Resolved: 401(k) plans were a lousy idea

Great Debates
1

Well, this isn’t my position, neccessarily. But it’s the position of
my editor, who’s assigned me to write a piece on what’s wrong with
401(k)'s, and how workers would be better off without them.

   The thinking goes like this:

    Who makes decisions about what benefits to offer workers? Well, not
 workers. Management does. And management of course has a strong
 interest in the bottom line. So while 401(k) plans are funded
 primarily by workers, pension funds are funded out of company profits.
 It's tough on the earnings reports. So when 401(k) plans became
 available, the theory goes, companies began getting out of the pension
 world. Responsibility for retirement security was transferred to
 workers from their employers. And many workers are not prepared to
 make investing decisions. "It's a travesty," says my editor. Is she
 right?

    Also, 401ks disproportionally benefit higher wage employees.
 Low-wage employees with little discretionary income cannot afford to
 contribute, much less pick up any company matches, and are left out of
 retirement programs.

 Had we not developed 401(k) plans in the first place, the theory goes
 (according to Karen Ferguson at Pensionrights.org) more companies
 would presumably still be offering pensions, and more workers would be
 covered under them.

   Also, says my editor, contributions matched in company stock are a
 bad idea. Suppose you had a bunch of Lucent stock your employer had
 matched you with. If you were going to retire next year, you'd be
 screwed. Lucent dropped something like 90% off its high. It really
 skews risk profiles and asset allocation plans.
    I have a hard time seeing any company match as a bad thing.
 Employers don't HAVE to match a penny. And even Lucent employees are
 STILL better off than they would have been had there been no match at
 all. Employer matches--whether in cash or in stock, are free money.
 And since not every company has the cash flow to provide employee
 matches in cash, then a match in stock is better than no match at all.

   Who's right?

   Also, 401(k) plans are more expensive, on average, than pension
 funds to administer--and its the worker who winds up paying the
 expenses. Hence, 401k plans tend to underperform pension plans by 1-2%
 per year, according to a Barclay's report I can't find on the web (but
 try http://moneycentral.msn.com/articles/retire/basics/6865.asp)

  THAT'S a pretty significant margin, over time.

   Then again, are pensions much better? What about workers who get
 screwed out of half their pension when pension plans switch to cash
 value systems? Isn't that as much of a risk as market risk?

   What price portability?

   What about passing assets on to heirs?

   What about caps on pension guarantees? And what about workers who
 don't qualify for pension guarantee insurance?

   What about pensions which subtract Social Security benefits from
 pension balances?

   What about workers who screw up their survivorship documents and
 cause their pensions to end when they die rather than when their wife
 dies.

   It typically takes 5-10 years for pensions to 'vest.' Leave the
 company before then, and you get nothing. But the average tenure for
 workers on the job is just 2.7 years, according to the Dept. of Labor.
  So would even low-wage workers truly benefit from a pension system,
 given the lack of tenure on the job?

   Would companies offering pensions become less competitive in the
 global marketplace than their more exploitive competitors abroad, and
 therefore be forced to lay off workers?

  The bottom line:

    Did 401(k)s fulfill their promise? Would we be better off without
 them? What should be done about it?
2

Pension plans only work for people who stay at one job for a long time. As you point out. This is a really big benefit of 401K plans as more and more people work for different companies through out their life

The matching system for 401K that I have seen match the first say $2000 higher than the next $2000 etc. So the benefits for higher income workers are not so skewed.

What happens to pensions if the company goes out of business, gets bought by another company?

401Ks also are more transparent as far as being funded properly.

3

Another advantage of 401(k)s for employers is that the investment risk in a traditional defined benefit pension falls on the employer. They promise to provide a certain benefit (typically some percentage of final compensation multiplied by the number of years in employment). In a 401(k), the money goes in at the front end and the employee is responsible for deciding among the investment options offered, and if the amount doesn’t increase over the years, that’s tough for the employee. The employer is not obligated to provide any particular amount.

4

The disadvantages of 401(k)s:

Just to enlighten you, the original 401(k) structure was vastly different from what you’re seeing today. It came out of a section of law that stated something along the lines of “if an employee gets a bonus as deferred compensation, it won’t be taxed” or something along those lines. So originally, you’d be paid a bonus and this would go into a deferred compensation account.
By now, it’s morphed into this form where employees have to do most of the contributing, which certainly does skew it in favor of highly-paid employees with minimal family obligations (no sick parents to look after, no children with chronic and expensive maladies).
Yes, some people did get the original structure: yours truly has, in the past three or four years, gone through the following metamorphosis in my 401(k), and I haven’t even changed jobs (yet):

1 - Originally, you got a 3% bonus at the end of the year. If you took it without saying anything, it was paid to you and you got taxed on it. If you faxed in a form saying you wanted it to go into your 401(k), it was placed there, and the company then matched the 3% you’d just “contributed” with another 3% and, voila! you had 6% of your salary contributed without ever having actually contributed a dime out of your regular salary.
2 - This got changed to a match, in company stock (an awful idea), whose percentage depended on your salary. Only the lowest paid workers got a guaranteed match. Everyone else had to contribute some minimum to get the match.
3 - This has finally morphed, this year, into a form where everyone has to contribute to get a match (in company stock of course; God forbid any real money should be paid an employee if it can be helped), and the highest paid employees - to which because of my past success and dedication to my job I belong - get no match at all. And the amount of the match is capped at an absurdly low $1500. Like anyone will ever retire on that joke of a contribution.

So I’ve gone from getting 6% put away in my name to having to contribute every single last dime that goes into the account. And just like your editor says, our defined benefit plan has been, for all intents and purposes, completely gutted.
Needless to say, I’m more than a little angry. I know how to do math, and I know that this will never adequately provide for me and my wife in our retirement.

5

I’d rather willingly put my money in a 401k than have the Fed Gov steal my money and put it in the Social Security toilet.

6

Thanks for the reply, pantom, et.al.

Yeah, the editor’s pretty much against matches in company stock. I’m not convinced it’s a terrible thing though.

1.) The match is voluntary. The company doesn’t HAVE to pay squat.

2.) Not every company has the cash flow available to apply matches on a cash basis. In these cases, the choice isn’t between a cash match and a stock match–the choice is between a stock match and nothing. I’ll take the stock, thanks. It’s still free money. And even if the stock loses 90% of its value (a la Lucent), then 10% of Lucent is still free money. I’ll take it.

3.) Sure, company stock screws up asset allocation plans. But if you want to give me free money, I’ll let you screw up my asset allocation plan any day of the week.

4.) For years, money managers and financial journalists have been harping for companies to align the interests of management and employees with stockholders and shareholders. I’m cautious about slamming too hard on companies who provide a match in company stock. After all, do we really want to come out now and say that such an alignment is a BAD thing all of a sudden? So a company is damned if it does and damned if it doesn’t.

That said, while I think we should encourage employers to provide such a match, either in cash or in company stock, I do believe workers should be free to liquidate any portion of their company stock over 10% of their 401(k) plan’s assets, just in the interests of diversity. The underpinning to that argument is this:

Companies have a fiduciary responsibility under ERISA to operate their 401(k) program solely in the interests of employees. Aligning employee and shareholder interests is done in the interests of SHAREHOLDERS, not employees. As employees approach retirement, it is in the best interests of employees to diversify out of company stock–particularly in extreme cases such as Coca Cola, Abbott Labs, and International Paper, where company stock at one point reportedly exceeded 90% of 401(k) assets (!!!) GE was in the 80% figure. Bell South was in the 60% range.
In such cases, where employees requested to be allowed to diversify, and the companies refused to allow it, I think a case can be made that companies violated their fiduciary responsibility under ERISA.

Unfortunately, no lawyer’s gonna take the case. Not too many people were clamoring to diversify during the big runup, anyway.

You may be interested to know that the 2001 Bush Tax Cut law raises allowable contributions to 401(k) to 15,000 from 10,500 per year, and relaxes some of the ‘top heavy’ provisions that place a percentage cap on what you can contribute. So check into it, if you’re frustrated by the contribution cap. Allowable IRA and Roth IRA contributions are likewise increased from 2 to 3 thousand dollars, starting January 1rst, and they increase to 5 thousand dollars each over the next few years. I know that’s going to make a huge difference in my life over the years. :slight_smile:

Specifically, what changes did your employer make to your pension plan, pantom?

<<<I know how to do math, and I know that this will never adequately provide for me and my wife in our retirement.>>

Imagine how us LOWER paid employees feel! <g>

7

Actually, what happens is that the employees take it in the shorts for everything now. Need to boost quarterly profits for the investors? Better do some cost cutting layoffs regardless of the long-term implications. Need an extra basis point on the bottom line, let’s lose those employee benefits. Oh, I forgot, I own 1,000 options in my employer, call it Microsoft, cutting my job to boost the share price leaves me far worse off even if the share price actually goes up.

Shareholders and managment and employees do not necessarily have a shared interest. There are countless examples of senior management that get highly rewarded for a merger that results in massive layoffs and gutting companies. Digital/Compaq, Compaq/HP, BP/Arco, UBS/Swiss Bank Corp.

There is no one profile of a shareholder, and there are plenty of rapicious ones out there that want a company to do anything short term to boost the share price, even if that means bankruptcy in the long term. They don’t care, these type of shareholder will have made their money and run long before it all comes crashing down.

8

p2, do yourself a favor and head out to your favorite newsstand and buy this week’s issue of Barron’s. The editorial is on the subject of forcing employees to get company stock. There’s a couple of very good examples of why this is bad in there. The editorialist takes e-mail, and from my experience, he takes the time to reply and is extremely articulate when defending a position he’s taken.
It’s one thing to give employees the opportunity to buy company stock, or to give them incentives to do so. It’s something else entirely to force it down their throats, and then make them keep it for either a very long holding period or for as long as they’re with the company. The latter is undertaken by managements who want to immunize themselves from pesky independent shareholders by putting the shares in the hands of people who can be expected to reliably vote with management. For the employees, it’s a bad deal because instead of being able to put their savings in a diversified portfolio, they’re forced to keep a large portion of it in the stock of the company they work for.
As to what happened by me: first they eliminated the medical benefits from the defined benefit plan. Then they eliminated the old defined benefit plan and replaced it with a cash balance plan. The first version of the cash balance plan was bad, but not awful. Arguably, it could have allowed you to retire decently after a time.
Now they’re about to force a new version on us next year with lower percentages in yearly contributions across the board. I’m in my mid-40s, and I’m going to get 3.5% of my salary contributed this year. That’s a bad joke and a slap in the face to all of us who stuck around for years thinking we were actually working towards something. This will be the third year in a row that they’ve downgraded our defined benefit pension plan. At this point, they might as well eliminate it and roll whatever balances we might have in there over to our 401(k)s, just so we don’t get insulted by them throwing pennies at us for our work.