The 401(k) – the investment vehicle that was supposed to revolutionize retirement planning – turns 25 today.
How’s it doing? Well, depends on whether you can retire on $60,000.
That’s the median balance for heads of households ages 55-64, according to the Federal Reserve’s 2004 Surveys of Consumer Finances report, the latest Fed data available. That would provide a monthly income stream of $250 for those who draw down at the recommended annual rate of 5 percent – enough to keep the cupboards well-stocked with Alpo.
“There’s a terrible reckoning coming when people realize how little they get from $60,000,” said Alicia Munnell, director of the Center for Retirement Research at Boston College.
Count yourself lucky if you ever have that reckoning. More than half the U.S. population does not have a 401(k) or any other type of retirement plan. And Social Security? Well, that’s another story, but at least there’s generic dog food, too.
The 401(k) takes its name from subsection (k) of section 401 of the Internal Revenue Code. In 1981, the IRS issued rules allowing workers to make tax-deferred contributions from their pay, which employers could match, up to a certain level.
The 401(k) was designed as a supplement to traditional “defined benefit” pensions that guaranteed payments to retirees. These older plans didn’t reward people who changed jobs. The 401(k) allowed workers to roll their funds into individual retirement accounts upon leaving their jobs and were, thus, portable.
Companies no longer needed employees to hang around for an entire career, thanks to technology and the manic pace of mergers and acquisitions. So Corporate America shifted the risky burden of retirement planning from companies to individuals. The 401(k) went mainstream and the traditional pensions became an endangered species.
Today, 90 percent of 401(k) plans represent the only retirement plan offered at a given employer, according to the Investment Company Institute in Washington, D.C. The ICI is a bit of a cheerleader for 401(k)s since it represents the mutual fund industry, which receives about half the assets of America’s 401(k)s.
The ICI calls the 401(k) a “mainstay of America’s retirement security,” with $2.4 trillion in assets in 2005 versus $1.9 trillion in all private-sector defined benefits plans.
Never mind the $60,000 balances.
“You can’t judge what’s going to happen based on today’s retirees because they haven’t had a full career with these plans,” ICI economist Sarah Holden said.
Using a model based on the past behaviors of 401(k) participants, she concludes that people in their 20s today will be able to replace half their incomes when they retire with their 401(k)s. Is that all?
“Too often, the perceived shortcomings of the 401(k) are stated in comparison to a world in which everyone participates in a defined benefit plan throughout their career,” said Patrick Purcell of the Congressional Research Service. “Unfortunately, this world never existed.”
In a survey by Brown & Tedstrom, a Denver-based firm that manages more than $300 million for people at or near retirement, most respondents said they could live 10 years or less on their current savings. But people in their 60s can now expect to live another 20 years.
The problem may be cultural, said managing partner Mark Brown: “The American value system has been consumption- based rather than savings-based.”
Many people make bad investment decisions, even when they do save.
“Research has shown that they make mistakes every step of the way,” Munnell said.
Like focusing on tech stocks just before a big crash, or working for Enron and believing the company line.
Many companies still offer plans where there are no good investment options, said Brooks Hamilton, a Garland, Texas- based consultant who designs 401(k) plans for companies including Neiman Marcus and Frito-Lay.
Many employers have been sold underperforming funds by salespeople who care more about fees than performance.
“The ignorance level in this field is overwhelming,” Hamilton said. “(Some people) don’t know the S&P 500 from the Indianapolis 500.”
Al Lewis’ column appears Sundays, Tuesdays and Fridays. Respond to Lewis at denverpostbloghouse.com/lewis, 303-954-1967 or alewis@denverpost.com.
