The Great 401(k) Hoax, Continued
This standard retirement-savings vehicle is still woefully substandard. The only solution is for employees to become far more active
In 2002, along with co-author Anne Colamosca, I wrote a book entitled The Great 401(k) Hoax. We revealed that after almost two decades of booming bull markets in stocks and exponential growth in the number of households enrolled in 401(k) retirement plans, the average American family was nowhere close to ensuring financial comfort for its golden years. Ted Benna, whose reading of Section 401(k) of the Internal Revenue Code led him to invent the corporate-sponsored plans of the same name, shared this view: "If I were starting from scratch today, building the 401(k), I'd frankly blow up the existing structures."
Unfortunately, the stock market crash and a weak economy have only made things worse for many Americans. And revelations of the gross mismanagement of the 401(k) plans at many corporations, most spectacularly Enron and WorldCom, have led to precious little reform in the 401(k) arena. So, if you're approaching retirement or even middle age, you should be thinking about reassessing your retirement planning (see BW Online, 10/15/03, "It's Time to Retune Your 401(k)"). And corporations still have important lessons to learn about increasing employee awareness of one of the most important benefits they can offer.
ALARMING SITUATION. The news isn't all bad: Congress has increased allowable 401(k) contributions to $12,000 this year and to $15,000 in 2005, and it enacted laws permitting catch-up payments by those over age 50 (see BW, 07/28/03, "Playing Catch-Up Can Be Good for You"). New restrictions have also been imposed on matches in company stock. At Enron, for example, employees had to take Enron stock, and when valuations plummeted, they lost most of their retirement savings.
Also, more companies now allow employees to get professional advice on investing their retirement money. Beyond those changes, however, little has happened that leads me to believe that 401(k) performance will materially improve in the years ahead.
The relatively small returns to a large number of Americans in the 401(k) system are all the more alarming given the revelations of underfunding of traditional defined-benefit pension plans. That system has been weakened by new rules that allow corporations to change the interest rate assumptions underlying their plans. The result: Companies are permitted to reduce their annual contributions to these old-style plans, to the possible detriment of retirees.
SYSTEM ON THE CHEAP. Who's to blame for these latest twists on the 401(k) hoax? "Don't put it all on us," say the financial institutions that manage 401(k)s. The industry says blame also lies at the feet of eligible workers who never enrolled in company 401(k) plans in the first place or who failed to make sufficient contributions or set aside sufficient retirement savings. This line of reasoning has some validity. America's consumer society still hasn't learned to place a sufficient emphasis on savings.
The retirement system's biggest failure, however, lies with business itself and with the way in which Wall Street manages money. It's important to understand that the 401(k) is a retirement system on the cheap. Theresa Ghilarducci, a Notre Dame University pension whiz, estimates that the 401(k) system costs business only about 50% of what a defined-benefit system would cost.
And as the decline in the value of 401(k)s during the stock market slide showed, employees bear a significant risk that market underperformance over an extended period of time will undermine the value of the eventual pension. Defined-pension benefit plans have no such risk.
STAGNANT POOL. The dirty little secret of the 401(k) industry is that workers don't gain as much as you might think when the market does well. Mounting evidence shows that 401(k)s provided paltry returns during the great stock market boom of the 1980s and 1990s, when the benchmark Standard & Poor's 500-stock index quintupled in value. The data that show this best have been compiled by New York University professor Edward N. Wolff. His numbers show that, adjusted for inflation, the total pool of money set aside for retirement didn't increase in the 15 years from 1983 to 1998. Over that period, 65% of American households headed by a person from 47 to 64 years old had either the same or less pension wealth in 1998 than they had 15 years earlier.
As might be expected in an era of growing inequality, the well-to-do did better than average families. For the top 20%, pension wealth grew 19% over 15 years -- a paltry performance in a period of rocketing stock prices. The very rich did much better. The pension wealth of the top 5% of American households increased 176%. Still, even that number is disappointing given a vaulting stock market.
Wall Street has made a widespread effort to blame 401(k) troubles on the reluctance of companies to offer financial advice for fear of being sued. Congress has tried to ameliorate such fears with new incentives to allow employees to seek retirement-planning advice. But few analysts are willing to admit that professional financial advice appears to be very close to worthless, particularly the stock market advice that pros offer.
The Great 401(k) Hoax, Continued
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STARTLING MESSAGE. The best evidence on this has been provided by Gregory Baer and Gary Gensler. Those experts compared the performance of diversified mutual funds with the performance of index funds. Their conclusion: In general, managed fund returns were lower than those of index funds.
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They say the difference could be explained by the cost of the investment advice. This comparison, of course, applies to diversified funds and is no argument against diversification, the best possible insurance against 401(k) disaster. But the message is startling and a bit disturbing: Wall Street money management appears to be an almost perfect example of professional mediocrity.
Still, most companies and most employees continue to sock away money in 401(k)s. A survey by the Profit-Sharing/401(k) Council of America found that 80.3% of eligible employees held balances in 401(k) plans in 2002 -- up from 78% in 2001. Workers contributed 5.2% of their pay, off slightly from 5.3% in the previous year, but slightly higher than the 5.1% rate in 1998. And that's a pretty good record in a period when paycheck deductions for health insurance were rising sharply.
QUANTUM LEAP NEEDED. Meanwhile, Corporate America has increased matching contributions to 2.8% of pay in 2002 from 2.5% a year earlier. Companies also raised the number of funds offered in plans. Some 81% of plans had at least 10 funds available, up from 70% in 2001, and 62% in 2000. The council also found that nearly 52% of plans offered advice to their participants, up from about 41% in 2001 and 35% in 2000.
While these changes, particularly the increase in company contributions, should help, they're unlikely to go very far in putting an end to 401(k) woes. The main flaw in almost all companies, most experts agree, is a failure to encourage a workplace dynamic in which the worker will pay more attention to his 401(k). The only road that has a chance of encouraging a quantum leap in 401(k) involvement is a radical change in the way in which funds are administered and managed.
Systems in which employees are passive recipients of investment advice from a group of underperforming professionals are bound to fail. In this regard, the 401(k) industry is right: The impetus for change must come in large measure from the employees themselves. In an ideal 401(k) world, conversation among employees about retirement programs should be almost as common as talk about the movies or where to have lunch.
WORKERS, UNITE! Statistical evidence indicates that increased employee involvement would help across-the-board. In June, 2000, and during several periods since, Professor Esther Duflo of Massachusetts Institute of Technology and then-Harvard Professor Immanuel Saez (now at the University of California at Berkeley) analyzed plan participation data and found strong statistical evidence that decisions about retirement plans are heavily influenced by fellow workers in the same department.
The study focused on the role that information and social interaction play in decisions, and it outlined practical steps that plan sponsors can take. These steps center on organizing meetings around natural peer groups within the workplace. The researchers also found that Internet sites highlighting real-life examples of how co-workers have found ways to improve the performance of their 401(k)s and to increase savings prove to be a great help (see BW, 07/28/03, "Planning at Your Fingertips").
The implication is that company programs or employer-directed 401(k) meetings don't do the trick. Instead, what's needed is an environment in which employees themselves are the source of the education effort.
EVERYONE PAYS. The major problem is that an employee-organized 401(k) group, like any other employee organization that goes much beyond getting together for jogging at lunchtime, tends to be viewed with suspicion and met with resistance by employers. The reason: the U.S. management tradition that considers worker-sponsored initiatives to be a threat to managerial prerogatives and an invitation to union activism.
It's past time for management to realize that employees can't afford to be passive about an issue that has the power to determine whether they'll have a decent standard of living in the last 30 years of their lives. After all, the economy's health will be dramatically affected by how well retirees are able to live. Corporate America has a huge stake in this outcome. If the aging baby boomer demographic is so strapped financially that its spending on goods and services is limited to necessities, businesses will bear the brunt.
Now, more than ever, effective retirement planning must come front and center.
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Wolman, former chief economist for BusinessWeek, is at work on a new book, with co-author Anne Colamosca, about election-year economics
Edited by Beth Belton |
