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As traditional pensions shrivel and Social Security marches toward a leaner future, more people are depending more than ever on their 401(k) and similar plans as they save for retirement. Yet as Paul Merriman shows in this article, most of these plans are seriously flawed.
Imagine for a moment that you’re a captain about to sail a ship across the ocean. At minimum, you know you should expect rocky reefs, rough seas and strong headwinds. You’d be naïve not to anticipate danger, so you prepare as best you can, salting away supplies while you gird yourself to make the most of whatever favorable winds come your way.
But what if some members of your own crew turn out to be mutinous: serving another master without your knowledge? And what if your maps prove out of date and incomplete? Your choices at sea could turn ugly. You might need to do a lot of bailing. You might run aground or even have to swim for your life.
Though this analogy is imperfect, in many ways it reflects the financial reality for tens of millions of Americans, particularly baby boomers approaching retirement.
More and more, the support systems that boomers have counted on for a relatively safe voyage – “storm protection” in the form of pensions, Social Security, health care, and even 401(k) plans – are getting weaker, sometimes even capsizing. In some cases, these tools may be acting as if they were incompetent or disloyal members of your crew.
Let’s look at why this matters so much.
PENSIONS: BROKEN
Over the past 25 years, the number of jobs in the private sector offering pensions has declined by half. Now only about one in five Americans can look forward to a traditional pension. Those lucky enough to be in that group have ample reason for anxiety – including thousand of employees at bankrupt companies like Delta Air Lines, Northwest Airlines, United Airlines and Delphi Corp.
Overall, pension plans have a deficit estimated at a staggering $450 billion. While some of those companies are fundamentally healthy and will undoubtedly make good on their obligations, others will not.
This means troubles not only for workers but for you, me and every other taxpayer. That’s because the plans of companies that fail become the responsibility of the federal Pension Benefit Guaranty Corporation. Although the PBGC is theoretically self-financing through premiums it collects from employers, there’s an inconvenient detail: In its annual report to Congress in November 2005, the agency reported that its obligations exceeded its assets by $22.8 billion.
Some people believe this is similar to the savings-and-loan fiasco of the 1980s, when some S&L’s took huge, foolish risks with deposits that were insured by the government. Likewise, the pension guarantee has encouraged some employers to promise – and encouraged some unions to demand – unrealistic high pension benefits.
As Roger Lowenstein recently wrote in a comprehensive New York Times Magazine piece, the first private sector pension was offered in 1875 by American Express, a stagecoach delivery service. It required employees to work for 30 years before they could collect benefits. This pension wasn’t seen as an employee benefit so much as a management tool to retain workers.
Eventually, the government established rules that forced employers to extend their pensions beyond executives to include rank and file workers. Unions began to demand pensions, which were promised by many companies. When unions could not force employers to fund these promises, both the unions and employers found ways to pretend the money was really there by assuming unrealistic future returns on investments. (This is akin to an individual who saves and invests $10,000, assuming a huge future rate of return, and concludes that his or her retirement is taken care of.)
SOCIAL SECURITY: NOT SO SECURE
Social Security has always been problematic, a collection of promises and assumptions that most politicians would rather avoid looking at in great detail. The system was established in the 1930s as a means of forced savings. Workers would set aside a small amount of their pay, the government would invest it for them and the savings would be paid back decades later. However, the “savings accounts” are a fiction.
In fact, Social Security spends its current tax revenue (payroll tax collections) to meet its current obligations, the payments now received monthly by millions of Americans. What’s left goes into a trust fund that in effect “lends” this money to the government for other needs. This means the money isn’t really there to pay future benefits.
But the inevitable has been known for decades: at some point the system will have to pay out much more than it’s taking in. By 2042, the Social Security Trust Fund may run dry, given today’s benefits formulas and tax rates.
Unfortunately, substantial reform of the system doesn’t seem to be in the cards any time soon.
POPULATION: LIVING LONGER
If most people didn’t live past 75 or 80, underfunded Social Security and pensions would be less of a problem. But life expectancies are increasing, putting a bigger burden on retirement plans and savings. A couple age 65 and in good health has a 50 percent chance that one of them will live to age 92; there’s a 25 percent chance one of them will live to be 97.
We all know health care costs are rising, and as people get older they require more health care. Inevitably, this will continue to put additional strain on retirement budgets, both private and public.
THE 401(K) PLAN: YOUR LIFEBOAT
All these things are largely out of any individual’s control. Pensions, Social Security and medical costs will be what they will be. Your own savings are more important than ever.
Pensions have largely been replaced by 401(k) plans, which have become crucial for many people. This is the element over which you, as both investor and beneficiary, have the most control. Your 401(k), in a sense, should be your personal lifeboat.
These plans could be effective lifeboats. But unfortunately most of them are designed in ways that make them ineffective. I believe that 401(k) trustees could be accused, with some justification, of arguably treasonous behavior that undermines your plan to keep a steady wind in the sails of your retirement savings.
Faithful fiduciaries should act like reliable crew members on a sailing vessel. They should control and account for investment expenses and monitor the activities of service providers. Most important of all, they should not only allow but encourage investors to properly diversify their portfolios.
I am sad to report that such behavior is extremely rare in the world of 401(k) plans. Fortunately, when they are armed with the right information, committed people can force change. We have put together some resources along these lines at www.401khelp.com.
I encourage you to visit that site and click on the “ Improve your plan ” link. I hope some of my readers will take this ball and run with it, making 401(k) and similar plans better for the many investors who need them.
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