More Fear and Loathing in 401(k) Land

The buzz article of the month seems to be Time’s Why It’s Time to Retire the 401(k) which came out October 9th. It is not to be confused with Time’s Should the 401k Be Killed? from last winter. And I am sure the serious print Train_wreck_at_Montparnasse_1895_2journalists at Time would be offended if I likened their work to the 60 Minutes  piece from the spring Retirement Dreams Disappear With 401(k)s. (See my comments on that here.)

I suspect there are many more such articles and TV news segments out there telling us how 401(k)s are terminally broken. I don’t have the heart to search for them. These particular three say roughly the same thing, with similar quotes from experts and profiles of folks in their sixties who are poorer than they expected to be and, we presume, than they deserve to be.

There is an unavoidable, and I think completely unhelpful, undercurrent in this genre that the 401(k) is not a good idea with some serious implementation issues, or even a noble experiment that failed, but a scam perpetrated on workers by Evil Big Business. 401(k)s, we are told, were designed by our beneficent law givers in Washington as a nice side dish to the main retirement course of corporate pensions. Somehow, when we weren’t paying attention, employers pulled a switch on us and passed off the side dish as the whole meal.

As Time tells us in the recent article:

The tax-deferred 401(k) plan, and others like it, such as the 403(b) and the IRA, have become our nation’s go-to retirement piggy bank. Invented nearly 30 years ago as an executive perk — one more way to dodge Uncle Sam — the 401(k) was never meant to replace the employer-guaranteed pension fund, supplemented by Social Security, as the cornerstone of our nation’s retirement system. But propelled by a combination of companies looking to cut costs and consumers who wanted control of their retirement destiny, that’s exactly what happened.

But 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 setting aside the question of what may or may not  have been the original intent, in practice a 401(k) 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. You can argue that pension schemes are better, but arguing that 401(k)s were "never meant" as an alternative is just silly.

This wave of anti-401(k) literature that we are now seeing has a fairly obvious cause. The stock market recently took a tumble. I haven’t done anything like a scientific study, but I’ll bet that there was hardly any buzz around the problems with 401(k) two years ago. Things were good, 401(k) (and IRA) balances were big, and nobody paid much attention to the terrible problems that were apparently always there. Then the accounts suddenly shrank and it occurred to a lot of people that they would have been better off with a boring old pension.

Come to think of it, why don’t we all have pensions? It must be because we were cheated out of them. The Time article tells us about a man who had a salary of $80K when he retired. Had he been covered by a pension, he would have gotten a monthly check of about $3100 in retirement. Of course, this ignores the annoying detail that if he had been covered by a pension, he likely wouldn’t have been paid $80K. The money for the pension has to come from somewhere.

And here is, I think, the flaw in the campaign against 401(k)s. People think that having a guaranteed pension is a fabulous idea, provided that they don’t have to pay for it. As long as it is free money dropping from the sky, it’s a good thing. But ask if they would prefer a) a pension scheme paid for via a reduction in salary or b) no pension or salary reduction but a special tax deferred account to help you save on your own, no pension wins in a landslide.

What we have done in America is to replace centralized corporate pension schemes with millions of individual pension schemes. There are a few drawbacks to this, principally that if you make every worker his own pension fund manager, most workers will have totally incompetent pension fund managers.

It’s not the worker’s fault. Turns out it’s pretty hard to find good professional pension fund managers, never mind millions of competent amateur ones. I don’t think it would be impossible, in principle, to have a nation of consumers who did a decent job of managing the funding of their own retirement, but I think we are, at best, decades from that. And I haven’t seen much forward motion towards the goal of late.

No Comments

  • By Rob Bennett, October 21, 2009 @ 1:54 pm

    I don’t think it would be impossible, in principle, to have a nation of consumers who did a decent job of managing the funding of their own retirement, but I think we are, at best, decades from that. And I haven’t seen much forward motion towards the goal of late.

    I’ve seen forward motion, Frank. The very articles that you are referring to represent forward motion. There has to be a consensus that there is a problem before there can be a consensus re the solution. The crash has scared people. That’s the first step to getting people to accept that there is a problem. We weren’t even talking about this stuff in the days when we were all pretending that Passive Investing could work long term.

    I don’t think it is going to take decades. It might take five years. I recommend legislation requiring The Stock-Selling Industry to calculate how much money was spent promoting the Passive Investing “idea” and requiring the same amount of money to be spent promoting Rational Investing principles over the following five years.

    During the discussions I have been involved in in the Retire Early and Indexing discussion-board communities, I have talked to thousands of middle-class investors expressing a desire to be able to learn the realities of stock investing. If there are that many just participating at those few boards, there are obviously millions out in the real world.

    Internet blogs and discussion boards provide us with the means to get the word out. Now we just need to work up the courage to insist that honest posting be permitted. We live in exciting times.

    Rob

  • By Neil, October 21, 2009 @ 2:34 pm

    I’d rather have my own account than a pension for a simple reason – you’re not dependent on the company keeping afloat. Lots of people who worked their whole lives and didn’t save at all – because they had guaranteed pensions – are now in big trouble because their former employers are going under, their pensions are underfunded, and they’re still not going to have the retirement they were hoping for.

    Pensions have been chronically underfunded, because it’s hard to go to your employees and tell them they need to give up the 10-15% of their income needed to fund them properly. They generally rely on rosy investment predictions, and then charge only 6-8% from the workers.

    Then, once a company has a large number of retired, former employees, there on the hook for topping up the fund by millions each year to pay people who no longer produce anything for them.

    The 401k and similar give people a clear cause and effect – set aside money now so that you can retire later. Then if the market performs badly you get less money. The pension is subject to the same forces as the 401k, but the worker only sees it when the investment losses (or underperformance) roll over and bring the golden goose down. See GM for details.

  • By Larry, October 21, 2009 @ 3:41 pm

    The value of the 401(k) depends a lot on the investment choices the employee is given, and which ones they select. In my current job, we’re with Fidelity, and several of us insisted that the plan offer some low-cost index funds, which I think have done fairly well for me given the circumstances. Besides, once you leave a job you can rollover your 401(k) to an IRA, which gives you greater choice. So I don’t see anything inherently wrong with the 401(k) provided you’re given good investment choices, and there’s a lot to be said for the employer match (we get $.25 to the dollar for those earning under $100K, which is most of us).

    The problem comes with 401(k)s where the employee is not given good choices, or where they’re not well-diversified, or where they’re not given good investment advice by the plan administrators who want to conceal the deleterious effects on the investor of the high-load, high-expense ratio funds they’re pushing.

    Even at best I don’t think the 401(k) should be the sole investment vehicle, however. I myself have a 401(k) through my company, 50/50 Fidelity stock and bond index funds, as well as a Vanguard IRA rolled over from previous jobs and a few smaller sources.

  • By Kosmo @ The Casual Observer, October 21, 2009 @ 4:52 pm

    I have a (well funded) defined benefit (yep, defined BENEFIT) pension and a 401(k).

    The funny thing is that some employees complain that my company’s 401(k) matching isn’t on par with that of some other companies.

    Um, yeah. It’s because we get the pension, too, and the other companies don’t …

  • By Jim, October 21, 2009 @ 5:43 pm

    I certainly don’t think that 401k’s are broken. I do think they could use some improvements. Some 401k’s have very few investment choices. Fees on 401ks are not transparent and should be.

    For people who prefer a pension, we should give them that choice, but make it a fixed withdrawal from their pay. e.g. options 1) 401k you manage on your own 2) put fixed % of your pay into a defined pension plan. 3) a combination of both

  • By Patrick, October 21, 2009 @ 5:49 pm

    “if you make every worker his own pension fund manager, most workers will have totally incompetent pension fund managers”

    I have had a 457(b)(the government 401K) based pension fund for more that 20 years. No guaranteed pension, no social security. My enlighted employer uses Schwab as the fund manager and I get access to Schwab’s Personal Choice Retirement Account (PCRA) which lets me choose from among 100′s of mutual funds, including index funds with management fees as low as .26%, no load, no transaction fee. (Really, this is not a plug for Schwab)

    Even after the great recession, given a couple of years to recover, I will retire better than I would have if I were covered by social security or a guaranteed benefit plan.

    While I am a strong advocate of personal control, I have a real concern for workers whose employers would hire poor retirement fund managers or who simple don’t have the patience or capacity to invest wisely. When they have lost their retirement fund to incompetance or chicanery what are we going to tell them. “Sorry dude, you made some bad decisions. Guess you’ll just have to live in a box and eat dog food in your golden years.”

  • By Jim, October 21, 2009 @ 6:17 pm

    Neil,

    Defined benefit pensions are guaranteed by the Pension Benefit Guarantee Corporation (PBGC). The PBGC acts similar to the FDIC but instead guarantees pensions against bankruptcy. They guarantee up to $4500 a month currently.

  • By Matt, October 21, 2009 @ 9:02 pm

    The unmentioned problems with pensions include the cost of running them and the headache of accounting for them. On the employee side, the topic of unvested benefits often escapes notice.

    There was once a man in Michigan who erected a billboard in his front yard reading “Ford Motor Stole My Pension”. I don’t remember the details, but I will suggest he would have preferred a 401(k).

    If people want a defined-benefit retirement, the term for that is annuity. Like life insurance, the annuity is something that sucks, but is not without utility. Maybe companies could offer something like a portable annuity option at the same contribution level as their 401(k)s; people would probably wind up with a lot less, but who knows.

    Of course, after an extended bull market, there would be articles about the poor people who got suckered into taking the annuity option rather than the 401(k).

  • By Jim, October 22, 2009 @ 2:39 pm

    “There was once a man in Michigan who erected a billboard in his front yard…I don’t remember the details…”

    I have to say that I’ve never found self erected front yard billboards to be unbiased sources of factual information.

  • By Matt, October 22, 2009 @ 2:48 pm

    My point, Jim, is that the billboard stands as a representation of the man’s opinion. It was humorous, and the details were not important.

  • By bex, October 22, 2009 @ 4:18 pm

    Frank,

    You missed the one good point in the Time article: the suggestion of retirement “insurance.” In other words, perhaps the primary retirement plan should be something more like a guaranteed annuity, where you got a fixed amount based on how much you put in. So, if you want $5k per month in retirement, then you probably need to sock away $10k of your income per year.

    The “right” way to do this is to make it opt-out, based on government guidelines… and make it painfully clear that going below those guidelines will put your retirement at risk.

    But… then we’re back at the problem with mismanaged pension funds…

  • By Financial Samurai, October 25, 2009 @ 12:54 am

    I have saved for 10 years the max in my 401K, and all I have is about $200,000 in it.

    After 20 more years, MAYBE it grows to $1 million, but I doubt it, more like $700,000 or so How am I supposed to retire on that? I’m not, hence why 401K is undependable.

    We need to raise the 401K contribution pre-tax limit to $50,000/yr at LEAST!

    FS

  • By Guzzo, October 25, 2009 @ 8:27 am

    Now we just need to work up the courage to insist that honest posting be permitted.

    You mean create a job entitled “Post Czar”?

  • By Brad, October 25, 2009 @ 10:26 am

    Financial Samurai: “We need to raise the 401K contribution pre-tax limit to $50,000/yr at LEAST!”
    How is that going to help the average worker making around $67k/yr TOTAL before bills? (I think thats the average but its close enough for my point).

    401ks are a tool. More often then not when a tool isn’t used properly we want to replace it with something else other then admit we didn’t use it properly in the first place.
    Lots of people are saying we should go to pensions because they work. Do pensions invest in some mythical market that was untouched by the past two years? I would love to see an article interviewing pension fund managers and what position they are in right now.

    Education and more choice are needed to improve but not replace 401Ks. We could scrap it and come up with something new but if you don’t educate people on how to use it we will have this same discussion 30 years from now that we need something new because it didnt work.

  • By kmf, October 27, 2009 @ 1:58 pm

    Zvi Bodie advocates a 100% TIPS portfolio for money needed for retirement (link in header), That’s right, a zero equity allocation. People certainly may disagree with the merits of this, but I’d bet a lot of people with 401K plans have no idea what TIPS even means, let alone have access to a TIPS fund in their 401K (I’ve never seen one in any of mine). Even those with a reaonable understanding of investing struggle with the real meaning of risk in a portfolio. Usually they don’t understand until they have taken a drubbing at the hands of the market.

    Frank suggests we may be decades away from a general public capable of managing their investments. I’d argue that it’s an impossibility.

    I’d also argue that the answer to the question of pension w/reduced salary v. no pension w/401K would change greatly depending on how far one is from retirement (but sadly, it’s probably more dependent upon recent stock market performance).

    There is no question that the tanking of many 401Ks over the last two years is driving all the media. It’s a shame, although not particularly surprising, that not so many media outlets were reporting on this in 2006 when the S&P 500 returned 15%.

  • By Daddy Paul, March 3, 2010 @ 3:56 pm

    Most people who complain about their 401K have have no idea what they are doing and generally are a bunch of whiners.

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