I was all set to write about another topic this week, but upon reading the comments on Eric Schurenberg's recent post advocating change in the 401(k) system, I just had to chime in. And if you've read even a handful of my previous posts (such as the one on mutual fund expenses, or the one on fiduciary duty, for instance), you won't be surprised to know that the comment that really caught my attention was the one from the Investment Company Institute's (ICI) Rachel McTague.
In both his July 29th post and his post a month prior Eric did a good job of laying out the problems with our nation's retirement system, but I'll provide a brief recap.
First, the plans are expensive. Good data on 401(k) plan expenses are notoriously difficult to get, but reasonable estimates place the costs in the range of 0.5 percent to 2.5 percent per year. The smaller your employer's plan is (in participants, and importantly, assets), the more likely it is that its costs are at the higher end of that scale.
Second, participation in retirement plans like 401(k)s is spotty. Roughly half of all full-time employees do not participate in any employer-sponsored plan, either because their employer does not offer one, they're ineligible to participate, or they simply choose not to.
Third, many of those workers who do participate make bad choices in any number of areas, such as:
- Contributing too little. The median 401(k) participant contributes just five percent of their annual income to their employer-sponsored plan. Including the employer's contribution, the total amount is just 9.1 percent, less than two-thirds what most advisors recommend is needed to accumulate a sufficient nest egg.
- Poor investment decisions. Over 19 percent of participants in their 20s have zero exposure to equities. At the other end of the spectrum, more than 30 percent of workers in their 60s have more than 80 percent of their retirement account invested in equities. Perhaps even worse, among plans that offer company stock as an investment option, the average participant holds more than 20 percent of their plan's assets in this option. Remembering the fate of Enron, WorldCom, Lehman Brothers, and a host of others highlights the risk of such a concentrated investment.
- Cashing out. 18 percent of all participants had a loan outstanding on their 401(k) at the end of 2007, with the average balance equal to 12 percent of the plan's value. Even worse, a staggering 45 percent of workers who changed jobs in 2004 cashed out their retirement plans, using their retirement savings for other purposes.
401(k) defenders, like the ICI, rightly point out that this balance may not include any retirement assets held in former employer's plans. But when we consider that nearly half of all participants cash out their retirement plans when changing jobs instead of rolling them into the new plan, it's a little hard to believe that the retirement scenario of the typical worker is much rosier than this paltry balance would indicate.
It's not hard to consider these figures and imagine that our nation will face a retirement crisis in the not-too-distant future -- a crisis that was precipitated largely by basing our nation's retirement system on the notion that the average American worker had the time, interest, and ability to fund and invest their way to a secure retirement in their spare time.
The evidence amassed over the 30-plus year history of the 401(k) has clearly demonstrated just how flawed that assumption is -- it's akin to asking the average worker to become their own auto mechanic on the side, but with much larger potential social costs. Which is why it's great news that these flaws are finally being acknowledged and solutions are being debated; and why it's so distressing to hear defenders of the status quo, like the ICI.
Ms. McTague's comments in Eric's post provide a nice summary of the ICI's position on this issue, so I'll address a few of them here.
- "There's ample evidence that the 401(k) plan is a successful savings vehicle ... [and] we would be making a grave mistake to use recent market events as an excuse to dismantle the 401(k) system."
COMMENT: I think the difference lies in one's definition of "successful." Yes, Americans have amassed $2.4 trillion in 401(k) plans. That sounds like a lot of money, until you go a step further and consider that the total translates into the miniscule median balances described earlier. And during the three decades that this "ample evidence" as been accumulated, pension coverage has dramatically shrunk, and personal savings have dried up, leaving workers more reliant than ever before on their retirement savings.
- "We support improving disclosure about ... historical returns, and more; delaying the required minimum distribution age ...; ... and making financial literacy a national priority."
COMMENT: Ah, so if the average employee only had better-disclosed information about the historical returns of the funds in their plans, they'd rush right out and increase their contributions. Really? I might be operating in a bubble, but I've never had a conversation with anyone who complained about how difficult it was to get historical mutual fund returns. I've had lots of conversations with educated professionals who admitted they didn't know anything about how to set their asset allocation; or how to determine how much they needed to contribute to fund a retirement 20 or 30 years in the future; or how to make sure they don't outlive their nest egg. But I've not heard a single complaint from anyone trying to determine what their mutual fund earned last year. (In fact, most are painfully aware of this.)
Delaying the required minimum distribution age is actually a fine idea, even if the ICI is endorsing it because it allows their member firms to hang onto those assets a bit longer. But let's be honest: the problem isn't the government forcing retirees to withdraw too much from their retirement account; the problem is that there isn't enough in the retirement account to begin with.
And I love the part about making financial literacy a national policy. Presumably the ICI would like to play a role in shaping that policy. I can only imagine their curriculum: How to pick a fund with the best three-year record; Why your mutual fund's fees aren't as important as you think they are (and why they're actually pretty darn low, in any event); and Why the mutual fund industry is one of the most competitive on the face of the planet. Sounds like just what the doctor ordered to fend off our national retirement crisis.
- " ... a 401(k) is not designed to be a worker's sole source of retirement income. Instead, it serves as a complement to Social Security ... Preserving the essential nature of Social Security as a universal, employment-based, progressive safety net for all Americans while addressing its long-term solvency should be a top national priority."
COMMENT: This is a classic bait-and-switch. Yes, the Social Security system needs addressing. But using that as some sort of excuse to ignore the flaws with our 401(k) system is the equivalent of your doctor telling you that he's not going to worry about your broken leg until your broken arm is healed. It makes no sense.
In any event, Ms. McTague is correct. 401(k)s are supplemented by Social Security. But Social Security was designed to provide only a very basic standard of living for our nation's elderly, and the depressingly low levels of retirement savings indicate that a staggeringly large portion of our workforce will be getting very little "complement" to Social Security from their 401(k)s, which will leave a significant proportion of our population relying almost solely on Social Security to fund their living expenses once they're unable -- not just unwilling -- to work. Does that sound like a system that's working as planned? There's simply no good reason that we can't -- and shouldn't -- address both.
The ICI and its member firms deserve a seat at the table as solutions are debated, but unless and until they begin to demonstrate enough intellectual honesty to stop trying to stifle attempts to solve this problem, their voices should -- and hopefully, will -- fade into the background.
Image via Flickr user thinkpublic CC 2.0