Why 401(k) plans will fall short for most Americans

August 26, 2011

It’s time to end the fraudulent notion that 401(k)-type plans are adequate retirement vehicles for most Americans.

They fall short in so many ways, but mostly because they’re too expensive, are exposed to excessive unhedged market risk, poor allocation and contain no income guarantees. There is a better way: Congress can fix the problem while boosting private investment.

With the latest market rout, it’s hardly surprising that most Americans say they are “not where they need to be” on retirement saving. Most are behind after two recessions, two market crashes and yet another downturn.

While most 401(k) balances rose over the past two years, more employees than ever before have taken out loans against their major source of retirement funds. The ever-worsening economy has forced Americans to treat their 401(k) balances like piggy banks.

Should future retirees be consistent hostages to market conditions, praying that a rebound in stocks will help fill the gap?

Since there’s no guaranteed, inflation-adjusted annuity incorporated into 401(k)s — regular monthly payments that rise with the cost of living — it will be difficult for future retirees to attain a dignified lifestyle. They will also be fully taxed on all withdrawals for conventional 401(k)s (Roth accounts’ payments are generally tax-free), so the biggest tax hits may be yet to come.

The 401(k) doesn’t work on a large scale because it exposes nearly every participant to market risk that can’t be fully hedged.  No one can consistently predict market cycles and less than half of employers offer personal planning services that offer meaningful guidance to protect you from the pitfalls of market investing.

A generation ago, retirement investing didn’t worry Americans because most had a defined-benefit pension plan that pooled investments by professional outside managers to ensure a fixed payment based on salary and years of service. Now defined-contribution plans like 401(k)s, 403(b)s and 457 plans are the dominant form of employer-sponsored programs. They were never meant to be mainstream pensions.

Not only are they more expensive for participants, but neither employer nor worker contributions are mandatory in 401(k)s and are much smaller than under the old-style pensions. And unlike Social Security or private annuity payments, nothing is guaranteed in 401(k) land. You’re handed a lump sum at retirement and you’re on your own nearly every step of the way.

“The financial crisis has dramatically demonstrated how a collapse in equity prices can decimate retirement savings,” writes Alicia Munnell, director of the Center for Retirement Research at Boston College, in an upcoming book. “The crisis has also highlighted the fragility of existing retirement system, where 401(k) plans serve as the primary supplement to Social Security.”

Another leg needs to be added to the present system to ensure a decent standard of living in retirement. There are a handful of options.

Expand Social Security
This is probably the least likely to happen, given the GOP’s assault on the program. Yet it makes the most sense. Social Security provides the only low-cost, inflation-adjusted annuity on a mass scale. The system, however, is currently running a deficit and will exhaust its trust fund in 2036, according to the most recent Trustees/ report.

Financing can be bolstered through immigration reform, adding government workers to the system and better portfolio management of the trust fund. Prof. Munnell and others have suggested allowing Social Security to invest in an indexed form of the stock market. Independent Vermont Senator Bernie Sanders would apply the Social Security payroll tax to those making $250,000 or more. Since Social Security does not contribute to the federal deficit, any number of funding strategies can be applied.

Offer a guaranteed annuity
This option could be tacked onto the present 401(k) system. Instead of getting a lump sum, you’d be receiving guaranteed monthly payments for the rest of your life when you retire. This would be a supplement to Social Security and private pensions.

Offer a new universal plan
This would be a new, universal savings account available to everyone that wouldn’t be tied to employment. It would be automatic and could be linked to an annuity. Retirement policy experts have been proposing such a plan for years, but proposals have yet to make it to the floors of either house of Congress.

It’s also easy to make a case for consolidation of existing plans. There’s currently a confusing hodge-podge of accounts that could be rolled into one comprehensive program.

There so many plans for every type of business and employee that, like the rest of the U.S. tax code, it’s a complete muddle. And when it comes to retirement program options, more is not necessarily better — and mostly comes up short.

19 comments

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All of this does nothing to protect the American people against continued political fraud. Why in the world would you trust Government to take care of you, at least in the USA and under our current Constitution? Look at Social Security. Look at Medicare. These are both deliberate Ponzi schemes that are kept going by people who know they are frauds and have no intention of paying their obligations but who want to steal the “contributions” anyway. Guarantees? What a joke!

When the US strings up these fraudsters on gallows lining the Reflecting Pool and requires the images be broadcast on every video medium, then you can start thinking about trusting the Government again. But you would be a fool. Again.

Only the certainty of a terrible fate awaiting them will keep politicians hands of retirement money. And that will not happen short of a violent change of Government. So buy land and gold, and bury the gold. And learn how to grow your own food.

Posted by txgadfly | Report as abusive

Is Reuters becoming the Drudge report of the left? Sad if the once proud news agency is going the way of the talking empty heads.

Posted by dottedyelowline | Report as abusive

The suggestion that “Financing can be bolstered through immigration reform” is absolutely idiotic! Exactly how will adding to the ranks of the unemployed by importing a larger labor force improve our ability to finance social security? Check the statistics of the BLS (Bureau of Labor Statistics) and you’ll find that the employment level and labor force participation rate are in steady decline while the number of unemployed Americans continues to grow.

The retirement of the baby boom generation is often cited as the reason for the strain on the Social Security trust fund. How will the retirement of the future “immigrant boom” help social security? We’d be facing the exact same problem but on an even bigger scale. Attempting to cure an aging population problem by creating an even bigger problem in the future is a Ponzi scheme. It doesn’t work.

Stoking “economic growth” with population growth has been an easy way out for economists too lazy to develop real economic solutions. Population growth is now one of the biggest contributors to worsening unemployment and our economic decline.

Posted by Pete_Murphy | Report as abusive

I congratulate the author whoever he or she is. Someone finally noted that immigration reform can solve much of the Social Security problem. Now go on and show how it can solve much of the deficit problem also. These numbers bandied about by the CBO and others are all based on a demographics curve that can be changed by immigration reform.

Posted by bluetiger | Report as abusive

Debt deflation is usually associated with losses in financial wealth and there is simply no other way. Increasing debt levels year over year has produced the idea that we are wealthy. Now, we see slowly the unsustainability of those debts as it starts slowly to affect countries.

Banks were given a very important privilege to create money in the form of extending credit. This function requires diligence and careful consideration in regard to individual credit risks as well as to overall credit levels in the system. The financial crisis revealed that the banks were operating at too high a leverage and with too much risk. They were used to be saved by the Central Banks and certain that in times of difficulties the Central Banks were there to save them. They were like trained dogs and their master Greenspan or Bernanke would always be there to rescue them when unforeseen difficulties arose.

That may be true but that does not absolve them from their obligation to monitor overall debt levels in the system as well as being diligent in evaluating the debtors ability to not only service a debt but to be able to repay it over time. The banks clearly failed in this function that is the core function of banking but focused mainly on their compensation packages. The way these bankers enriched themselves in the process of driving the financial system into a wall was appalling and the average income earner was never able to comprehend their schemes but preferred to simply ignore them. Of course, the bankers explained their outrages income levels with free market principles of supply and demand, where the best simply could be hired with those kinds of benefits only. In hindsight those superior managers seem to have missed their mark considerably. The most interesting aspect of all of this is the fact that, after we have been more than 3 years in this financial crisis, the bankers continue to loot the system as if nothing ever happened.

Read more …. : http://scare2012.blogspot.com/

Posted by linushuber | Report as abusive

There is a new risk to retirement plans that no one anticipated. It is that after you have spent forty years saving your nickels and dimes so that you will have interest income to take care of you, some lunatic will get control of the Federal Reserve and give unlimited funds to the banks for free so you get no interest and have to spend your principal. Wait. That already happened.
www.santaclaussyndrome.com

Posted by RLamarSmithCPA | Report as abusive

401(k) plans fall short of what? Short of any promises that were given about return rates to be achieved in the markets? There never were any promises. Short of the high return rates of the 90s? Nobody is surprised anymore that those returns were not sustainable. Until something better than 401(k) plans comes along, it is irresponsible to speak of “fraudulent” notions about 401(k) plans. The financial markets have huge underlying potential regardless of the market fluctuations we have seen over the past decade or so. And anybody with access to low-cost, diversified investments, be it in 401(k) plans, IRAs, or elsewhere, should exploit that potential. Don’t blame the vehicle if the road is bumpy.

Posted by klingsor | Report as abusive

In other words, trust our government to manage my money. No thanks. Our current social security system is at risk because of gross government management. This article must have been written by a left wing Democrat.

Posted by actnow | Report as abusive

txgadfly is CLUELESS!!

(1) Never in all of human history have any but the top 5% been able to ‘retire’ as we understand it. The other 90-95% either

(a) worked until they died

(b) or if unable to work were

(i) supported SOLELY by their younger relatives (yeah, clueless txgadfly, do YOU personally want to pay all the bills for all your parents, grandparents and aunts and uncles?) or
(ii) died in a ditch or went to the county poorhouse (19th century)

Social Security and its offshoot Medicare are merely the second option with the burden spread across all the younger population. That keeps 1 person from having to support 3 or 5 or more elderly relatives while the person next door has no such responsiblities because all theri older relatives died.

My grandparents worked and paid in and their money went to my great-grandparents. My parents paid in and their money went to my grandparents and great-grandparents. I paid in through working and my money went to my parents and grandparents.

It is an INTERGENERATIONAL CONTRACT – so you clueless txgadfly won’t have to pay all your parents living expenses or heart surgery.

Then in the mid-70s the amount paid in was raised (the % of payroll tax) and I paid in more and it was set aside to help cover the bulge of those born between 1946-64/65 aka ‘the trust fund.’ Unfortuantely the conservatives beloved nitwit Reagan raided the trust fund and gave other politicians the bright idea of borrowing the money and giving Soc Sec Treasury bonds. Time to pay it back.

Soc Sec can never end unless an entire generation stops breeding or working.

(2) Here is why 401ks really can’t work.

(a) 50% of workers are offered NOTHING in the way of retirement benefits – neither a 401K or pension

(b) average worker makes $32,000. And they are supposed to save out of that – an amount that can’t pay the necessities?

(c) Assuming someone is making the average wage at age 66/67 of $32,000 or after taxes about $28,000. They would get the average Soc Security of $1200 or $14400 a year. They would need at least another $13000 + the heavy costs of Medicare of around $5500 a year per person.) That means they need another $18,500 a year. (After all on $32,000 a year it is doubtful they own a house would still have rent)

$18500 a year for 25 years adjusted for inflation over that time means they would need to have $658,000……

$658,000 would be equal to every penny in their take home pay of $28,000 for 23 1/2 years .

Not bloody likely.

Posted by onthelake | Report as abusive

The reason pension plans are weak and continue to get worse is that top managements have their own guaranteed plans (approved by Wall Street) and they could care less what happens to their workers. Just like politicians in Washington if their fate was tied to the workers they would find better solutions to protect their own interests. The solution is simple. Workers and executives should be in the same pension plans (add Congress to Social Security) without exception. The 401(K)scam worked only for Wall Street and should be abolished. The only reason defined contribution plans have been decimated is that Wall Street found easy money to loot with Mergers and Acquisitions which have added very little value over the years. You split up AT&T for a few years and then put it back together. Who benefits? Not the workers and not the economy or society. Same goes for all mergers and in every case pension plans are looted and then eliminated. Who is watching? It used to be that what was good for GM was good for the country but that is not true with Wall Street! America needs patriotic corporate leaders that do not ignore their corporate social responsibility. Mergers and Acquisitions should be illegal period. They are the root cause of the destruction of our pension system and diminishing employment opportunities at all levels. Just look at the destruction of Middle Management jobs in the Banking Industry. Now, we have Too Big to Fail and nobody can see any real value from the unending mergers that benefit only Wall Street and the CEO’s. Are we going to see any solution soon. Not very likely since they have the power to block any meaningful legislation that tries to restrain their scams. Just look at what they are trying to do with the modest Dodd/Frank! The own the Republicans and the whole talk about privatizing Social Security is just another scam to hand over the Trust Fund to Wall Street. Let market forces work unless they work against Wall Street.

Posted by amj | Report as abusive

“The 401(k) doesn’t work on a large scale”

Exactly, It’s really simple.

higher the participation rate, the lower the expected return would be on the long run, to the point that you can only expect to get only your principle back.

The only way to mitigate that would be to have some people put in a lot more than they’ll ever get back. In other words, rich subsidize the poor.

This is why social security will never work because the payroll tax is taxed on only the first $100k, and even a billionaire would eventually get all his money back that he put in through payroll tax.

Spread this article to everyone please.

Posted by materialrisk | Report as abusive

1. End tax deduction on 401k and others. This results in misallocation of capital.

2. End cap on payroll tax.

Doing these two will fix most of the problems.

Posted by materialrisk | Report as abusive

“A generation ago, retirement investing didn’t worry Americans because most had a defined-benefit pension plan”

Nonsense. Relatively few people had a good pension plan, and a large percentage of those who thought they did lost it when they changed jobs. The many problems with company sponsored pension plans is why everyone prefers a 401k. In addition, really good pension plans tended to bankrupt the company (can you spell GM?).

“Social Security provides the only low-cost, inflation-adjusted annuity on a mass scale. The system, however, is currently running a deficit and will exhaust its trust fund in 2036, according to the most recent Trustees/ report.

Financing can be bolstered through immigration reform, adding government workers to the system…”

Again, nonsense. Social security is very expensive for those of us who work. It’s already going broke, adding more people it will help how?

“This would be a new, universal savings account available to everyone that wouldn’t be tied to employment. It would be automatic and could be linked to an annuity.”

The annuity couldn’t possibly be better than what Social Security already provides; this is just another entitlement program to run out of funding.

Posted by Tom_in_PA_USA | Report as abusive

Totally absurd. I don’t know how they calculate that the SS trust fund will last till 2036 when a simple calculation on my own account shows that I’ve already used mine up, based on contributions, after only 6 years. Those of you in your 60’s can easily check this out by taking your most recent Social Security annual statement and adding up all the income shown over your lifetime which was below the annual cap and then multiplying by 0.10 (the average 10% total contribution of employee and employer) and then dividing that result by the monthly amount that SS says you will be payed. The net result is the number of months that you can collect if your account was treated as though it were an IRA account. This assumes that any interest that the government earned on your account funds was offset by inflation (which it was). If there is any money left in the account it can come only from two sources: 1) contributors who died before collecting much (or any) and 2) and excess of contributors over retirees. If the latter is the main source of the excess balance then this is a ‘Ponzi Scheme’. That’s how it works, folks.

Posted by Eric93 | Report as abusive

I don’t believe the trust fund will be “exhausted” in 2036; only that by then it will be able to pay somewhat less than the promised amounts. The last figure I recall is 75%.

Posted by Bartolo | Report as abusive

The 401(k) is the biggest scam devised against the American public since the creation of the FED in 1913.

Posted by gruven137 | Report as abusive

The 401(k) promise? Market returns and the idea that it would be a mainstream pension plan. But you actually get neither because there are no guarantees, plenty of unhedged market risk and not even matching the market after fees. Only Warren Buffett is getting a decent deal: Guaranteed 6% preferred dividend in Bank of America in a near-zero yield world. I maintain that 410(k)s will never be adequate savings vehicles in their present form. Social Security can be bolstered. Raise the earnings cap. Then find some way to create a real savings account that’s portable, tax efficient and guaranteed to some extent.

Posted by johnwasik | Report as abusive

I have made 900 bucks over 6 years with 38,000 in a 401k. I would have made more money at 1% interest in a money market account. Alley bank has a 1 year CD with .99 percent interest and this would have been compounded if I kept doing it. Therefore, I would have made more moeny in the bank. Inflation was 3.4% this year. Me and my husband make 100k together yearly. I believe we could live on just 38k very poorly. I found out I will need to have 105k when I am 65 to spend 38k a year. This is insane. Therefore, if I want to live to be 85 I need two million dollars, there is no way this can happen. Retirement is just a dream everyone is going to have to work until they die. Many old people now have social security and pensions. Even people who never paid a penny into social security are collecting (crazy). Our children and myself are screwed. There is no way we can save enough money. In addition America is going to go bankrupt so we could wake up one day and gasoline be 20 bucks a gallon because no one wants American money and our money will be worth nothing once we are bankrupt. The ONLY way to protect your money is to convert it to a different currency. I have not done it yet but thinking of doing it soon.

Posted by silagan | Report as abusive

There is nothing “crazy” about people who never paid into Social Security getting benefits, such as women who haven’t worked outside the home or the disabled, many of whom cannot work at all. Just so you know.

Posted by tonysam | Report as abusive