Time recently carried a long article that, depending on your point of view, is an expose of the problems with 401k plans or a hatchet job. The article relates the problems with 401ks by telling the stories of a number of retirees from Occidental Petroleum, which was one of the first large corporations to adopt this type of defined contribution plan. The writers contend that in most cases, the employee would have been better off in a traditional defined benefit pension plan. So let’s take a look at their criticisms of the 401k.
The first retiree case study is Robert Shively. He is now age 68 and holds a part-time job. The article suggests that he would have been better off with a fixed $1308/month pension than his current pension of $405/month plus his $70,000 remaining 401k balance. A lot of information is missing, so it’s hard to tell what the deal is. We don’t know when Mr. Shively retired, what his original 401k balance was, what percentage of his income he was saving in his 401k while he was working, and how much he is spending. So despite the article’s contention, I think the information here is inadequate to make a reasonable judgement.
The second retiree case study is Ernie Lucantonio. He retired in 2005 at age 57 with $350,000 in his 401k. The article implies that he would have been better off with a pension of $3,100/month. Ernie, too, took a part-time job. Elsewhere in the article, it states that Mr. Lucantonio was saving 6% of his salary in his 401k. So what is the culprit here? Is it the 401k or is it the fact that the client a) needed to save much more than 6%, probably 10-15%, b) retired early, and c) retired with inadequate savings? It’s also not clear what Mr. Lucantonio’s spending habits are like because it does indicate that he bought a tricked-out vacation cabin after he retired. Score: 401k 1, client’s financial planning and acumen 0.
The third retiree case study is Dennis O’Neil. He also retired early, but the article does not say when. He is now age 63 and has $500,000 left in his 401k. The article suggests he would have been better off to have a defined benefit pension payment of $2,200/month. Mr. O’Neil is worried about running through his 401k in the next decade, and no wonder! The article says he spends $75,000 per year. Somehow, no matter how I do the math, the great pension of $2,200/month comes to only $26,400 annually, which would still not even come close to supporting Mr. O’Neil’s spending habits. (Mr. O’Neil is trying to play the market to stay in the clover–always a clever idea for retirees.) Again, what is the culprit here? Is it the 401k or is it the fact that the client a) retired early, b) with inadequate savings, and c) is overspending to an enormous degree? Score: 401k 2, client’s financial planning and acumen 0.
The article cites the biggest problem with 401ks as the fact that they could drop a lot in the year you decide to retire. Apparently, risk management and asset allocation do not enter the equation–like maybe it would be a good idea to scale back your risk level in the few years before you retire. The proposed solution to the 401k crisis is to pay into a plan that will give you a guaranteed income–you put in 6% of your salary and get a guaranteed 26% of your salary in retirement. Wait a minute here! Didn’t Mr. Lucantonio save 6% of his salary in his 401k? If he had had the miracle income guarantee plan suggested by Time, with his pre-retirement salary of “nearly $80,000,” he would be able to draw a guaranteed income of $20,800 ($80,000 x .26) or $1,733/month. Or alternatively, Mr. Lucantonio could take his stated $350,000 401k balance when he retired and buy an immediate annuity. I went on to an immediate annuity website to calculate what a joint annuity would be. Guess what–$1,735/month! Of course, interest rates were a little higher in 2005 when Mr. Lucantonio actually retired, which likely would have made for a larger payout. If the annuity did not cover a spouse, the payout is also higher by $200/month or so. Son of a gun! The miracle program is apparently already in existence, disguised as an immediate annuity.
Certainly a lot can be done to improve client’s retirement readiness with a 401k. Help with investment decision-making, counseling on the appropriate savings level, and assistance with asset allocation and risk management are all needed. And let’s not forget why individuals clamored for 401k plans in the first place: the age of lifetime employment was over and workers were tired of forfeiting pensions with 5-year or 10-year cliff vesting when they changed jobs. 401k plans are portable and always fully vested.
After reading the article carefully, almost every problem these retirees are having has little to do with the structure of the 401k plan. Almost every problem stems from:
1. inadequate savings rate
3. lack of risk management and/or poor asset allocation decisions as client nears retirement
4. lack of knowledge of other retirement income products
I find it hard to believe that any competent financial advisor would have suggested retirement, let alone early retirement, to any of these individuals. And let’s face it: math is math. If you don’t save enough while you are working, you won’t have enough when you retire. There’s no magic income guarantee plan that doesn’t exist already. You might want to read this article, because investors are reading it and they need answers.