I don’t really have time or the brain cells at 1:00 AM to write about the latest AIG feeding frenzy, but I do feel compelled to put something out there to counter the Boston.com article suggesting that the taxpayers are now funding outrageous pension benefits.
Let’s be clear: Non-qualified benefits are subject to forfeiture, are not protected in bankruptcy, and are the absolute last thing that would be paid if the company were liquidated. If the government takes full ownership, there would be no benefits paid on those non-qualified contracts. They are required to be subject to risk of forfeiture in order to retain their tax-deferred status.
Qualified benefits are the same benefits that anyone — not just executives — covered by a pension plan can earn. They are based on salary paid of $235,000 or less, and are subject to statutory limits. These limits apply whether you are the CEO of AIG or the owner of a vegetable stand on the corner.
Here is the text of a comment I left on Crooks & Liars with regard to this issue:
Before you aim at these plans, you’d better learn about them.
As I said on Twitter, everybody wants to hate AIG. Me, too. But taking aim at their qualified retirement plans because they have to disclose the value of accrued benefits on the balance sheet is an ignorant attack, one that would be far better left alone. For starters, the calculation of benefit values and liabilities for balance sheet purposes bears almost no relationship to reality, or the actuarial requirements for pension funding set by the Internal Revenue Service. Simply put, the FASB standards for pension benefits inflate the numbers by a minimum factor of 2.
All qualified retirement plans, whether AIG, or Granny’s Home-Grown Beet Farm down the street, are subject to the same rules. There wasn’t an exception made for AIG.
[A] comment earlier in this string starts to touch on the problem that AIG and many others (including the UAW, and other “friendly entities” to Dems) have, which is that the value of the assets will be substantially lower to fund those benefits than was reflected on the balance sheets you used for this post. That means that accrued liabilities are likely to double, and if AIG does declare bankruptcy, some (but not all) of those benefits will be insured by the PBGC — the Federal Government’s version of pension insurance, similar to the FDIC.
Don’t stir the pot with this. It’s already a disaster, but if progressives start taking aim at this, and turning up more Congressional hearings, and the House writes a bill aimed at hammering AIG, every single person in this country who is lucky enough to still be covered under a Defined Benefit plan (after they’ve been used as a tax carrot and stick depending on the state of the economy for the past 20 years) will lose future benefits.
A feeding frenzy is unnecessary here. Step back, do some research first, (feel free to email me on pension questions, or contact someone at http://asppa.org for details before going off on this. As one who has worked in this field for nearly 30 years, I guarantee you that attacking qualified benefits will have repercussions that will reach down to union workers and employees of the smallest businesses. It’s ignorant to walk this road.
As one who has navigated 25 years of pension legislation written at the whim of the current mood or revenue need of the day, I seriously hope that we can limit our criticism of AIG to the (many) legitimate issues on the table. The pension liabilities on a balance sheet are not one of those issues.
(As a side note, the FASB standards for reporting and valuing pension benefits bear no relationship to reality. Similar to the mark to market rule, accountants and actuaries seem to have difficulty agreeing on much of anything).
Tim Rutten’s appallingly ignorant editorial in today’s LA Times is the reason no one should rely upon a single mainstream source for their information. Rutten’s contention that the 401k plan is a failed experiment that was always intended to diminish workers’ retirements is the kind of sublime fiction that plays best with perpetual victims and incurable romantics.
Let’s debunk some of his fiction with facts:
An evolving workforce
Here’s the problem: In 1978, when Congress amended the Internal Revenue Code to include Section 401(k), it envisioned the provision mainly as a way for workers to supplement their companies’ traditional defined-benefit pension plans and Social Security. (Secondarily, it also was a nifty hideaway where highly paid executives could shelter income from taxes.)
Well, yes and no. In 1978, Congress understood that the personal savings rate was inadequate, that many baby boomers would not have the funds to retire if they relied upon their corporate pensions and Social Security alone, and IRAs were not getting much traction with the middle class and entry level groups.
Anyone who had their hands on Defined Benefit plans back in 1978 knew exactly what the problem was: Benefits were based on a set of assumptions made by actuaries about what the world would look like in 30 or 40 years, they were offset in one form or another by projected Social Security benefits, and were etched in stone. I can remember feeling incredibly foolish about preparing statements for employees trumpeting the $78.00 per month retirement benefit they were entitled to in 20 years.
Traditional pension plans (what I’ll refer to as DB plans for the rest of this post) were based upon the theory that the employer had an duty and obligation to reward long-term employees with a lifetime income when they retired.
But in 1978, the workforce was less stable. The days of going to work for a company and staying until one retired were in the past. Looking back at the difference between my grandmother and my mother’s careers (both for the same company in its various forms – Bell Telephone, Pacific Telephone, Pacific Bell, AT&T), it was clear that there was no longer any expectation on the part of employer or employee of long-term or career-long employment. Job-hopping was expected if anyone actually wanted advancement.
As to Rutten’s assertion that they were also a sweet tax shelter for the highly-paid, I can only say this: They were a sweeter tax shelter for the worker.
The Reagan Years, or the Big Pension Money Grab
Rutten goes on to contend that employers were looking for ways to get out of funding their pension and health plans, and turned to 401k plans as the answer. Again, he misses an entire chapter of Reaganomic revenue neutral pension-killing history in his analysis.
There is a dirty chapter in the history of pensions. When Reagan took office, interest rates were at an all-time high. Rates as high as 21% on short-term certificates of deposit were the norm.
Pension trustees have a duty to invest pension funds as a prudent man familiar with such matters would invest, and you can bet that a prudent man would see an investment in a 21% short-term Certificate of Deposit as a prudent one, particularly when the funds are insured. Right? Investments were made, only sometimes at Savings and Loans rather than banks (remember that the S&Ls were NOT insured..that will play into the scene), and big returns paid on investments.
Actuaries are paid to set assumptions for the long-term. As a consequence, they did not view the high interest rates as reason for an assumptions adjustment, understanding that they were aberrant and would work themselves out in time.
Under Reagan, the IRS was instructed to audit as many pension plans as possible, particularly the plans of small to medium-size employers, and challenge their interest rate assumptions in an effort to disqualify their deductible contribution and pull more revenue into the Treasury.
The audit program was a magnificent failure, but it set the stage for Congress to pass a law legislating a mandate for actuaries to set pension liabilities in lockstep with the movement of interest rates up or down.
In turn, that set the stage for a monumental pension plan meltdown. What happened next set the ball in motion for the rise of 401k plans and the death of the traditional pension.
Congress passed OBRA ’87, which limited the tax deduction allowed for pension plans to an amount calculated using an inflated interest rate. As a consequence, many plans appeared to be overfunded, which made balance sheets look great, but increased tax obligations for nearly everyone, most particularly small to medium-sized businesses.
To sum it up, Congress took the actions of an aggressive and wrong Internal Revenue Service and made laws that pushed pensions from the long-term outlook to the here-and-now for employers, while leaving employees with a theoretical retirement income and nothing real to show for their work.
For the next 20 years, pension legislation became the tax-revenue football, tossed from one side of the field to the next with no long-term idea of what a reasonable outcome should be, and certainly no sense of social responsibility for the worker.
When Rutten makes the claim that there was some conspiracy of opposing ideologies merging to form the 401k’s emergence, he’s got it backwards. The conspiracy of ideology killed traditional pensions, leaving employers with balance sheets that ballooned or shrunk depending on the whims of short term interest rates set by the Fed.
Simplicity and Portability: The New Standards
Here is a simple fact: For traditional pension plans to work, there must be a commitment to a long-term program that remains stable and impervious to the whims of markets and men.
We don’t live in a world or a legislative environment that invites such a commitment. This is the world where the 401k became king.
In Rutten’s world, companies “seized the opportunity to abandon their defined-benefit pension plans”. In actuality, the laws were so complex and the cost to maintain them so prohibitive, with so little return for the investment that employers and employees looked to 401k plans as a middle-of-the-road compromise.
In the eyes of an employee, a traditional pension plan looked like a dinosaur when compared with a 401k plan. The employee controlled the savings rate, the investments, and had access to daily reports if they wanted them.
You’d be surprised how many do want them. Employees are not the idiots Rutten describes here:
Today, more than 60% of all U.S. workers rely on 401(k)s as their primary retirement fund. They’re not eager to “choose” their own retirement program, nor are they enthusiastic “owners” of American business. They’re draftees. Essentially, millions of us have been conscripted into the equities markets, where we have helped fuel stock prices and provided a bonanza for the financial services companies that manage and sell investment funds.
Oh, no. The employees are not the victims, not by a long shot. I should probably remind Rutten that if 401k plans had not risen as they had, those same investment managers and insurance companies would have made just as much, if not more money and had more control of expanded and bloated contributions to traditional pensions if they had continued on through the last 15 years or so. If you think the unemployment numbers are bad now, try doubling them when employers have to balance pension obligations against workforce.
The issue isn’t whether dollars would go into the system; the issue is how and by whom those dollars would be contributed.
IBM tried to mitigate the problem by putting a cash balance approach in place. That approach set a defined benefit for all workers in place and offset the cost of the benefit with the 401k balance. It was an idea ahead of its time, because it allowed for the market variance to increase an employee’s pension while still keeping the baseline guarantee in place.
Ultimately IBM was sued for their attempt to ‘rob employees of their pensions’ and was forced to reinstate their traditional program just long enough to meet their obligations before it was terminated. The 2006 Pension Protection Act resurrected the cash balance plan as a viable way to balance guaranteed benefits against equity growth options, but it may still be an endangered species.
Reality bites. Reality is that pensions in this country are not provided by a few large corporations. Small business fuels a much larger sector of our working population, and small business cannot possibly assume the incredibly complex and often expensive obligations that come with the traditional pension model.
On the employee side, there was a clamor rising. Employees were barred from deductible IRA contributions if they were covered by an employer pension plan, but the benefits they were earning were inadequate to provide a decent retirement, even when combined with Social Security. There was a rising clamor among employees, demanding that they have the right to save for retirement through their employer, that they receive tax-favored treatment for those savings, and because it was “their money”, they wanted control.
Further, they wanted to take it with them to the next employer and the next, rather than risk losing part of their retirement if a former employer went out of business.
Employees weren’t asked because employees were asking. In the 90′s, particularly the mid to late 90′s, the ones asking for the 401k plan were the employees, not the other way around. Most employers were neutral about it, but employees were absolute: They wanted control, they wanted choice, they wanted the opportunity to manage their own retirement plans. To be a competitive employer, a 401k was a must in the benefit package mix.
What happens when all the rules break? Or are broken?
Enter 2008, the year that everything everyone knew to be true was proven false. In investment policy land, there are a few basic rules. We all know them. If stocks drop, bonds are the fail-safe to hold steady. If interest rates rise, invest in mortgages for the return. If all else fails, keep your money in cash investments where you won’t make much but you won’t lose much either.
Every one of those rules broke in 2008. Every investment manager I know, including the one I live with, was left on a floor trying to sweep up the shards and put them back together in some sort of meaningful order. Bernard Madoff’s enormous scam aside, all of us have to accept that the collapse of the markets last year broke every single rule taken as gospel by the majority of those who manage investments, analyze markets, understand how investing and capital markets work.
You will hear theories for years and years. I believe we will eventually discover a deep well of greed and avarice on a global and mind-bending scale at the genesis of this crisis.
What you will not hear: the 401k experiment fueled the crisis or bankrupted our populace. It simply isn’t true. It’s Rutten being hysterical about his own losses, but the fact is that 401k plans remain viable, and are one of our best pathways out of the mess going forward (provided employees ignore hysterics like Rutten and think logically).
My 401k has lost about $10,000 since last year. That’s a significant hit for me, but it’s all on paper. I have continued to contribute and actually increased my savings rate right now, keeping my focus on the long-term and my retirement years 20 years down the road. I didn’t liquidate anything nor do I plan to. Not only that, but when I find another job, I can take my 401k balance with me.
So I haven’t lost a darn thing. Not one penny.
On the other hand, if Rutten had his way, we’d all liquidate and make those losses real in the name of a ‘failed experiment’. It’s laughable to hear him quote Robyn Credico’s sudden epiphany on the failure of 401k plans, given her recommendation just over a year ago that employees be allowed to invest 401k funds in annuities at a time where the insurance industry teetered on the brink of being the loss leaders of our modern time.
401k plans may be the way back. At the bottom of this crisis is a crisis of confidence. We have the choice to pick up our toys and go hide in a cave, or to boldly use the combined leverage of our 401k investments to fund a future where we can retire comfortably. It’s risky, but 401k participants have been taking the risk for the past 25 years or so, every time they allow part of their paycheck to be invested.
Before writing 401k plans off as a failed experiment, I’d suggest that Tim Rutten get in touch with his facts and the reality of our times. There will be no return to the days where benevolent employers gave us our gold watch and lifetime pension. On the other hand, we now have the clout and the ability to shape what our future will be. We are not at the mercy of financiers; we ARE the financiers. We need confidence and integrity returned to our regulatory system to complete the picture.
Change is coming.
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?
- 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.
- 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.
- 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
This is excellent news. According to a statewide survey conducted by the Public Policy Institute of California, Propositions 4 (Parental notification before a minor can have an abortion) and Proposition 8 (Same sex marriage ban) are below the 50% threshold. Among likely voters, Proposition 8 is losing 52%-44%.
The study also found that the economy is the issue first and foremost among voters (Hear that, Senator McCain? No one wants to hear your smears, they want to hear what you’re going to do about this mess!). 55% of likely voters weight the economy as the top issue. That’s a 21-point jump since a similar poll done in August.
Some other interesting findings: Only 9% of Californians think the initiative process is working, the majority thinks reforms are necessary. (Count me in that 91% who think the entire initiative process is a joke that makes bad law and worse situations – I think they should be abolished.)
The item that most concerned me: Only 51% of likely voters have a great deal or a lot of confidence in the nation’s voting system. I’ll have more to say on that in a different post.
You can read the entire survey here.
Yep, you read it right. Wachovia, the same Wachovia that the Feds tried to force-sell to Citi for $1/share while screwing the shareholders and Wells Fargo Bank, is extending an 8 million dollar loan to the GOP for campaign activities to support GOP House candidates.
They deny credit and freeze assets of others, the feds try to force a fire sale to Citigroup, and now they’re financing the end days of GOP campaigns?
H/T Daily Kos
Love it. Just love it.