7 Problems With An All-401(K) retirement

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
digit8
Posts: 614
Joined: Mon Jul 14, 2008 5:26 pm

7 Problems With An All-401(K) retirement

Post by digit8 » Sun Dec 23, 2012 11:54 am

I found this a relatively even-handed article on potential problems associated with a retirement system increasingly focused on the 401(k) system.



http://timothymobley.wordpress.com/2012 ... 401k-plan/
"You can't latte yourself to bankruptcy. The bladder won't allow it." | -Katherine Porter

User avatar
JamesSFO
Posts: 3111
Joined: Thu Apr 26, 2012 10:16 pm

Re: 7 Problems With An All-401(K) retirement

Post by JamesSFO » Sun Dec 23, 2012 12:11 pm

Meh, it feels rather devoid of content. I was sort of hoping for something substantive and not what that is like the old Smart Money 10-things your fill-in-the-blank won't tell you.

EDIT: to add missing not
Last edited by JamesSFO on Sun Dec 23, 2012 12:29 pm, edited 1 time in total.

User avatar
bUU
Posts: 570
Joined: Sun Nov 25, 2012 11:41 am

Re: 7 Problems With An All-401(K) retirement

Post by bUU » Sun Dec 23, 2012 12:19 pm

I think tilting this article so that it seems to cast aspersions specifically on 401(k)s doesn't make sense to me. In other words, I think 401(k) is a red herring. The threats would apply equally to an IRA-focused system, and a traditional (taxable) investment-based system. The article also seems to be asserting that ERISA was the sole cause of the discontinuing of pension plans. While it may have provided employers cover for doing so, I'm pretty confident, myself, that pension plans would have traversed the same path over the last thirty years regardless of the existence of 401(k)s.

User avatar
nedsaid
Posts: 10500
Joined: Fri Nov 23, 2012 12:33 pm

Re: 7 Problems With An All-401(K) retirement

Post by nedsaid » Sun Dec 23, 2012 1:04 pm

There are a lot of flaws with the 401k's and 403b's. Yet I am pleased that I have control of the vast majority of funds dedicated to my retirement. Why? The traditional pension plans are pretty well flawed also.

Now that interest rates and investment returns have been lower, it is harder and harder for defined benefit (traditional pensions) plans to meet their obligations. In my home state, the recession has hit our government agencies particularly hard because of increased contributions to the State retirement system. My state is in effect laying off government employees in order to pay for increased pension costs. Not only the costs for people now retired but also for the shortfalls in funding to meet future obligations.

Like it or not, most of us have to take responsibility for our own retirements. We have to take this seriously and not blame others.

We have to view 401k's, 403b's, 457's, IRA's, Roths and the like as our pensions and we have to invest them accordingly.
A fool and his money are good for business.

umfundi
Posts: 3361
Joined: Tue Jun 07, 2011 5:26 pm

Re: 7 Problems With An All-401(K) retirement

Post by umfundi » Sun Dec 23, 2012 1:22 pm

The biggest problem (in my mind) is that defined-benefit plans used to cost employers about 15% of payroll to fund. Now they are gone, and employers are, generally, just saving that money.

The first problem is not with the alphanumeric soup of IRA, 401k, etc. It is that future retirements are being severely underfunded. I was fortunate enough to have both a good DB plan and access to a reasonable 401k.

The second problem is that upon retirement, most people will have a lump sum, not a guaranteed income stream. They are easy prey for the financial industry. What people need is a reliable, low-cost way to annuitize at least part of their lump sum into a lifelong pension.

Keith
Déjà Vu is not a prediction

User avatar
ruralavalon
Posts: 14079
Joined: Sat Feb 02, 2008 10:29 am
Location: Illinois

Re: 7 Problems With An All-401(K) retirement

Post by ruralavalon » Sun Dec 23, 2012 1:45 pm

Never had a pension, or access to a pension.

Thank goodness for the 401k (flaws and all), its the primary source of my retirement funds.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

User avatar
nedsaid
Posts: 10500
Joined: Fri Nov 23, 2012 12:33 pm

Re: 7 Problems With An All-401(K) retirement

Post by nedsaid » Sun Dec 23, 2012 1:45 pm

My suspicion is that the monies saved by employers dumping defined benefit plans are now going into health care costs.

I agree that people should consider putting part of their nest egg at retirement into an immediate annuity for a guaranteed income stream. I am undecided on this, a lot will depend on the level of interest rates when it comes time to make a decision. Right now rates are so low.

I have read that the rule of thumb for a comfortable retirement is saving 15 percent of income. Isn't it interesting that is the same number cited as the cost of pensions for employers? Makes sense.
A fool and his money are good for business.

User avatar
bUU
Posts: 570
Joined: Sun Nov 25, 2012 11:41 am

Re: 7 Problems With An All-401(K) retirement

Post by bUU » Sun Dec 23, 2012 1:47 pm

nedsaid wrote:Like it or not, most of us have to take responsibility for our own retirements. We have to take this seriously and not blame others.
Yes, though to be fair, there is a big difference between what we "have to" do and what people will do (and to a great extent, for many many people I know, what people simply will be utterly unable to do).
umfundi wrote:The biggest problem (in my mind) is that defined-benefit plans used to cost employers about 15% of payroll to fund. Now they are gone, and employers are, generally, just saving that money.
Conceptually, they're paying 15% more in salary. I know that there is a lot of resistance to thinking of it in that manner, but to a great extent the labor market is a marketplace like any other. Goods (time and effort) are traded for money, with the prices set based on what the market will bear (subject to government regulation, of course). There's nothing that would have forced companies to pay the salaries that they're paying today, plus 15% to fund pensions, if pensions didn't go by the wayside, so the market would have never have driven wages up to where they are now if pensions were still part of the equation.
umfundi wrote:The first problem is not with the alphanumeric soup of IRA, 401k, etc. It is that future retirements are being severely underfunded.
My father worked most of his life in what I guess we could call "the pension era". Yet, here he is, in the last years of his life, just scraping by. His various pension opportunities in his trade never came to fruition. I gather from that (Does anyone know for sure?) that the percentage of workers who earned pensions back in the 1940s and 1950s (for example) was actually lower than the number of workers today who will eventually receive benefits of 401(k)s. So this issue of "retirements being severely underfunded", I think, is nothing new. Perhaps now it is more so the case that retirement savings are insufficient to last through retirement, while before it was more so the case that people didn't have any retirement benefits available to them at all. Isn't that the case?
umfundi wrote:The second problem is that upon retirement, most people will have a lump sum, not a guaranteed income stream. They are easy prey for the financial industry. What people need is a reliable, low-cost way to annuitize at least part of their lump sum into a lifelong pension.
Surely there are answers for that now, no? (I haven't gotten far enough down the path toward retirement, even though it is roughly eight years away, to have researched that aspect yet.)

User avatar
nedsaid
Posts: 10500
Joined: Fri Nov 23, 2012 12:33 pm

Re: 7 Problems With An All-401(K) retirement

Post by nedsaid » Sun Dec 23, 2012 1:54 pm

If people are unable to manage their own investments, they can pick a target date fund or a risk based fund (60/40 stocks/bonds would be best) and be done with it until retirement. Upon retirement, they could annuitize a part or all of their retirement savings.

Target Date funds and risk based funds have their flaws but are far better than what most people would do on their own.

We expect people to be financially savvy and unfortunately most people are not.
A fool and his money are good for business.

umfundi
Posts: 3361
Joined: Tue Jun 07, 2011 5:26 pm

Re: 7 Problems With An All-401(K) retirement

Post by umfundi » Sun Dec 23, 2012 2:19 pm

I have read that the rule of thumb for a comfortable retirement is saving 15 percent of income. Isn't it interesting that is the same number cited as the cost of pensions for employers? Makes sense.
Except, when I started my career in the 1980s, the mantra was to plan for a three-legged stool. Social Security, your pension, and your savings would each constitute about a third. And, for your part, you needed to save 15%. That other leg, the employer DB pension, also worth a third, is now gone.

Keith
Déjà Vu is not a prediction

umfundi
Posts: 3361
Joined: Tue Jun 07, 2011 5:26 pm

Re: 7 Problems With An All-401(K) retirement

Post by umfundi » Sun Dec 23, 2012 2:33 pm

bicker wrote:
umfundi wrote:The second problem is that upon retirement, most people will have a lump sum, not a guaranteed income stream. They are easy prey for the financial industry. What people need is a reliable, low-cost way to annuitize at least part of their lump sum into a lifelong pension.
Surely there are answers for that now, no? (I haven't gotten far enough down the path toward retirement, even though it is roughly eight years away, to have researched that aspect yet.)
bicker,

Yes, there are options, see http://www.immediateannuities.com. But, who knows that?

I think it is entirely reasonable to have to have Defined Contribution savings plans, but there must be incentives for them to be adequately funded. (That gets employers off the hook for unfunded future obligations.) Then, when people retire, there should be a mechanism to annuitize those lump sums into lifelong income that is encouraged. That is very much missing.

At this time, it's just not in the mental model for retirement in the USA. Other countries, like Australia, seem to be getting there.

Keith
Déjà Vu is not a prediction

save-early-often
Posts: 29
Joined: Tue Apr 17, 2012 10:04 am

Re: 7 Problems With An All-401(K) retirement

Post by save-early-often » Sun Dec 23, 2012 2:36 pm

The blog post is a textbook example of a tactic used frequently by financial advisors which is to referred to as FUD. Fear, Uncertainty, Doubt. Impart one or more of these feelings on a client or a potential client and the probability of closing a sale is increased.

User avatar
mickeyd
Posts: 4629
Joined: Fri Feb 23, 2007 3:19 pm
Location: Deep in the Heart of South Texas

Re: 7 Problems With An All-401(K) retirement

Post by mickeyd » Sun Dec 23, 2012 3:37 pm

I suspect that I am like many Bogleheads in that I would have saved/invested as much as possible over the years no matter what government-sponsored scheme I was eligible for. I began saving/investing long before the 401(k) or IRA was even being considered by the crowd in DC. I have taken advantage of the opportunity to stash away money in the offered tax shelters over the last 30 years or so, but I would have saved as much as I could in a taxable account if the tax-favored accounts had not been available.

Many of my fellow Americans would not have done so without these tax-sheltered accounts.
Part-Owner of Texas | | “The CMH-the Cost Matters Hypothesis -is all that is needed to explain why indexing must and will work… Yes, it is that simple.” John C. Bogle

User avatar
Svensk Anga
Posts: 438
Joined: Sun Dec 23, 2012 5:16 pm

Re: 7 Problems With An All-401(K) retirement

Post by Svensk Anga » Sun Dec 23, 2012 6:08 pm

I think there is some nostalgia for the good ole days of defined benefit pensions (DBP), now that they are well on their way out of fashion. I think there were a lot of issues with DBP that are being forgotten:

1.) You had to be vested to get a benefit. It might take five or ten years with one employer to get vested. If your plan vests in 10 and you leave in year 9, you lose 100% of the benefit. A 50% drop in one's 401k balance looks mild by comparison. Your 401k will eventually bounce back. You probably never get the unvested benefit back.
2.) Because of item 1, you could be stuck in a bad situation for years, waiting for vesting.
3.) DBP's often had no COLA. That was fine back in the days when one retired at about the average life expectancy, but not so good now when retirements might be 30 years.
4.) Maybe you had a DBP early in your career and it was vested when you left at age 35. Draw on it, with no COLA, when you are 65, and inflation has rendered it trivial.
5.) Say you're now mid-50's, are vested, and have a lot of credited service with your current employer. Suppose further that inflation is high and the work situation has become difficult. Do you stay to try to keep the benefit you earned with all those years of service growing with inflation, or do you take the leap to a potentially better situation? If the latter, you have to play the vesting game again.

I think that defined contribution retirement plans have enhanced worker mobility. The golden handcuffs are no longer there, holding workers in less than ideal situations. Workers are free to find the job that best matches their skills and ambitions. I suspect that across the whole economy, many workers being free to optimize their own career paths has added something non-trivial to the growth of the economy.

Bob's not my name
Posts: 7405
Joined: Sun Nov 15, 2009 9:24 am

Re: 7 Problems With An All-401(K) retirement

Post by Bob's not my name » Sun Dec 23, 2012 7:20 pm

I went to dictionary.com to look up "even-handed" to see if I'd forgotten what it means. I hadn't.

digit8
Posts: 614
Joined: Mon Jul 14, 2008 5:26 pm

Re: 7 Problems With An All-401(K) retirement

Post by digit8 » Sun Dec 23, 2012 9:44 pm

Interesting reactions all around....the gist seems to be a feeling that it was biased, which strikes me as weird. Most of these on the face of it strike me as pretty much on target if overly general, and in the Boglehead spirit if not actively, generally agreed on in these boards. The ideas that the general public need to contribute more to the plan, be a bit more careful with their investment choices, watch fees and avoid loans....did not seem particularly out of line with this board, or even negative, merely cautionary.


Then again, I didn't see another iteration of the defined benefit vs defined contribution debate coming about from this...so what do I know?
"You can't latte yourself to bankruptcy. The bladder won't allow it." | -Katherine Porter

User avatar
grabiner
Advisory Board
Posts: 22900
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: 7 Problems With An All-401(K) retirement

Post by grabiner » Sun Dec 23, 2012 10:35 pm

digit8 wrote:I found this a relatively even-handed article on potential problems associated with a retirement system increasingly focused on the 401(k) system.

http://timothymobley.wordpress.com/2012 ... 401k-plan/
I don't think the article was researched well, as there are several points which the author does not appear to undestand. While it is a bad idea to use a 401(k) loan as an ATM, the consequence of default is a tax bill, not ruining your credit score, as it would be if you defaulted on a credit card. And consider the comment about professional managers not being able to manage well:
The truth is that most investors are not that great at picking investments. This is not necessarily due to lack of knowledge. Same is true for professional fund managers. For example, The Vanguard S&P 500 which is the most famous index fun in the United States marketplace, failed to match the performance of the benchmark index as of December 31, 2011.
This isn't the right comparison; the 500 Index doesn't try to pick investments. It is true that most money managers underperform their benchmark, but using the 500 Index isn't the way to illustrate it.

I would also say that it isn't true; the managers of Vanguard 500 Index outperform the S&P 500 by a few basis points every year, although investors may have underperformed according to how much they paid the managers. The Institutional Plus class has beaten the index ten years in a row, although this streak is likely to end in 2012 due to rounding.

Another unreasonable quote:
According to the Social Security Administration, the National Average Wage index for 2010 is $41,673. If one were to contribute the maximum 401K deferral amount per IRS regulations of $16,500, that represents a whopping 40% of income.
That's a big "if"; workers making $41,673 a year are allowed to save 40% in a 401(k) (and another 12% in an IRA), but they don't need to save that much. Workers with pensions also contribute to their pension plans, and contributing an equivalent amount to a 401(k) instead (plus an employer match equal to what the employer contributed to the pension) is likely to be a reasonable contribution.

(edit to rearrange material)
Last edited by grabiner on Mon Dec 24, 2012 10:47 am, edited 1 time in total.
Wiki David Grabiner

User avatar
ruralavalon
Posts: 14079
Joined: Sat Feb 02, 2008 10:29 am
Location: Illinois

Re: 7 Problems With An All-401(K) retirement

Post by ruralavalon » Mon Dec 24, 2012 10:42 am

digit8 wrote:I found this a relatively even-handed article on potential problems associated with a retirement system increasingly focused on the 401(k) system.
To me it looks more like an advertisement for the author's financial services.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

User avatar
ascenzm
Posts: 257
Joined: Sat Mar 10, 2007 8:16 am
Location: PA

Re: 7 Problems With An All-401(K) retirement

Post by ascenzm » Mon Dec 24, 2012 11:12 am

digit8 wrote:I found this a relatively even-handed article on potential problems associated with a retirement system increasingly focused on the 401(k) system.



http://timothymobley.wordpress.com/2012 ... 401k-plan/
I never like to have all my eggs in one basket so I made sure that my 401K account balance was never a majority of my assets. As an aspiring early retiree I like the flexibility that comes from having a majority of my investments in non-retirement accounts. With 401Ks you are looking at RMDs, the potential of a much higher federal marginal tax rate when 401K assets are withdrawn and I will not mention my biggest fear since I'll be getting into politics.

I stopped Roth IRA contributions a few years ago due to income limits. Due to the concerns I expressed above, I reduced my 401K (now Roth 401K) contributions to the minimum I can contribute (6% of gross salary) to allow me to capture the maximum employer match (3% of gross salary). I used to contribute the maximum allowd to my IRA and 16% of my gross salary to my 401K.

Mike
Avatar is a Japanese Cherry tree in Washington, DC during the peak cherry blossom time.

User avatar
grabiner
Advisory Board
Posts: 22900
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: 7 Problems With An All-401(K) retirement

Post by grabiner » Mon Dec 24, 2012 11:56 am

ascenzm wrote:I never like to have all my eggs in one basket so I made sure that my 401K account balance was never a majority of my assets. As an aspiring early retiree I like the flexibility that comes from having a majority of my investments in non-retirement accounts. With 401Ks you are looking at RMDs, the potential of a much higher federal marginal tax rate when 401K assets are withdrawn and I will not mention my biggest fear since I'll be getting into politics.
If you retire early, you can withdraw your Roth IRA contributions (and already-taxed rollovers or conversions from at least five years ago) without any tax, even before you reach 59-1/2. Also, when you leave the employer, you can roll your Roth 401(k) into a Roth IRA, and that has to be better than a taxable account unless the Roth 401(k) has extremely high costs.

But I do agree with the principle of tax diversification; if you have both a traditional and a Roth account, you can withdraw from whichever one is better for your tax situation in that year. This is a potential disadvantage of going all-traditional (although not one that the original article mentions anything about).
I stopped Roth IRA contributions a few years ago due to income limits.
You can use the backdoor Roth IRA unless you have a traditional IRA.
Wiki David Grabiner

Post Reply