Writing in the October 19, 2009 issue of Time ® “Why It’s Time To Retire the 401(k)”, Stephen Gandel writes “The ugly truth though is that the 401(k) is a lousy idea, a financial flop, a rotten repository for our retirement reserves. In the past two years, that has become all too clear.”
Is that how you feel?
This story is largely based on the experience of several retires from a company that terminated its pension plan twenty-six years ago and replaced it with a 401(k) plan. Clearly we would all like to have a pension plan, Social Security and other savings when we enter retirement. We would also like to be mortgage free, but that is not the real world in large part of our own doing. In short, millions of Americans are better with the 401(k) than without it.
The fact is that a majority of Americans never had a pension plan even before the idea of a 401(k) was popular; one of the reasons we have IRAs. The remaining bastion of the defined benefit pension is among government workers. At the state level pensions are generous and expensive, and many are in serious trouble with their funding. And for the taxpayers, they are probably unaffordable as well.
The current gripe with the 401(k) is that it is subject to Hamlet’s slings and arrows of outrageous fortune. Ok, we get it the market goes up and the market goes down and sometimes at inopportune times. On the other hand there are steps people approaching retirement can and should take to mitigate that. My own 401(k) plan is worth more today then it was a year ago. I’m not an especially wise investor but I do know enough to put a good chunk of my funds in less volatile investments in the years before retirement and during retirement and I also know enough to keep plowing money in while the market is low. And as for keeping up with inflation yes, you do need to plan for that and that means you have to start out with more money than you think you will need so you have a cushion. But that issue is not unique to those dependent on a 401(k) plan, the vast majority of pension plans (government being the likely exception) do not have cost of living adjustments built in while the cost of living adjustment within Social Security is one of the main drivers of the coming meltdown of that system.
Individuals can also minimize their retirement risk by taking all or part of their 401(k) plan and buying an annuity so that they too have a steady stream of income with an enhanced sense of security. Interestingly, the average person may not think that way even in the face of future economic uncertainty. In the relatively few defined benefit pensions plans that offer a lump sum distribution in lieu of a life annuity, the great majority of participants take the lump sum thus placing themselves in the same position as those with only a 401(k). In one plan I operated, 99% of the people took the lump sum and a few promptly lost their pension with poor investments.
We often forget that the ups and downs of the stock market dramatically affect those employers who provide a defined benefit pension as well as individuals. 2009 and 2010 are excellent examples of that. In extreme cases the very survival of the pension plan, if not the employer is placed at risk so the defined benefit plan may be good for workers, but it is not without its own outrageous fortunes.
Aside from the obvious decline in the stock market, why do 401(k) plans fall short? It is mostly because people do not save enough, make in-service withdrawals, borrow from their account and do not pay attention to their investments. The argument goes that lower paid people cannot save, yet we still expect them to pay 7.45% of their pay for Social Security and Medicare. Why should be saving (on a pre-tax basis) for ones future retirement be any different? One alternative proposed by Teresa Ghilarducci of the New School would be to have a new 5% payroll tax and in return the government would guarantee an income for life equal to 26% of final pay. So, on one hand people cannot afford to save and on the other we talk about a new 5% tax. If that same 5% were invested by the employee in many cases with the employer match it would be actually seven and a half percent. In addition, such an open ended commitment by the Federal government implies that the growth of the account is actually guaranteed by all taxpayers. Why not simply put the 5% into a 401(k) and direct a portion of the savings into an accumulating annuity so that when the worker is ready to retire, some portion of their savings will always be in the form of a lifetime benefit?
Retirement as those of us who are in that phase of life know is a somewhat scary prospect. Aside from the “what the heck do I do now” realization most people are faced with the “how do I live like I used to” question as well. Without a guaranteed steady stream of income, there can be many sleepless nights not only watching your investment balance but wondering how much you can withdraw and not run out of money. It is not easy, but that does not mean we should give up the 401(k) as a “lousy idea.” The defined benefit pension is gone forever (unfortunately), Social Security is not becoming more generous and given the state of federal budgets and deficits the possibility of a new government entitlement is remote (let’s hope).
That leaves us with finding ways to improve what we have with the 401(k) plan which includes, enhanced investing and retirement planning education, expanding automatic enrollment, adding annuity options to all 401(k) plans, encouraging higher employer matches, non-matching employer contributions and perhaps profit sharing contributions on top of a match.
And after all that happens we need to dispel the idea that one can retire at 55 and live fat dumb and happy for the next thirty years.