequences.  Many, out of ignorance, made foolish choices about how to invest their money.  And many did not set aside enough money each year to begin with, choosing to convert what would have been their part of a DB plan not into a DC plan but into cool toys and fun vacations.

To me, what Americans did wrong managing their own retirement savings, and why, would have made a much better and more interesting story.  Which is why I am not a television news producer.

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