Will Democrats Kill Your 401k?
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
Privatizing Social Security: Reason #6,467,982 not to vote McCain
The very first blog post I ever wrote was a screed dressing down George W. Bush for even thinking about privatizing Social Security, and now we have John McCain endorsing the same policy.
Privatizing Social Security is the very worst idea the Republicans have ever brought forth. It’s nothing more than a money grab intended to take away what few retirement benefits are available to lower and middle class workers.
Consider this: If George W. Bush’s effort to privatize Social Security had been passed, every American within 15 years of retirement could have lost over 50% of their retirement accounts in the last 8 years as a result of market fluctuation, malfeasance (think “subprime mortgage crisis”), and fees.
All it should take to convince anyone to back away from privatized Social Security is an understanding of where the money goes. Right now, Social Security is backed by the full force and guarantee of the federal government. That’s how it must remain. Privatizing it, even a portion of it, means sending money to the very same Wall Street investment banks that the federal government just bailed out.
It means the possibility of your retirement dollars invested abroad. It means there are no longer any guarantees.
When John McCain says he doesn’t understand economics, he tells the truth. He also doesn’t understand how pensions and Social Security work.
Privatizing Social Security means only one thing: The government wants to shirk the responsibility to pay guaranteed pensions to citizens who have paid into the system for their entire working lives, not to mention their employers, who match the employee contribution. Among the Republican proposals, this one is the most insidious and yes, even criminal. They lie and say they’re empowering citizens, when they’re robbing them.
McCain has walked back his statements, just a little. But not enough. Here’s what he says today:
John McCain supports supplementing the current Social Security system with personal accounts–but not as a substitute for addressing benefit promises that cannot be kept. John McCain will reach across the aisle, but if the Democrats do not act, he will. No problem is in more need of honesty than the looming financial challenges of entitlement programs. Americans have the right to know the truth and John McCain will not leave office without fixing the problems that threatens our future prosperity and power.
Here’s what he said in 2004:
Q: Will privatizing Social Security be a priority for you going forward?
McCAIN: Without privatization, I don’t see how you can possibly, over time, make sure that young Americans are able to receive Social Security benefits.
In addition to the veiled contradiction, his current position is dishonest. Exposing the lies:
- Social Security is not an “entitlement program“. Social Security is paid for by employees and employers, as is Medicare. The benefits provided by Social Security are earned, not given.
- Social Security can ALREADY be supplemented with personal accounts. That’s what IRAs, Roth IRAs, 401(k) plans and employer Profit Sharing plans are. Of all the lies, this one is the most offensive. While Republicans claim that Democrats support big government and spending out of one side of their mouths, they advocate for a mandated retirement savings program that shifts the burden of providing guaranteed and earned benefits from the government to the individual. Should every individual be saving for their retirement? Absolutely, without question. But the mechanisms are already in place for that to happen. The suggestion that a mandate will stabilize Social Security is just specious, and smacks of Big Brother intervention.
- Finally, what does he mean by “If the Democrats do not act, he will.” Will he simply bypass the Congress and will of the people with an executive order abolishing Social Security?
Here’s a hint to John McCain and the Republicans: After 8 years of seeing what little financial security they had ripped away by investment bankers’ malfeasance and Republican greed, Americans are not going to take kindly to your efforts to shear away what little tiny bit of security they might have for retirement. This is particularly true of those of us who fall into the Baby Boomer generation, who have seen Republicans slide their retirement dates from 65 to 70 over the past 10 years.
Leave Social Security alone. Shore it up, quit using it as a credit card to bury war costs into the budget. And above all, do not let John McCain and the Republicans take your retirement dollars and hand them to liars, thieves and Wall Street greed.
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