Cracks in the nest egg
401(k) plans falling short for most, author warns
The 401(k) plan kind of sneaked up on us. Named after a section of the tax code in 1980 and accepted with little fanfare or debate, the 401(k) has quietly become America's de facto retirement system. Fully 58 percent of households covered by a pension plan have only a 401(k).
Trouble is, those 401(k)s have far too little money in them to allow retirees to live comforably. In her new book about 401(k)s, called "Coming Up Short," Boston College professor Alicia Munnell finds that for households headed by people in their late 40s and early 50s, the median 401(k) balance is $37,000, a small fraction of what financial planners say is needed. While some of those households will have money from traditional pensions to fall back on, most will not.
And for low-income people, the balances will be especially skimpy.
Munnell's findings square with what others have found about retirement savings. A recent study by the Employee Benefit Research Institute, a Washington think tank, concluded that American retirees will have at least $45 billion less in retirement income in 2030 than what they will need to cover basic expenditures.
Louis Berney, the editor of a newsletter that follows the 401(k) industry, said Munnell has put her finger on the essential problem with the system: "We've put all the responsibility on employees, and most of them are overwhelmed."
Traditional pension plans paid employees a fixed benefit, based on salary and years of service. Companies contributed money to the plans and managed the investments. With the 401(k), the shoe is on the other foot. Employees put away money for their own retirement. At the vast majority of companies, employers match at least a portion of the employee contribution. The plans are portable, so people can move their money as they switch jobs. Employees also decide how their funds are invested. Munnell found that the very quality that makes 401(k)s so appealing -- the fact that they let individuals control their own destinies -- also explains their shortcomings. "The reason for the low balances is that the entire burden is on employees, and they make mistakes at every step along the way," Munnell writes.
The list of missteps is a long one. More than 25 percent of those who can participate in 401(k) plans choose not to contribute. Fewer than 10 percent of those who do participate contribute the maximum amount allowed. Many people don't diversify their holdings. Too many employees fill their accounts with company stock alone, a strategy that entails considerable risk.
In theory, 401(k) plans should work better. If you assume an average income worker starts a 401(k) in his 20s, contributes a typical amount to the plan -- 6 percent of income plus a 3 percent employer match -- and earns a normal return -- about 7 percent a year -- the balances should be much bigger than they turn out to be. What accounts for the gap?
The answer: The mistakes people make, including one big one that caught Munnell by surprise. She found that when people switch jobs, many of them withdraw and spend their 401(k) money, rather than roll the funds over into Individual Retirement Accounts. The biggest offenders are younger workers. "They buy a car, they go to grad school, they buy a house," she said. "What they don't do is save for retirement."
Alicia Munnell is no stranger to public policy debates. In 1992, as an executive at the Federal Reserve Bank of Boston, she was the lead author on a study that found evidence of racial discrimination in mortgage lending in the Boston area. The banking industry disputed the report but ultimately changed its practices. "The study had a real impact," said Richard Syron, Munnell's boss at the Boston Fed and now chief executive at Freddie Mac, a leading issuer of mortgage securities.
Munnell, 60, has had a keen interest in retirement issues since she wrote her Harvard doctoral thesis on Social Security. She is a strong defender of the current Social Security system. In 2001, she testified in Congress against a plan to create individual accounts within Social Security. "Individual accounts are unduly risky for people's basic retirement benefit," she said. Before coming to Boston College, where she is director of the Center for Retirement Research, Munnell spent four years as part of President Clinton's economic team.
Said Munnell, "We aren't going to go back to the old traditional pension plans. We have to get over that. We have to figure out how to make these plans better." Munnell's ideas are based on a simple notion: that some of the burden for decision making has to be lifted from the shoulders of workers. In her book, she proposes a series of defaults, automatic fallbacks that would be applied to 401(k) accounts unless an individual chose to opt out. For example, employees would automatically be enrolled in the program. If they did not want to make their own investment choices, reasonable choices would be made for them. When they left a job, their accounts would automatically be rolled over into IRAs. Workers could go their own way at each step of the process. "You could still go dot-com wild if you wanted," said Munnell. The hope is that the defaults would point people, including unsophisticated investors, in the right general direction.
David Wray sees merit in Munnell's proposals. Wray is president of the Profit Sharing/401(k) Council of America, a trade group. In the early days of 401(k)s, he said, empowerment, putting employees in charge, was critical. "Over time there has been a realization that empowerment doesn't mean employees have to make all the decisions," he said.
Exactly who would make the decisions and how such policies would be adopted in such a decentralized business is not clear.
Munnell would like to see government take a bigger role, a difficult sell in the current political climate. Still, she is convinced some kind of reform is critical. "It sounds nice to say, `Let everyone do it,' " Munnell said. `Now we have an assessment of what that means. People need help."
Charles Stein can be reached at stein@globe.com.
