Asking For More Than 401(k)s
The NY Times ran an editorial on Friday lamenting how employees are borrowing more and more from their 401(k)s to pay for medical bills, mortgage payments, and stints of unemployment. The Times reports that this trend is exacerbated by the "401(k) debit card," which holders use like any other debit card, except the money comes as loans from their 401(k)s rather than as deductions from a checking account.
What the article, like the Democratic Party, neglects is the inadequacy of a retirement system reliant largely on 401(k)s. In her new book, When I'm 64, economist Theresa Ghilarducci demonstrates that we can have a system in which workers save for their own retirements without the risk and inequity of 401(k)s.
Ghilarducci's book provides an historical and economic analysis of America's pension system, along with an excellent and timely indictment of relying on 401(k)s to provide a middle-class retirement for Americans. With individualized savings, of course, individuals must not only save, but must invest wisely and get lucky that the market is performing well when they reach retirement age. One surprising fact is that those who spent the most time choosing their plans and consider themselves the most informed actually make the worse choices. Participants often wind up paying enormous sums--up to 20-25%, estimates Ghilarducci, of the value of their total retirement savings over time, thanks to the magic of compounding interest--in fees. (Fund companies charge individuals higher investment fees for actively managed accounts than professionals and institutions.) Moreover, income tax deductions provide greater subsidies for wealthy workers--workers who are already able to save more. (According to Ghilarducci, the top 3% of wage earners receive 20% of the subsidies; the top 10% receive 50% of the subsidies; and the top 20% receive 70% of the subsidies.)
Barack Obama continues to ride the 401(k) bandwagon in his overall retirement policy platform. Some of his proposals are undoubtedly an improvement on the current situation: he endorses the overwhelmingly popular ideas of lifting the cap on Social Security taxes--although the campaign is so afraid of actually raising taxes on the rich that the increase would not take effect until 2018--and taking privatization off the table. Obama's plan would mandate that employers offer their workers 401(k)s and automatically enroll workers. In addition, lower-income workers would receive a tax credit so that they would be more able to save. Such changes, however, do not address the fundamental insecurity or inequity of 401(k)s.
In the book's final chapter, Ghilarducci proposes "Guaranteed Retirement Accounts," which would supplant 401(k)s. Everyone must save 5% of their income into their personal GRA, with the government contributing $600 (inflation-adjusted) of this amount every year. The Treasury gets this $600 per person by eliminating subsidies for 401(k) contributions over $5000. In other words, her plan democratizes $115 billion per year of tax subsidies--and so it would actually be cheaper than more modest proposals. It is administered by the same agency that administers pensions for federal employees and is run by professional investors. And, everyone is guaranteed a 3% inflation-adjusted rate of return (the government, not individual workers, assumes the risk).
Ghilarducci believes this plan could be adopted: she cites a 2006 HSBC Bank survey finding that Americans do not want the retirement age raised or benefits cut, but we do want the government to force us to save. In a three-part exchange with Ghilarducci, Jacob Hacker argues that 401(k)s are embedded and, for political reasons, more modest proposals--they typically neither guarantee a return nor eliminate regressive tax subsidies--"might be the best we can do." What do you think?
Another problem with 401ks are the vesting schedule. Employers' matching contributions are usually not vested for 3-5 years. Given today's employment market, many people won't be working (willingly or not) long enough at a company to qualify for the matching funds.
August 17, 2008 3:54 PM | Reply | Permalink
As someone whose family lived in a totalitarian state, I think it's truly extraodinary that anyone in America would ever even consider imposing the compulsory personal contribution.
It reveals the "progressive" wisdom, often found on this site, that Americans are basically stupid (low information voters??) and are incapable of making their own choices.
Apart from the direct benefit to the investment and banking industries that this proposal would generate, I fail to see the benefit of Government-enforced contribution that will NOT guarantee a return.
August 17, 2008 4:21 PM | Reply | Permalink
Lalo35adm says;
I wouldn't say "Americans are basically stupid", but I would say the majority of Americans ARE "low information voters", politically, and as regards to investing.
Don't make the mistake that because you and those you socialize with may be political sophisticates, and wise, well informed investors, that you reflect the general public.
For starters, look at those 'capable' of making their own choices when they signed for sub prime, no interest (deferred) ARM mortgages for homes they couldn't afford.
Look at the 401K choices of most Americans, and regardless of age I'll bet you find them weighted heavily in Bonds.
Bush wanted to privatize Social Security, using Government Bonds to pay for the transition. All this because the Republicans said the Government Bonds in the Trust Fund were worthless.
When the word "risk" was presented to those joining the privatization scam, they would have wanted the retirement money secure, so obviously many would have opted for the most secure, "Government Bonds".
As for political sophistication, count the number of Limbaugh dittoheads and Hannity sycophants in the country.
August 17, 2008 5:05 PM | Reply | Permalink
So let's say that my plan was to set aside my savings so that I could use them to set up my own business, take risk and with hard work provide for my own retirement.
Instead, the authors of this proposal take the lowest possible common denominator and force on me, as well as everyone else.
How about we implemenet a program that EDUCATES people about investing and retirement planning instead of simply dictating they must allocate their money??
August 17, 2008 7:29 PM | Reply | Permalink
Lalo35adm says;
I imagine you would also take care of your own Disability Insurance, survivor's benefits, and medical coverage and forego Medicare.
So, to protect taxpayers from paying for your decisions, if you go bankrupt when you're 60 or 65, or you become disabled at some time, you agree to moving in with your children and have them take care of all your needs rather than rely on Social Security and Medicare for help?
yeah, that'll work, heh. I can see it now, 300 million savvy investors (Well, subtract non adults from that number) What you suggest is a tactic the right wing uses; ( I don't infer you're right wing) 'oversimplification' as a cure.
Medicare and Social Security are insurance programs just as a mandatory retirement account would be.
You see this as an individual issue not as a societal issue. As a retired businessman who turned the firm over to his sons I always saw Social Security, Medicare and Retirement as a societal issue.
August 18, 2008 9:08 AM | Reply | Permalink
I like the idea of a government guaranteed retirement account in addition to my personal 401(k). And we have it. It's called social security.
If you want to augment social security, I'm fine with that. But I don't want my 401(k) plan replaced. I like my fund choices, its portabilty and the tax advantaged status of my contributions.
My 401(k) plus social security seems like a good plan. I do believe, by the way, that I can beat 3% over inflation over a period of time. Picking low fee mutual funds is a good start.
August 17, 2008 5:04 PM | Reply | Permalink
I retired in 1993, relying on a 401k account, my company pension, and Social Security for the bulk of my retirement income. It worked reasonably well, although continual inflation will destroy any retirees income eventually.
My 401k was not augmented by company contributions. I just had a choice of about 4 investment options when it started, and like most people I selected a bond fund. But, at that time those funds were paying about 20% annual return! Later, as interest rates became more rational I switched to a S&P 500 index fund. The system worked very well for me, effectively doubling my Social Security check.
Just because the stock market is in the doldrums now, largely because we have had 8 years of Republican misfeasance and malfeasance, is no reason to knock 401k funds. Contrary to Phil Tedesco's comments, I paid almost no commissions for my fund. Commissions are for those who like the excitement of buying and selling on whims. Even now I have extra funds in a second S&P 500 fund, and paid no commission for that fund either.
Some of my co-workers were uninformed enough to put their entire 401k into company stock, at the urging of the company, and they lost their entire savings when the company went bankrupt. I don't sympathize with people who make such a dumb mistake.
I don't want another "government guaranteed" return when I live my second life - Social Security is just fine.
August 17, 2008 7:19 PM | Reply | Permalink
hoppy said;
hoppy, thanks for the reminder of ENRON type retirees investing all their savings in their company, it complements my above post on the unsophistication of the general public vis a vis investing.
August 17, 2008 7:25 PM | Reply | Permalink
I do recall reading somewhere that you generally shouldn't have more than 25% (unless you're a principal) invested in your company's stock. Remember, your job, 100% of your income is already dependent on how well the business is doing.
August 17, 2008 8:16 PM | Reply | Permalink
Twenty-five percent of your assets invested in any one company (whether that company is your employer or not) is way too much for most people. I'd be wary of investing more than about 5% of my assets in a single company unless I could afford to lose all of that money, I was a well-compensated senior executive in the company who was required to hold large amounts of stock, or it was my own company and I had no other way to finance my business. I'm all for employees holding some of their employer's stock--as long as those employees aren't depending on that stock for a significant portion of their retirement income.
August 17, 2008 9:37 PM | Reply | Permalink
Thanks for these comments. I largely agree with JohnW. I'd recommend the Sunstein and Thaler's new book, Nudge, which documents, with data from behavioral economics research, how poorly a job people do saving for retirement. (Nudge, though, opposes mandates for ideological reasons not dissimilar to those Lalo put forth.)
I'd also respond that, under Ghilarducci's plan, we could all still save for retirement in addition to GRAs--there would just be no tax benefit. The tax benefit is regressive (given our progressive tax structure and the greater ability of the wealthy to save).
Also, the 3% return is a floor, not a ceiling. As Ghilarducci notes, we should expect professionals to do a better job than individuals investing. I link to an article in yesterday's Times about people contemplating retirement now--it's not good, entirely b/c the market is currently down.
August 17, 2008 7:40 PM | Reply | Permalink
If we have the urge to mandate, we couldn't we have mandatory retirement planning education for everyone, organized by employers?
August 17, 2008 8:19 PM | Reply | Permalink
Lalo35adm says;
Excellent suggestion.
August 18, 2008 9:12 AM | Reply | Permalink
Wonderful! Now, could you please please please keep your hands off my money?
August 18, 2008 3:48 PM | Reply | Permalink
Lalao35adm says;
tsk, tsk, tsk
August 18, 2008 7:10 PM | Reply | Permalink
Phil,
Whether or not the tax benefit is regressive doesn't mean a lot to me in this case. If you want to encourage people to save for retirement, then you should give them incentives and the tax code is a great place to start.
August 18, 2008 11:21 AM | Reply | Permalink
I'm somewhat shocked by the numbers proposed by this author. My view is simple (as someone who lost a military pension during the reductions in the 1990s) - the government will not be given any additional control of people's retirements until they satisfy the demands of American workers to secure the existing system - Social Security. The last attempt to reform Social Security resulted in the "Do Nothing" option winning out. As someone who participated for over 10 years in the "future compensation" system of the USAF, and lost the future compensation when the government chose to significantly reduce the number of people in the military, allowing the government to control even more of my future retirement is NOT a viable option. I save at the maximum amounts into my 401K for the simplest or reason - I have nothing else beyond a shaky promise of social security. There is no government subsidy of my 401K dollars - my employer does a 3% match and the government allows me to use pre-tax dollars, but I have nothing else and the use of pre-tax dollars is little more than an additional incentive beyond the pure fear of losing the remaining money I have saved into the Social Security system. Due to the late start in retirement savings (having trusted my first "career" employer's promises) I am now saving over 40% of my gross income including SS, 401K, and after-tax investment. I don't consider anyone receiving their income via W2 wages "rich" and am shocked by the approach advocated by the book author.
August 18, 2008 10:40 AM | Reply | Permalink
RS -- I think you're right on when you say that nobody who pays the rent and buys food with W-2 wages is actually rich. You're also right on in putting the tax incentives into proper perspective. It's a very minor perk. If anything there should be more tax breaks for 401(k) investors.
August 18, 2008 11:37 AM | Reply | Permalink
Those tax breaks you get when investing in a 401k plan are just loaned to you. When you retire and need to use those funds you quickly find out that it is then time to repay the breaks. It is certainly true that the tax breaks are valuable beyond their actual value at the time, because you get the investment use of that money for many years before having to repay the breaks. But, when you need that money later in life, just pray you only need a little at a time.
We need to give up the scare talk about the lack of safety of our SS contributions. It is a "the sky is falling argument". SS has always been safe and will continue to be safe. Nothing whatever has been proposed that changes that, and no politician will be reelected if he does anything to make it less safe. No investment will ever be as safe as SS.
August 18, 2008 12:10 PM | Reply | Permalink
Good points, hoppy. Tax deferrals are valuable but as you say, if you need to take a big 401(k) distribution, even to handle a medical bill, that money winds up taxed, sometimes at a punitive rate. My problem with Tedesco's thesis here is that there are probably too few tax breaks around 401ks, not too many.
August 18, 2008 12:29 PM | Reply | Permalink
destor and RS--I think there's actually a lot of agreement here: The issue with the tax breaks is that there are too few breaks for people who aren't paying high marginal rates. If you're paying 35% (taxable income over $349,700 in 2007), you get 35 cents on the dollar from Uncle Sam up to the maximum ($15,500), which you can afford to contribute. If you're paying, say, 15%, you only get 10 cents, and it's unlikely you can contribute all that much.
August 20, 2008 11:26 PM | Reply | Permalink
oops--I meant 15 cents.
August 20, 2008 11:26 PM | Reply | Permalink
Yes, Hoppy makes good points. Part of my issue with the original author, and I've only listened to the NPR interview (http://www.npr.org/templates/story/story.php?storyId=92213600)
is what she proposes seems more like an add-on to Social Security - which is a program itself that has little confidence with younger workers. Of concern is having another program that, falsely, gives the impression to workers that their retirement income is secure based upon incredibly minimal contributions while they are working. Yes, if the people receiving 401K tax deductions are incredibly successful with their investment decisions, then they will help subsidize with their taxes on 401K withdrawals those were are much less successful in their retirement years. Expecting more than that is really wishful thinking.
August 18, 2008 1:00 PM | Reply | Permalink
Sorry for not responding for a couple of days. I have been out of town and offline.
401(k)s are a significant part of our pension system, and this welfare is funded through income tax deductions--why should progressives support a social welfare that is regressive?
The point of a retirement system is to provide security. Empirically, our system leaves very many people very insecure. The mandate gets everyone to save, and the government contributes $600 towards everyone's saving AND would subsidize up to $5000 of savings (the number in Ghilarducci's plan).
Yes, the tax benefits are partly in the form of deferred taxation, (1) that is itself a huge benefit; (2) you also are taxed lower on it (given our marginal system), all the more so if your income falls into a lower bracket.
August 20, 2008 11:05 PM | Reply | Permalink