Buy a House

It’s time for a declaration: Enough of not enough.

Only one event could make the market crash of last year worse, and it is happening. Many employers are choosing to eliminate their contributions to 401(k) plans. According to Hewitt Associates, a one-year suspension will cost a young, $50,000-a-year worker $16,000 in future retirement money. It will cost $48,000 if the employee also suspends contributions for that year.

This follows the worst peak-to-trough decline in U.S. equities since the Great Depression, a period where many workers have seen their 401(k) accounts shrink further than the gallows humor “201(k)” to the near-death experience of a 101(k).

Skeptical? Just consider the impact of employer stock. In the 12 months ending Feb. 28, only 12 companies in the Standard & Poor’s 500 provided a positive return. Over 200 companies lost at least half their value. Entire industries virtually disappeared.

If you worked at Bank of America, Citicorp, AIG or General Motors, the value of your company stock fell to virtually nothing. Ditto, if you worked almost anywhere in the newspaper industry. Shares of Gannett, the largest publisher of newspapers in America, fell 88 percent. Shares of McClatchy, Media General, Lee Enterprises, and Sun Times Media fell 89 to 95 percent. Although employer stock as a percentage of 401(k) plan assets has dropped over the last 5 years, it still looms large in some plans. And it still represents a major hazard to retirement security.

In spite of this, 401(k) plans are the primary instrument, other than Social Security, for providing retirement income. They surpassed defined benefit pension plans in assets and number of workers covered long ago.

That’s part of the problem. A generation ago, an employer contributed about 7 percent of pay to fund worker pension plans. Basically, the employer had 100 percent of the responsibility for both saving and managing retirement funds. Before this recession, the cost of the employer contribution had been cut in half— to about 3 percent of pay. If more employers drop their 401(k) match, workers will be responsible for 100 percent of the saving and managing. Employers will be responsible for zero percent. It’s not a pretty picture.

Plans have improved in some respects:

  • The automatic enrollment that ERISA attorney Brooks Hamilton and I advocated through a paper written for the National Center for Policy Analysis in 2001 is now common.
  • The default choice is likely to be a balanced fund rather than a money market fund.
  • More plans offer low-cost index funds.
  • At some plans, expenses have declined.

Unfortunately, there is also bad news:

  • Most workers remain totally unprepared for the task of managing their retirement assets.
  • Just as executives at firms that have taken government bailouts continue to feel bonus- entitled, those in financial services continue to believe that high expenses are justified--- in spite of their failure to add value.
  • The majority of professionally managed funds still trail their appointed index, a reality that has been a consistent feature of investment management for decades.

Plans that were created to help workers build savings for retirement continue to be expensive, risky and complicated. Because of their legacy connection to retail mutual funds, many 401(k) plans carry an unneeded expense burden. As I pointed out in an earlier column, every dime contributed by some employers is absorbed by the high costs of some plans. They also carry an unneeded burden of risk--- fund manager risk and company stock risk.

All other things being equal--- gross return and career contributions --- a federal government worker with a virtually cost-free plan who starts saving 6 percent of income at age 30 will accumulate about 10.5 years of final income by age 67.

A private-sector worker with a typical plan will accumulate only 8.5 years of final income by the same age, if the plan has costs of 1 percent a year.

A worker with a plan that costs 2 percent a year will accumulate only 7 years of final income by age 67.

Those are big differences. Put another way, 2 to 3.5 years of income are siphoned off by the costs of typical plans.

We can’t do anything about market ups and downs--- including the horrors of the last year. But there are concrete things we can do to increase what most workers accumulate.

In the next five columns I’ll show how we can do it.

Next Sunday: Starting Plan B.

On the web:

Sunday, March 20, 2009: Is Your Employer Match Being Wasted?

Hewitt Study of 401(k) Match

Hamilton and Burns: Reinventing Retirement Income in America