Will Democrats Kill Your 401k?

October 23, 2008 · Posted in Congress, Domestic Policy, Election 2008 

The short answer is NO. But if you follow news about 401k plans, you might find some pretty scary headlines like this one or this one, where the writers contend that the Democrats want to take away the tax incentive out of 401k plans and force a mandatory pension savings of 5% on employees.

Let’s put this in perspective. Testimony was given to the House Education and Labor Committee by Professor Teresa Ghilarducci. And it was dramatic testimony, no doubt. She proposed to eliminate all tax incentives for 401k plans and shift to a universal government-sponsored program with mandatory minimum savings rates per worker of 5% with a government-subsidized match of $600/year for lower-income workers. (As an aside, this time of year is generally when House Committees hear testimony on pension and tax reform, so it’s not unusual to have such testimony given).

Drastic. And it will not happen in this way, in this form. I cannot stress this strongly enough. This is certainly one proposal presented in testimony, and I suspect it got the press play because it is also the most drastic testimony I have heard about. However, others have testified, proposing milder and far more necessary reforms.

401k plans are flawed. They have been flawed from the beginning, and some changes have reduced the flaws while other have highlighted them. The biggest fallacy of the 401k is the idea that it should be the single vehicle to fund our retirement. If you haven’t figured out why by now, here’s an example:

Jenny Worker enrolls in her company 401k Plan and socks away 3,000 per year. Her company contributes a $750 matching contribution. Jenny starts her 401k contributions at age 25 and has them invested in a moderate portfolio mix of stocks, bonds and cash. Her average rate of return over the past ten years has been 8%. On 12/31/2007 Jenny is now 35 and her 401K balance is $54,325.

Against her better judgment, Jenny checks her 401k statement on October 15, 2008 and discovers that her balance is now $35,200 based on a 35% or so loss on her investments. Jenny’s retirement fund, adjusted for inflation and future rates of return, will not meet her targets for retirement income or security, even if the markets recover most of their values over the next ten years.

This is the danger that everyone who works with 401K plans warns against. But even those of us who are professionals never, ever expected or anticipated a simultaneous crash of the bond AND stock markets at the same time, where money market funds even found themselves at risk. Certainly if we had plotted models based upon this kind of contingency when markets were moving at a growth rate of 10% or so per year, we would have been viewed as nutcases without legs to stand on.

And yet, here we are. The primary flaw in the 401k model is that it is clearly subject to the whims of the market, and there are never ANY guarantees in the markets, no matter how stable they may appear. Add employees’ lack of education about investing or the markets, and it paints a stunning picture where the one with everything to lose is the employee, while the employer bears no burden or obligation for those employees’ retirement security.

What reforms make sense?

  1. Keep the tax incentives, but require some sort of minimum investment in Treasury Bonds with a guaranteed rate of return of 3%. Sell it as patriotic, even — a way to pull our country out of the crisis and debt to foreign countries. I’d rather have the US owe ME than have China own the US. To those of you who cringe at anything earning 3%, I challenge you to look at your 401K portfolio rate of return today if 25% of it were invested in guaranteed treasury bonds. Somehow that 3% looks a whole lot better than a 35% loss.
  2. Require fee transparency and simplicity. It’s true. There are many hidden fees in 401k investments right now that eat into that rate of return. Those fees may be acceptable, but you as the participant should have the absolute right to know what they represent and who receives them.
  3. Give incentives for entry-level employees to save One of the biggest issues Congress has with 401k plans is that it benefits mid-level and highly-paid employees quite well, while leaving the entry-level employees in the cold. Barack Obama’s plan has a tax incentive for any worker who saves through a 401k plan to encourage them to save from the beginning.

There is another factor that I haven’t addressed here, and that is the “guaranteed pension” that used to be the mainstay of every employee’s retirement. I am not addressing it here because I’m not sure how, in our current economy, that burden can be placed upon corporations with any expectation for economic growth. However, I do think that a blended approach, where participants in 401k plans are guaranteed a minimum retirement benefit by the employer which is funded by 401k and employer contributions, would be a good approach to the problem.

Don’t be fooled by the hysterical GOP headlines. It’s a play for votes, no more, no less. At the same time, I’d encourage everyone to stay engaged and aware of the proposals swirling around 401k plans and make sure any action Congress takes next year is responsible and actually benefits YOU.

Update: Actual summary of the hearing

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Comments

  • Janet
    Then why not simply personalize social security as Bush wanted? You get what you paid in. Right now I pay and I will never see any of that money. I sure as hell am not going to give the government money that they then use for who knows what, like war against Iran or bailout for the auto industry. Nothing is safe with those people. What they should do is increase pre-tax dollars you can pay into a 401K, not abolish tax-free deductions. Because let this be clear: If they tax the money I put into my 401K it means a massive tax increase for me. I certainly would not have the incentive anymore to work 80+ hours/week and most certainly I would leave the country and work elsewhere.
  • If Bush had gotten what he wanted, Social Security would be underfunded by at least 40 percent just like many 401k plans are today. I can see that there are many out there who really don't understand that a baseline benefit guarantee at retirement is valuable and good. But it is just the foundation upon which to build.

    To be clear, the only ones saying there is any threat to the tax preferences given 401k plans are the Republicans, not the Democrats. You're being played for political points.
  • Tim
    The problem I have with this scheme is this, government isn't trustworthy. I don't care who's in the White House or who's running Congress.

    Leave my 401K alone.
  • They created it and regulate it. As a result, you get a tax break. Accept their involvement, it's inevitable.
  • Tom McGuire
    In your example above, "Jenny" is 35 years old when she apparently realizes that the stock market can actually lose value (how radical). Jenny is, therefore, still 30 years away from having to cash out her 401(k) to supplement her retirement. For Jenny, and those like her, to panic over a drop in value of their 401(k) accounts is beyond premature. It's not unlike worrying about the drop in value of your home when you plan on living in it for 30 more years. Current valuations are exactly that; current. They change every day, and I will hazard to guess that Jenny will be just fine if she leaves her stock shares the-hell-alone as the market, ever-so-slowly recovers. Now, if you truly want to protect the Jenny's of the world, then don't force a 30 year-old in to a 3% government bond fund that won't likely keep up with inflation. Inflationary risk, and the subsequent loss of purchase power as a result, is a very real risk about which no one has talked. The most obvious answer to this has already been thought of by the mutual fund industry years ago. It's called a target fund, whereby the age of the investor dictates the allocation of investments. So, if you keep the minimum that 30-year old Jenny has to invest in government bonds to say . . . 20%, then you won't get much heartache from the industry. The problem with that is that during market downturns like now, the 80% in stocks is getting killed, so Jenny's 401(k) statement will still show brutal losses. If you raise her minimums to say . . . 60% bonds for greater protection, then during the next market rally, she will lag badly behind as stock portfolios rally and poor Jenny is ecking out her 3%. Here's one idea. Make advisors to such plans, or sponsoring employers to such plans have all employees over the age of 50 sign an acknowledgment of some sort that clearly outlines the risk to staying largely in stocks as they progress closer to the age of actually needing the money, and that it is advised that they enter a target fund that will take their future age in to account. Then, let them choose. Mandating a small percentage to government bonds won't save Jenny's portfolio in a crash, and increasing it sufficiently to protect her in a crash will kill her returns long-term as future markets rally.. Hopefully, Warren Buffet will bend Obama's ear and make it clear to him that this is a poor idea. Guaranteed returns won't save 401(k)'s. Proper allocation based on age and risk-tolerance is the answer, and all responsible plans should be offering such advice right now.
  • Andrew
    Requiring investment in Treasuries? BS!! Quit the notion that the government knows how to make our decisions for us! If I don't want to own Treasuries, I shouldn't have to. Whose money is it? Furthermore, the way to get us out of foreign debt is to pass a Balanced Budget amendment. Not to dictate who should invest in Treasuries!

    The government better keep their frickin' hands OFF my 401K! What they oughta be doing is phasing out Social Security -- I'd kinda like to not be paying 7% towards someone ELSE's retirement each pay period, and be able to stick that 7% in my OWN retirement savings!!! That is the ONLY just and right thing -- to let us KEEP OUR OWN MONEY!!

    This nation was founded on PERSONAL PROPERTY RIGHTS, and those Founders must be rolling in their graves to see this even up for debate!!
  • Jay
    AH MEN BROTHER!!!
  • Oh, and PS...

    This idea that you are an island where no one but you matters? (this goes to your comment about SS)

    Brace yourself for a society in your world with more disease, poverty and suffering. Like it or not, we don't live in a cocoon. We actually do have obligations to others. Think of it this way: 93% is yours. Even 70%. All yours. To do with what you please. That's not such a bad thing.
  • Andrew,

    Calm down. You make a big uppercase point about personal property rights. Yet, I and a zillion others have personal property that's worth about 2/3rds of what it was a year ago, with absolutely no action on our parts. Whose personal property are we about here?

    My point with treasury bills was that they are a safe bet. Not even money market funds were exempt from this market insanity, since they depended on commercial paper movement to stay afloat. Had there not been intervention, people might have found their so-called 'safe' money market funds worth far less than $1/share.

    If not treasury bills, then insured bank accounts. Whatever the outcome there needs to be some minimum amount of 401k funds invested in low-return, rock-solid safe LIQUID investments.
  • Annie
    I was going to vote for Obama but no more. I won't invest in treasuries...particularly not 25% of my portfolio. I'll stop contributing to my retirement account. The next thing you know they'll require a defined benefit which I do not want. Gene Sperling is behind this Universal Retirement Account idea....hardly a fringe group. I do not fear Obama but I fear the Democratic Congress. Sorry Obama but these people are untrustworthy in my opinion.
  • A defined benefit should be the foundation of any private retirement plan, so there is some minimum income that can be relied upon in case of death, disability and normal retirement. I argue for a blend of both, where there is a floor benefit with a 401k layered over it.

    But whatever your thoughts on 401k plans, it seems to me to be foolish to vote against obama because you're afraid of a mandate. Lord knows bush got his majority in congress for six years and managed to do nothing good with it. What makes you think anything could be worse.?
  • ginger225
    Most of my money is in a 401k. Iam doing a 72T an I am doing the gov plan. I do not want my only income taken by you . Go to Blank!
  • Taken by me? I have no idea what you mean by that.
  • ginger225
    My husband worked 30 years in coal, 30 years of very very hard work. This is my only income as a widow. I am in 5.35% CDs not your stupid stock market. My husband worked for that pension. I get 40,000 a year an if any one tryes to take my only income from me there will be Heck to pay. Born in 1950 you people never plan to give me SSI. It is not my falt you let people like GM not save for promised pensions. I will never work for this gov. again I will stand in a bread line first!!!!
  • I'm not sure where you're getting the idea that anyone wants to take your pension from you. I certainly don't. I want you to have a pension you can live on.
  • Thank you for this post. There's a lot of misinformation out there. I work for the House Education & Labor Committee -- here's more information on our chairman's position on 401(k)s and other retirement plans: http://edlabor.house.gov/issue....
  • Betsy,

    Thank you for the comment and the link. I view it as imperative that 401k and pension plans do not become a hysteria-filled political football. I will be writing a follow-up post to this one with your information included.
  • Freedom Fighter
    The market blood-letting is the beginning realization of what an Obama presidency is going to mean to the US economy. Most of those companies will not be around this time next year, and those that are left will have half the employees. But at least there will be fewer rich people and that's really what its all about. Trickle up, baby!
  • Jay
    Revel in the fact that there will be fewer employers who will have enough capital to hire new employees. Wen your cup is empty, how is there any thing that can possibly trickle up.
  • Oh, bow to gloom and doom. Because the trickle-down economic theory has worked to the benefit of those who have, and to the detriment of those who have not. Top 1% earners today make 1M on average per year as opposed to $330K in 2005. Cry me a frickin' river.

    And then consider the possibility that the other 99% will either save or consume with some extra money. All of a sudden that economic outlook isn't quite so bad. Let's just make a bet right here and now. If Obama's elected, I say 4 years will see a turned-around economy and the markets will respond accordingly. You think not. If I'm right, you publicly acknowledge. If you're right, I publicly acknowledge. To the widest audience possible.
  • Jay
    That top 1% also pays 75% of the tax burden. By all means, let's penalize the people that supply the jobs and reward those who don't pay anything into the system. Who can Obama give 95% of the Amercan people a tax cut when 40% of them don't pay any taxes. Also it's interesting that the $ amount to qualify as a "RICH PERSON" seems to keep being lowered(From $250,000 a year to Biden stated $150,000. Some might want to let their campaign know that it's usually customary to start breaking your campign promises AFTER the election. I guess that's just OBAMATH.
  • No, it's republican talking points.
  • Thanks for this information. I can imagine that both parties will have a lot to say about this issue after the election. Let's hope they want to make points with their constituents and really do work together to find a solution. Now I know to keep listening for details.
  • Clear and true -- the antidotes to partisan campaign hysteria.
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