January 30, 2009
401k, 401k, Wherefore art thou oh 401k?
John Kostrzewa's article on the failure of the 401(k) in this past Sunday's ProJo (which didn't go immediately on line, for some reason) hit home for many, I'm sure. He focuses on the fact that the 401(k) "system" requires rank amateurs to make relatively un-educated investment decisions. He has a point, but it's not just the untrained, risk-taking (or naive) investors who have taken a bath in this market. Even careful investors who take the time to educate themselves have been hit hard. I'm no financial wiz, but I do my homework and I've now got less in my 401(k) than what I've actually contributed over the past 12 years. The mattress would have been better (I kid....I think...). So, how did we get to rely on the 401(k) so much?
The reason for the tumult is that the self-guided 401(k) replaced defined-benefit plans in which companies guaranteed a pension for loyal workers. Under the pension plan system, companies assigned professionals to mange pools of money to make sure the funds would be there to cover a worker’s retirement.It sure has. Kostrzewa mentions some possible solutions, but this WSJ piece by Anne Tergesen is much more in-depth. I still think the 401(k) is an important piece of the equation, but only a piece.But it was expensive. And Congress was convinced to expand the availability of the 401(k), which was written into law in 1978 and for years used only as a supplement to the pension and Social Security system.
The use of 401(k)s expanded as the philosophy of an “ownership society” took hold and the responsibility and risk of planning a financial future shifted to individuals. The 401(k) program grew to 50 million Americans with $2.5 trillion in total assets.
For awhile, during the bull markets, everybody seemed happy with the switch. But the bear market that has devalued stocks, and sliced 401(k) investments, has exposed the flaws.
But pensions have been shown less than bulletproof, as well.
As a thirty-something, the 401k, or some vehicle bound to the individual, seems the better long-term direction.
Is this really what we're up against now?? From the WSJ article:
"Backers of legislation in Congress -- including new White House Chief of Staff Rahm Emanuel -- point out that the income-tax breaks available to 401(k) participants offer the most generous incentives to those who need them least. Indeed, while someone in the 35% tax bracket is able to reduce his or her federal income-tax bill by 35 cents for every dollar contributed to a 401(k) or IRA, someone in the 10% bracket saves 10 just cents. The millions of households who don't earn enough to owe federal income tax get nothing."
So let me get this straight. Someone who *pays* 35 cents per dollar into the tax system can get a tax break for 35 cents per dollar by participating, someone who *pays* 10 cents per dollar into the tax system can get a tax break for 10 cents per dollar by participating and someone who pays no taxes gets no tax break. Is that about right? And Rahm Emmanuel has a problem with that? He wants "Legislation sponsored by Mr. Emanuel calls for expanding the saver's credit to include families earning up to $70,000. It would also make the credit available to those who owe no federal income taxes. And it would raise the credit to 50 cents for every dollar contributed to a 401(k) or IRA -- up from 10 to 50 cents now"
which basically says that if you pay in 10 cents, we'll give you 50 cents back?? Are you kidding? Where's that other 40 cents going to come from? Oh, that's right, the guy paying in and getting back 35 cents.
Fun with math. Deposit $10k and assume 8% per year growth for thirty years. Then assume a loss of 33% of whats accumulated, occuring in the 31st year. Compare that to $10K with an assumed guaranteed 6% for 31 years. People don't react well to meltdowns even if objectively they are still better off. This is why insurance companies can make money off guaranteed annuities.
If the gubmint wants to tweak the rules, they could try and incent lifecycle shifts in investment mixes - ie, as you get older, you move to more conservative but probably lower yield investments. They might also want to cap percentage of investment in the 401k sponsor company. These aren't huge or difficult changes to make.
Posted by: chuckR at January 30, 2009 4:20 PM