Where I tell Tim Rutten to get a 401k education
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.