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 quote
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.
Investing, Media | Frank Curmudgeon | 
April 27, 2009 9:52 am
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By ObliviousInvestor, April 27, 2009 @ 10:59 am
I had several issues with this piece as well. It brought up the topic of excessive fees in 401k plans (admittedly, something that’s a serious issue) and seemed to blame those fees for the big declines in people’s portfolios.
It’s like they mixed up two stories–one about excessive 401k fees and an entirely separate one about how people don’t know enough to properly invest their 401k assets.
By My Journey, April 27, 2009 @ 11:00 am
Did the show happen to show what asset classes the people were invested in?
Did the 60 year old, have 100% equities, or even 90% equities?
By Brian Reese, April 27, 2009 @ 11:31 am
This quote:
Would make for an interesting post. My dad was talking about this yesterday. I was trying to explain some of the fees they might have been talking about but, the quote really looks like a sound bite with little basis to me.
By GPR, April 27, 2009 @ 11:57 am
In the big picture, of course I support 401ks, and my wife and I have historically contributed as much as possible.
But right now, this moment, for say, the next 6 months, does it make sense to contribute? Even with a match (which I don’t get for a few more months anyway), my company 401k is sinking fast.
I think I might want “cool toys and fun vacations” over huge losses. Or at least repayment of all debt.
By GPR, April 27, 2009 @ 11:58 am
Should also have said I know the pre-tax income advantages. But even still…
By ebow, April 27, 2009 @ 12:32 pm
@ GPR — Buy low, keep contributing, especially if you are relatively young, at least once the employer matching kicks in. Chance are you are seeing a leveling off of losses, or a mild uptick in portfolio value.
By Jim Blankenship, CFP®, EA, April 27, 2009 @ 1:34 pm
What everyone seems to misunderstand is that simply contributing to a 401(k) does not expose ones assets to stock market risk. The amount of risk you take is totally dependent upon your choice of investments.
So – in answer to @GPR’s question: if you’re getting a match on your contributions, then by all means you should contribute to a 401(k). Then you decide how to allocate those funds. If you are squeamish about the stock market, put your money in bonds. If you’re squeamish about both stocks and bonds, put your money in the default money market or cash option. You’ll still reap the benefit of the tax deferred on your contribution, plus receive the company match.
@Frank, another excellent post – I’d been closely following the popular press’s coverage of “broken 401(k)” and but had missed this 60 Minutes report. Keep up the great work!
jb
By SJ, April 27, 2009 @ 1:46 pm
@Jim — Precisely!! So many of my friends are frozen into inaction b/c they don’t know what fund to “invest” their roth ira into and if they can change afterwards -___-
I think the old retirement plan was earlier death (Anyone read Galapagos?)
How about we treat them as a car license and make people take a quick test to be able to receive benefits lololol…
The fees and options can be annoying tho… I’m lucky the UC system is nice =)
By Dave C, April 27, 2009 @ 9:10 pm
Some of the language in the story gave me the impression that the media is hoping to play on the collective anger that a lot of America has towards Wall Street. The bit about “There clearly has been a raid on these funds by the people of Wall Street” speaks volumes about the angle they are trying to push here. As with so many other things in this county, personal responsibility seems to be taking a back seat to getting rich and dealing with losses/
By Shadox, April 28, 2009 @ 2:57 am
Look, you have some good points, and personally I prefer DC plans rather than DB plans for the following reasons: (i) I have never been with a company for more than 3 years, i.e. it’s possible I would not get a cent in DB payments; (ii) I dislike the idea that my retirement savings are dependent on the financial soundness of my former employer (ask the former employees of some of the companies whose pensions just got dumped in bankruptcy court).
However, let’s not be naive here. The only reason that companies are pushing hard to move people from DB to DC plans is that these are cheaper. They are cheaper because the companies typically provide dramatically reduced benefits to the employees.
By Frank Curmudgeon, April 28, 2009 @ 10:18 am
Shadox: There is no question that companies prefer the cheaper DC plans because they are cheaper. But they are getting little, if any, pushback from employees for the reasons you cited.
Brian Reese, Dave C, et al.: I thought the surprise ending of the story, where it turned out to be about poorly disclosed 401(k) fees, to be really stunning. Of all the things they could have concentrated on! It’s like saying the food on the Titanic was terrrible.
By Roger, April 28, 2009 @ 9:08 pm
Interesting stuff. I thought I had heard that 401(k) plans were created as the result of a tax loophole that ended up being expanded into a widespread retirement plan. Hence, that rather unceremonious name of 401(k). But perhaps I’m wrong.
By SaveBuyLive, April 29, 2009 @ 2:06 pm
Where I currently work has a DB pension plan and to be honest I don’t like for many of the reasons you described.
1. There is a huge Byzantine list of rules as to who gets benefits and who doesn’t. I’m pretty sure that this is designed to benefit a certain group of long-term (20+ year) employees and to screw everyone else.
2. I have no intention of staying with this company for the long term mostly because I hate the geographical location. This means that I’m probably going to get nothing. Or at best about $12 a month.
3. They use their pension plan as an excuse not to match any 401 contributions.
To be honest, my 401 is far from perfect either, but I’ll at least see that money when I retire.
By Al23, May 1, 2009 @ 9:13 am
I agree with what most have written here. The 60 Minutes producers lacked focus, not knowing quite what they wanted to say. I completely agree that almost all 401k investors have barely a clue about either asset allocation or expense ratios. I’m lucky enough to work for a large hospital that still offers both a db and dc plans. The dc plan includes about 25 different funds, including 4 very low cost index funds. (er of 10 basis points!) I was hopeful that 60 Minutes was going to do a little educating that Sunday night, but alas they only spread confusion.
By racy, May 2, 2009 @ 6:42 am
I haven’t watched 60 Minutes since 2001, when they did a hit piece on the company I work for. Looks like they’re still at it!
By David Stillwagon, May 6, 2009 @ 4:58 pm
Before signing up for 401k plans most companies give you a wealth of information about the risks of the program and you can allocate the money in your account. The risk and potential reward is discussed in length before joining any plan.
By Larry, June 3, 2010 @ 12:42 pm
Companies use 401k plans because they are cheaper. Period. Wall Street and the mutual fund industry do pray on unsophisticated investors with regard to the fees in these programs. Remember, 80+% of the mutual fund managers DO NOT beat the averages over time, YET they still get big bonuses and the mutual funds still collect big fees. There should be a max fee on any 401k. Congress needs the will to change the legal structure.
By Brian Marvel, March 27, 2011 @ 7:26 pm
Have you thought of updating this article. I would be curious to see what people would prefer now; 401k v DB plans? The better solution for 401k’s would be guaranteed retirement accounts (GRA’s).
By Snookman, May 17, 2012 @ 2:49 pm
IMO the biggest issue with 401k is that it’s employer sponsored. Why is the employer involved in my investment choices? They are involved because they’ve decided that having only 30 mutual funds to choose from (versus thousands if I approached Fidelity as an individual) is in my best interest. I feel I should be able to sue my employer for inserting themselves in my decision making process by choosing what investments are best for me!
Please contact your representatives in Washington and demand two things:
1. That the 401k stop being ‘employer sponsored’ and let it be self-directed (I tell my employer to send the payroll deductions directly to Fidelity in my personal account)
2. To allow a once per year rollover into a self-directed IRA to regain your personal freedom of investment choice.
thanks