Monday, October 12, 2009

401(k)s in the Crosshairs

I'm beginning to see more and more anti-401k talk these days. I've covered this topic a few times in the last twelve months — the articles "401k Mess" and "401k Tax Break Under Microscope" are examples that come to mind.

Now we have a glossy mag of no less stature than Time joining the 401k punching party:

Time:Why It's Time to Retire the 401k

And it's a long article, too — something like five pages of bodyblows dealt to the 401k setup. You know it's gonna be good when you get this on page one:

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.

One can sit back and pretty easily foretell what Time is going to harp on: They'll lament the disappearance of "guaranteed" employer pension plans. They'll point out that the 401k was never intended to be more than a tax-advantaged "executive perk."

And they'll posit that the answer to all this JUST MIGHT BE (of course) a NEW GOVERNMENT PROGRAM. Because all the previous ones have worked SO WELL.

There are other options, of course. Like this one:

But guaranteed accounts don't have to be run by the government. The ERISA Industry Committee (ERIC), a group that represents the nation's largest employers, has proposed a system of exchanges that would allow individuals the ability to buy a guaranteed retirement account on their own. Some government regulation would be needed, but it would be a private plan.

What the ERIC plan and others like it are essentially proposing is a form of retirement insurance. So instead of putting 6% of your salary into a 401(k) or some other investment account, each pay period you would send 6% of your check to a retirement-insurance provider. The policy would work similarly to a traditional pension in that it would provide a guaranteed monthly check equal to about a quarter of your final pay, from when you quit working until you die. Some employers might even be willing to pay the annual premium as a perk. If not, employees would pay for it much as they currently fund their own 401(k)s. But the policy would be portable. Contribute for 30 years and you would be guaranteed income in retirement, no matter how many employers you worked for. Combine your retirement-insurance check with the money you get from Social Security, which can equal as much as 50% of final pay, and presto: you have something approaching retirement security.

Just exactly how contributing six percent of one's income per year for thirty years, plus Social Security (yeah, right) gets one to "retirement security" ... well, I must be missing comething in my Google Docs Retirement Insurance spreadsheet for an employee starting with a $40k salary.

With pay raises of 2 percent per year, and expected annual returns of 4 percent per year, our $40k/year worker would amass just a touch under $172k at the end of Year 30.

From there, in a "math that almost works" world, our Joe Sixpack could withdraw about $12,600 per year (18 percent of his final pay, or $1,050/month) for 20 years before draining the account. (Note that these calcs are independent of taxes and inflation, both of which are pretty certain to be, uh, "non-negligible" going forward.)

Of course, there'll be Social Security payments to count on in 30 years. Don't forget about those. Ahem.

However, if I step into the "math that doesn't work" world which Time magazine seems to inhabit above, I'd find that Joe's account, if he withdrew "about a quarter of his final pay" each month, would be in the red by Year 43.

Good thing his retirement paycheck would be "guaranteed."

Look: At the conservative end, would Joe's monthly check for $1,050 be better than nothing? Absolutely. It might buy him a couple bags of decent sandwiches, anyway.

Does it resemble anything close to real "security?" No.

Does anything in the proposed plan resemble real "security?" No.

Plus I have a few more concerns about this "retirement insurance" setup:

  • If it's privately run, we're told that "some government regulation" would be needed.

I mean, they did such a great job with the banks and AIG and all. I'm supposed to feel reassured by this? Really?

  • If it's government run ...

Well, yeah. Just smell the goodness of those low, low returns you'll get by investing in long-term Treasuries and other government bills. Aw, what the heck — we can always just print it, right?

  • If the insurance companies can earn better than 4 percent a year, what's the investment vehicle?

Lemme guess: Stock market? Mortgage-backed securities? Collateralized debt obligations? Other financial hodge-podge?

Or are we looking at just another government-authorized Ponzi scheme?

And what happens to the market indexes when everyone's six percent STOPS going into their 401ks, and STARTS going elsewhere?

And if the premiums are just going back into the stock market, how's that better/different than what we have now?

Call this scheme whatever you like — retirement insurance, a privatized version of Social Security designed to complement the other doomed Social Security, or something else — but I want to know just how exactly they'll get to the level of "50% of final pay" that the Time author conjures above.

Of course, they did use the word "presto" in their presentation, which sort of suggests magic of some kind.

Could it be that maybe — just maybe — this whole "retirement security" insurance thing is, as I suspect, just a newfangled continuation of our country's ongoing War on Math?

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— Posted by Michael @ 8:17 AM


History tells us that the 401(k) rule was put in the tax code to benefit a couple of politically connected CEOs, but it has certainly encouraged a lot of saving. Since my company did not eliminate its defined benefit plan entirely, my 401(k) is the foundation of my retirement. Even though I rolled the assets into an IRA account upon retiring it was the opportunity to save and defer taxes that helped enable that retirement. Although I agree 100% that we donít need another government run program, I donít share your pessimism about Social Security. If the body politic doesnít have the backbone to let GM, AIG and the other poorly run companies fail, Social Security will be bailed out forever. Our kids (in my case grandkids) will shoulder that burden. What a shame!

Anonymous Anonymous
, at 9:01 AM, October 13, 2009  

Haven't 401ks taken enough of a hit in the past year?

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