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Hullabaloo


Wednesday, May 02, 2012

 
Retirement Blues

Guest post by Jay Ackroyd

I never thought highly of Joe Nocera in his role as a columnist for the NYTimes Business section. Far too much of the Times’ content consists of reporting from the point of view of the article’s subject, friendly expositions rather than adversarial explorations, and Nocera mostly fell into the former class. No Gretchen Morgenson he. So when Abramson added him to the stable of Op-Ed columnists, my expectations were low.

But he has exceeded those expectations. For instance, his coverage of the mistreatment of NCAA athletes has been both well done and is long overdue. Just this past weekend he wrote a column that displayed courage, humility and a willingness to state some unpleasant truths about retirement planning in the United States as he approaches his 60th birthday:

I can’t retire. My 401(k) plan, which was supposed to take care of my retirement, is in tatters.....

The bull market ended with the bursting of that bubble in 2000. My tech-laden portfolio was cut in half. A half-dozen years later, I got divorced, cutting my 401(k) in half again. A few years after that, I bought a house that needed some costly renovations. Since my retirement account was now hopelessly inadequate for actual retirement, I reasoned that I might as well get some use out of the money while I could. So I threw another chunk of my 401(k) at the renovation. That’s where I stand today.

As the column notes, he is not alone. Many Americans find themselves with much less saved than they’ll need to carry their lifestyles into retirement. A major reason for this is the gradual replacement of pensions plans with 401(k) plans.

A pension is a fixed payment that an employee receives for the rest of her life upon retirement depending upon time of service, retirement age and income earned. This payment is known in advance--that is, it’s a guaranteed amount, and stays in place until retirement. If you worked for two companies for long enough, you would qualify for a pension from each, an amount fixed at your termination. So retirement planning is easy and certain--you know how much you’ll get from your pensions, and from Social Security. You can then figure out whether you need to sell the McMansion and move into a condo to make ends meet--and you can also make supplemental savings with known values.

Pension plans are funded and managed by employers or unions, like CalPERS--there is one huge pot of money that funds current and future pension payments. They are regulated under ERISA and backed by the Pension Benefit Guarantee Corporation.

Defined contribution plans, like the 401(k), are funded and managed by the employee. The contributions come from the employee’s salary, before tax, and are generally partially or fully matched by the employer, although (remember Enron!) the match is frequently in the form of company stock. The employer provides employees with a menu of investment options, usually different kinds of mutual funds--growth stocks, bonds etc.--to allocate their savings to. The value of a 401(k) fluctuates as the value of its securities fluctuates. Retirement planning is complicated by the attendant uncertainty of its value at and during retirement, and, of course, by the uncertainty of when you’re gonna die.

401(k) plans are also regulated under ERISA.

If you’ve been following along, you can see that pensions are pretty good.You get them in addition to your salary. They’re managed by professionals who can use the sheer size of the funds to minimize trading costs. They generate a certain monthly value, for life. And you can’t get stupid and spend the funds on a mistress and a red convertible when you hit your midlife crisis.

401(k)s,on the other hand, basically suck. They come out of your salary; that is, the contribution reduces your take home pay, which means you will almost certainly underfund it.

Nocera again:
According to the Employee Benefit Research Institute, for instance, only 22 percent of workers 55 or older have more than $250,000 put away for retirement. Stunningly, 60 percent of workers in that same age bracket have less than $100,000 in a retirement account. [Behavorial economist Theresa] Ghilarducci told me that the average savings for someone near retirement in America right now is $100,000. Even buttressed by Social Security, that’s not going to last very long.
A 401(k) forces you to manage it yourself, or to pay someone to manage it for you. You’re locked into a menu of mutual funds with significantly larger management costs than the pension funds pay--you’re paying retail while the pension fund manager pays wholesale. The amount you can pull out per month is uncertain at retirement, and the value of your holdings will fluctuate throughout your retirement. Worse, you have a nearly unlimited opportunity to do something stupid and screw the pooch:
“People tend to be overconfident about their own abilities,” said Ghilarducci. “They tend to focus on the short term rather than thinking about long-term consequences. And they tend to think that whatever the current trend is will always be the trend. That is why people buy high and sell low.” Financial advisers — at least the good ones — are forever telling their clients to be disciplined, to create a diversified portfolio and to avoid trying to time the market. Sound as that advice is, it’s just not how most humans behave.
So why would companies replace a pretty good pension system with a 401(k) system that sucks? One reason is they stopped caring about employee retention. Pensions are great mechanisms for keeping people on board--you’ve gotta stay for a period of years before you’re fully vested in the plan, and the pension grows as your term of service and salary grows. There was a time when it was the goal of management to retain workers, to hold onto their institutional memory, and reward them at retirement. But that time has passed.

In an environment where workers are viewed by management as easily replaced, there’s no reason to consider employee retention as an important criterion, so getting rid of pensions meant a reduction in labor costs--remember, 401Ks come out of your paycheck, not corporate earnings.

But I think the elimination of pensions has more to do with the reduction in Federal tax rates for high income earners. Under a progressive federal income tax with high marginal rates at the top, pensions allowed big suits to reduce their tax burden by moving income to the time after they’d left the executive suite. ERISA requires that companies offer pensions to everyone if they were offered to senior management, so if senior executives wanted to use them to defer taxes, they had to extend them to everyone. The reductions in tax rates for top earners that began with the Reagan administration and continued through the Clinton, Bush and Obama administrations made it no longer worthwhile for CEOs to provide a decent retirement to their loyal, long term employees.

Jay Aykroyd contributes to Eschaton and runs the progressive online radio network Virtually Speaking. He also spent time on Wall Street, but don't tell anyone.