Time Mag: Why its time to retire the 401 (K)

[clifp]

This week Time Magazine cover story is an attack on the 401 (K).

Sadly it like what passes for financial journalism, is interviews with some employees (most of whom aren't particularly upset with 401 (K) ), misleading statistic and than quotes by academics.

I was annoyed enough that I wrote a letter to the editor, here is a slightly modified version of the letter.

Steve Gandel's article on the "Why it's time to retire the 401K", omits and distorts a lot of information about 401K alternatives. While 401K are far from perfect they are just a better retirement vehicle than anything else we have.

First Mr Gandel talks about the a time "when pensions were the norm", this is a mythical time. The chart on page 33 show the dramatic decrease in percentage of companies offering defined benefits plans, but it omits an important point; this chart is only for companies that offered a retirement plan. Prior to the widespread adoption of 401K the majority of American had NO retirement plans. The majority of Americans work for companies with less than 500 employees. Pension plans are expensive to set up, and administer much less to fund and hence cost prohibitive for small and medium firms. I believe that at no time were more that 1/3 of private sector employees ever covered by a pension plan and when you add in the arduous vesting requirement the actual coverage was even lower. The choice for most American isn't between a 401K and a pension plan it is between a 401K and no retirement plan.

Next the article compares the fates of Oxy Petroleum employees with 401K versus their expected pension benefits. Not surprisingly it shows the employees would be better off with a pension. The underlying assumption is that Oxy will be around to pay the pensions. Imagine if a breakthrough occurs in alternative energy and oil demand collapses, how will Oxy pay the retiree's pensions?. The answer is they'll do the same as many airline, steel, manufacturers, declare bankruptcy leaving retirees with dramatically reduced pensions paid by Pension Benefit Guaranty Corporation and/or taxpayers. A lifetime pension plan guarantee only last as long as the companies life, a look at Dow companies circa 1979 show only handful still in the index. Nor are public pensions the only ones in trouble. The Oct 11. edition of the Washington Post had a terrific article describing the horrendous shape of almost all state and local pension funds, with many expecting to have only 1/2 money the need to pay the pension of teachers, cops, city workers etc.

Finally, Mr. Gandel discuss alternatives to the 401K. These include plans like Guaranteed retirement accounts, and retirement insurance, but he omits a critical fact none of the alternatives would have fared much better in 2008. Pooling retirement money to reduce risk sounds like a sensible idea. However, there is very little difference between having one million people with $100,000 in their 401K and a single giant pension fund with $100 billion in assets. If values of the assets drop 30% like in 2008, either way there is only $70 billion to fund the retirement of a million people and that isn't enough money. As American taxpayers have painfully learned, insurance companies, even the biggest, can and do go broke. Trusting our future retirement to the next AIG seems especially foolish.

Guaranteed retirement income and eliminating market risks for retirees sound like worthwhile goals. Unfortunately they are pipe dreams. There is no magic bullet for funding retirement; Americans need to save more, and/or work longer. Like or not our collective retirement is linked to the country's economic prosperity and specifically to corporations generating enough profit to pay interest on their bonds, and dividends to their stockholders (which due to 401Ks includes the vast majority of Americans). Hopefully the events of 2008 served as a wake up call to these simple facts. One of the major of benefits of 401K is there transparency, you know how much money you have. Even more importantly your 401K money can't be easily stolen or distributed to others. The real problem with most pension plans all to often they unintentionally end up like Ponzi schemes, where current retirees receive too generous payments at the expensive of future generations. GM is but one example of this. Blaming the 401K for the poor shape many Americans are in for retirement is clear case of shooting the messenger.

 

[travelover]

Good post. When I read that article I was similarly disappointed. Somehow journalists seem to think that by presenting the case of a few real people as anecdotal evidence, they can make a wider, dubious conclusion more valid.

 

[growing_older]

It's a high profile pitch for Teresa Ghilarducci's plan. The proposal of forced enrollment in an insurance program for an annuity is playing fast and loose with facts, but insurance companies must love the prospect of additional (captive) business.

There are a lot of problems with this article. Clearly being a financial reporter doesn't require financial literacy, or even staying with a consistent set of facts.

Oxy Pete is both an "ideal" case study of 401k, and a company in dire trouble that used 401k to rob workers of benefits. Spending $75K from a 401k balance of $500k is both a formula for disaster and somehow okay and safe to spend $75k on a possible pension income of $27k.

 

[RunningBum]

Time magazine is a joke. I don't know when it went downhill, but the quality is so much worse now than what I remember from years ago.

I've found that writing letters to the editor just gets you on their spam list.

 

[Texas Proud]

There is so much bad math in that article it is amazing...

Take Oneil... he spends $75K per year... but would only get a pension of $2,200 per month IF they had a defined benefit plan... not enough to live off... and if he did not save anything, would be worse off than now...

And I have not read the whole article... but if Ox went BK... then I am sure his pension would go down... (maybe not.. it is not a lot)...

Oh well, some people think that someone will take care of them... and it is the gvmts job to do it.... or force someone else to do it...

 

[FUEGO]

Clif, good response to their poor journalism (editorialism??). Typical mainstream media quasi-news/article. It reads very populist, and so it appeals to the readers of TIME (do they have any left??).

I hope the day comes when folks realize their 401k balances, and hence their retirements and futures, are intimately tied to the future earning potential of private companies in the USA and abroad. Trying to guilt those big bad megacorps into funding and payout on on a defined benefit pension plan is a recipe for disaster as pointed out in clif's letter. Governments don't create wealth, they serve as backdrops to keep in place a system where individuals and corporations can profit, innovate, and prosper. Hopefully the Jeffersonian concept of an "ownership society" will extend to 401k plans.

 

[Texas Proud]

OK.... this is an interesting quote

"There are people in the Obama Administration who are supportive of some kind of guaranteed system," says Dean Baker of the Center for Economic and Policy Research. "People should not have to shoulder the risk of a bad turn in the market."

(I added bold)....

So my question would be... who SHOULD sholder the risk of a bad turn in the market? And also, who should benefit from an unexpected good turn in the market?

 

[audreyh1]

Sadly it like what passes for financial journalism, is interviews with some employees (most of whom aren't particularly upset with 401 (K) ), misleading statistic and than quotes by academics.

I was annoyed enough that I wrote a letter to the editor, here is a slightly modified version of the letter.

Good for you for writing that letter! Editors need to know when readers detect cr@p and get called on it.

Personally, when I heard discussions of this on CNBC, I thought the major flaw of 401Ks (IMO) was that you were not allowed to save enough! Certainly not as much as a SEP-IRA allows. They have fixed this to some extent in the last few years, especially for older savers.

"Financial Journalism" tends to annoy me so much these days that I avoid most of it - especially the TV "journalism".

Audrey

 

[novaman]

great letter....

yeah, Time Magazine has become a joke.

 

[W2R]

Good for you for writing that letter! Editors need to know when readers detect cr@p and get called on it.

Personally, when I heard discussions of this on CNBC, I thought the major flaw of 401Ks (IMO) was that you were not allowed to save enough! Certainly not as much as a SEP-IRA allows. They have fixed this to some extent in the last few years, especially for older savers.

"Financial Journalism" tends to annoy me so much these days that I avoid most of it - especially the TV "journalism".

Audrey

I wish I could have saved more in my TSP ten years ago. Back then, we were limited to a percentage and it didn't amount to anywhere near what I can contribute now. For example, in 2001 I was already 53 but still could only contribute $5,900, whereas this year I contributed $22,000.

But, because I couldn't contribute more I put the money in other investments and in buying my house. I'd rather have more in the TSP, though. Oh well!

 

[Gone4Good]

It will be interesting to see what the Editor's response is to your letter, please post it when / if it arrives.

Personally, I didn't think the article was a bad representation of the short-comings of the 401(k). The chief flaw I saw in the article was that it didn't highlight any of the short-comings of defined benefit pension plans. So the article is misleading in that regard.

And certainly 401(k) plans and corporate pension plans are superior to a government insurance plan, like Social Security, in that the former are actually backed by assets whereas the later is not.

 

[RonBoyd]

"Financial Journalism" tends to annoy me so much these days that I avoid most of it - especially the TV "journalism".

That's why they call it "Entertainment." Notice how you are encouraged, by the televison stations, to watch their regular programming on "News4" or "Colorado's News Station" or some similar classification. They understand.

 

[Red_y]

I thought by far the most misleading statement in the article was this one:

Remember, the biggest factor in whether the 401(k) works as designed has to do with when you retire. If the market rises that year, you're fine. If you retired last year, you're toast. And the chances of your becoming a victim of this huge flaw in the 401(k) plan are pretty high.

Gee, aren't there any other options? For instance, when I retired in March 2007, I had 5-plus years of living expenses set aside in CASH, as in savings accounts and money markets. I have not touched any 401k/IRA stock or bond holdings at all to fund my retirement. Those accounts have gone from nearly 900k to below 600k and now back to nearly 800k.

I am not toast. I prudently planned for market fluctuations in the early years of retirement. I'd rather see more financial education so that others make similar plans, rather than scrap the whole system.

 

[W2R]

I thought by far the most misleading statement in the article was this one:

Remember, the biggest factor in whether the 401(k) works as designed has to do with when you retire. If the market rises that year, you're fine. If you retired last year, you're toast. And the chances of your becoming a victim of this huge flaw in the 401(k) plan are pretty high.

Gee, aren't there any other options? For instance, when I retired in March 2007, I had 5-plus years of living expenses set aside in CASH, as in savings accounts and money markets. I have not touched any 401k/IRA stock or bond holdings at all to fund my retirement. Those accounts have gone from nearly 900k to below 600k and now back to nearly 800k.

I am not toast. I prudently planned for market fluctuations in the early years of retirement. I'd rather see more financial education so that others make similar plans, rather than scrap the whole system.

This is something that has puzzled me, as well. I have a lot of years' worth of living expenses set aside in cash, and dividends will add more. But then, if the market goes down, and I am living off the cash, when I rebalance I will be buying fewer shares of equity funds than I otherwise might. This would be because the imbalance will not be as great as it otherwise might be. So, there could be long term effects. Or maybe I just don't "get it".

 

[Alan]

I thought by far the most misleading statement in the article was this one:

Remember, the biggest factor in whether the 401(k) works as designed has to do with when you retire. If the market rises that year, you're fine. If you retired last year, you're toast. And the chances of your becoming a victim of this huge flaw in the 401(k) plan are pretty high.

Gee, aren't there any other options? For instance, when I retired in March 2007, I had 5-plus years of living expenses set aside in CASH, as in savings accounts and money markets. I have not touched any 401k/IRA stock or bond holdings at all to fund my retirement. Those accounts have gone from nearly 900k to below 600k and now back to nearly 800k.

I am not toast. I prudently planned for market fluctuations in the early years of retirement. I'd rather see more financial education so that others make similar plans, rather than scrap the whole system.

I agree that the article is cr@p but the basis behind it has been well publicized many times that the average punter is useless at managing a 401(k), including adjusting the AA on nearing retirement to have a cash cushion. All 401(k) plans have a MM equivalent option so 401(k)'s cannot be blamed for this failing.

The article did prompt me to look at my own situation. I started contributing into a 401(k) in 1994, simultaneously opening IRA's for myself and DW (who was working for a company with no 401(k)).

I've always been disappointed at the choices in my company 401(k), I am a reasonably knowledgeable investor and never did any major moves during the 2 bear markets this decade but the performance of my 401(k) is well below the rest of our investments.

In the last 16 years right up to current date my 401(k) has returned on average a meager 4.5%/year compared to the overall performance of all our investments of 9.2%/year. My 401(k) is approx. 23% of our total savings.

DW's company converted their pension plan to a cash balance plan and I think that worked better than a 401(k) for the majority of the workers as they had no decisions on how much to contribute or how to invest it. When she quit after 10 years we then rolled it over into an IRA.

 

[Nords]

This week Time Magazine cover story is an attack on the 401 (K).
Sadly it like what passes for financial journalism, is interviews with some employees (most of whom aren't particularly upset with 401 (K) ), misleading statistic and than quotes by academics.

I think all journalism degrees should include a history minor. Most writers, especially financial ones, seem to have no appreciation or anything before [-]WWII The Cold War[/-] the 1970s.

Maybe Time's right-- we should ditch 401(k)s and go back a century to a kinder, gentler time when everyone had corporate pensions. Oh, wait, back then hardly anyone had pensions!

 

[FUEGO]

Maybe Time's right-- we should ditch 401(k)s and go back a century to a kinder, gentler time when everyone had corporate pensions. Oh, wait, back then hardly anyone had pensions!

Look on the bright side though. Back then people died really young, so the concept of retirenment didn't exist for the rank ad file. Probably due to the working long hours in dangerous/toxic conditions.

 

[Martha]

Excellent letter Clifp.

 

[REWahoo]

Excellent letter Clifp.

Absolutely.

I read the article yesterday - or at least read a portion of it before giving up in disgust. Clifp, you expressed some of the same thoughts I had - only much more eloquently than I. Well done.

I'm not normally a Time subscriber but 'bit' a few months ago on an offer of a one year subscription for $10. I should have known better.

 

[Moemg]

This week Time Magazine cover story is an attack on the 401 (K).

Sadly it like what passes for financial journalism, is interviews with some employees (most of whom aren't particularly upset with 401 (K) ), misleading statistic and than quotes by academics.

I was annoyed enough that I wrote a letter to the editor, here is a slightly modified version of the letter.

e. Trusting our future retirement to the next AIG seems especially foolish.

Guaranteed retirement income and eliminating market risks for retirees sound like worthwhile goals. Unfortunately they are pipe dreams. There is no magic bullet for funding retirement; Americans need to save more, and/or work longer. Like or not our collective retirement is linked to the country's economic prosperity and specifically to corporations generating enough profit to pay interest on their bonds, and dividends to their stockholders (which due to 401Ks includes the vast majority of Americans). Hopefully the events of 2008 served as a wake up call to these simple facts. One of the major of benefits of 401K is there transparency, you know how much money you have. Even more importantly your 401K money can't be easily stolen or distributed to others. The real problem with most pension plans all to often they unintentionally end up like Ponzi schemes, where current retirees receive too generous payments at the expensive of future generations. GM is but one example of this. Blaming the 401K for the poor shape many Americans are in for retirement is clear case of shooting the messenger.

That was a great reply !

 

[Coach]

I agree the article was weak. But I do think there is a need for some reform in 401(k) design. I retired on a defined contribution plan, a 403(b) -- but it was actually designed to get people to retirement. Participation with a minimum 5% employee contribution was mandatory. Employer contribution has grown over time from 5% to nearly 10% of salary, and other employers do better than that. Investment management is provided through TIAA-CREF at low cost and with lots of counseling available.

I think a bit of enhancement to 401(k)s would go a long way to improving things. In addition to mandatory participation, and employer contributions based on salary rather than employee contribution, I'd like to get employers out of the 401(k) business altogether. An employee should be able to set up a plan with their provider of choice and the employer would remit to that plan provider for that employee. The employee would keep their plan when changing jobs. Competition has done wonderful things for IRAs and would do the same for 401(k)s.

Coach

 

[clifp]

I think most of the problems with 401(k)s are because people are clueless about investing. The recent changes which encourage companies to give investment advice and put peoples retirement on autopilot are great steps. I believe none of the Oxy Petroleum people interviewed were around for these changes.

I'd love to see new employee automatically enrolled in 401 at least enough to take advantage of the company match or say 6%. The money placed in a target date retirement fund, and require employees to opt out of things like automatically increasing their 401K contributions after pay raises. I'd even like to see more restrictions on withdrawals from 401(K)s, or at the very least require people to eat cat food for a day before letting the take out the money

I agree with Coach, letting people keep their 401(K) when they change jobs would go a long way toward solving one of the biggest problems, people have a tendency to cash out small 401K when the change jobs. I am not sure but I suspect that is because it is confusing and somewhat of a hassle to roll the money over into a new 401K or IRA.

I am expecting nothing from Time magazine but maybe Google will help my response get more widely read.

 

[ziggy29]

I think most of the problems with 401(k)s are because people are clueless about investing. The recent changes which encourage companies to give investment advice and put peoples retirement on autopilot are great steps. I believe none of the Oxy Petroleum people interviewed were around for these changes.

I also think part of the problem with defined contribution plans is that the time when contributions will produce the most retirement wealth -- when you're in your 20s and 30s -- is also the time when people aren't thinking about retirement and when people have the lowest earning power to set aside part of their pay.

I may not be able to FIRE as soon as I hoped after the market meltdown, but I'll still be okay relative to most folks. I've been putting 10-12% of pay into my 401K since I was 23 and more than that recently. Despite the recent haircut, all the money I put in from about 1989 through the 1990s is still way ahead of the game.

 

[growing_older]

I would love to see many of these proposed enhancements made to 401k or other defined benefit plans. I don't think that's the direction the "reformers" who are starting these kinds of articles are leaning. They seem much more inclined to invent group plans or insurance pools or government mandates and then make their solution mandatory. I'm sure I could have done better with my 401k, but the ability to move it to my own IRA every time I changed employment has done much better than any of the defined benefit plans I was (temporarily) a member of. I wish I could have contributed more in early years, but back then dollar and percentage limits were much lower than the current rules. Seems strange to be talking about scrapping the plans because under old rules (no longer applicable) many people didn't contribute more, instead of talking about how to encourage more contributions under the new rules.

I also don't understand the "average 401k balance" numbers that show up in all these articles. Do they account for the balances rolled into IRAs? It seems like they omit those, which gives a very odd measure of the value of 401k skewed by new participants who change employers, thus making their old 401k balances vanish from measurement.

 

[Alan]

I also don't understand the "average 401k balance" numbers that show up in all these articles. Do they account for the balances rolled into IRAs? It seems like they omit those, which gives a very odd measure of the value of 401k skewed by new participants who change employers, thus making their old 401k balances vanish from measurement.

Excellent point, not thought about that. First thing I'll do when I RE is to roll the 401(k) into an IRA and I expect many "with it" folks do exactly this. May well be a good reason quoted average balances always seem incredibly low.