Friday, April 4, 2014

Why the 401(k) concept isn't working (Immature America)

The great experiment known as the 401(k)/IRA is about to come to fruition.   Was it a good idea?   In many ways, no, it wasn't.

We are the 401(k) generation.   Anyone born from about 1960 until today was covered at work by a 401(k) and could also contribute to an IRA.    It is a generation without definite boundaries, however.   Some folks born earlier saw their pension plans converted to 401(k) plans, or were offered "lump sum" payouts which they invested in an IRA.   Still others, born later, have one of the few remaining defined-benefit pension plans available, usually from old-line manufacturers, schools, or the government.

But the rest of us, we have to live on our savings.   And it isn't working out well, for a number of reasons:

1.  People Aren't Very Bright:  There are folks who work hard and spend every penny they get.   You just can't explain to them why putting money aside for savings is a good idea.   It is like talking to a rock.  So a huge number of people are heading to retirement with nothing, even though they had the opportunity to invest in their 401(k) or IRA.

2.  The Poor are Penalized #1:   Middle-class folks take nice tax deductions with their 401(k) plan, which can knock them down from the 25% bracket to the 15% bracket.    The very poor have less "excess money" to invest, and when they do, they don't get as big a tax deduction (although they may qualify for a tax credit).   

3.  The Poor are Penalized #2:   Even if a poor person puts aside 10% of their income (which would be an heroic amount for someone at the poverty line) it will, by definition, not be nearly as much as a middle-class person who puts aside 10%.   A poor person could save heroically and the end result would still not be enough to retire on.

4.  Poor Investment Choices #1:   Even wealthy "smart" people make poor investment choices.   I know people who have a million bucks in their retirement accounts all in one stock.  The stock pays a good dividend, and their plan is to "live off the dividends and never touch the principal!" (which I have noted before, is a flawed concept).   However, they fail to realize that if that one stock drops in value or their dividend rate declines, they could be in serious trouble in short order.   Diversification is the key, and spending the money, over time, should be the plan.  Relying on high-rate-of-return investments is risky.

5.  Poor Investment Choices #2:  Still others make bad choices by being either too aggressive (trying to "catch up" for years of not saving) or too timid (afraid of losing money and instead falling behind due to inflation).   Let's face it, we are all not very good investors.   In fact, it is a rare talent.   Even very smart, college-educated people, make very bad choices.   The folks who invested with Bernie Madoff were all "smart" sophisticated people.

6.  Cashing Out the 401(k):   I know of folks who cashed out their 401(k) long before retirement.   Some just spend the money on a car or to "treat" themselves.   Others tried to "hang on" to underwater homes by using their 401(k) savings to make mortgage payments.   They end up in bankruptcy anyway and lose the home - and their 401(k) savings.

7.  Spending the 401(k) too Fast:   Once retired, many retirees take out too much money from the 401(k) at a time, so by the time they are 70, the money dries up, and they have to live on Social Security alone.   The stress of a self-funded retirement doesn't end when you retire.   You spend half your life worrying about saving, the other half, worrying about spending!

So, how does this compare to the defined benefit pension?

Well, the defined benefit pension has problems of its own, of course.   Primary among these is the under-funding of these plans by employers, who "rob Peter to pay Paul" and underfund the company pension plan, hoping that later profits will allow the plan to be fully funded down the road.    In addition, if a company's market share and profits diminish, they may end up with a huge liability for retirees, without enough profits to pay their pensions.

But, of course, these issues could be fixed by changing a few laws - requiring companies to fully-fund their pension liabilities (why not?) and do so with an independent 3rd party that would survive bankruptcy or downturns.

The main thing is, all of the seven problems outlined above would never occur with a defined benefit pension.   Each employee is provided with a pension, regardless of whether they contribute to it.  And each employee gets a set amount, every month, when they retire.   No one has to make decisions as to what to invest in, so we don't worry about poor investment choices.   The poor as well as the rich are provided with a pension, albeit the poor get a smaller amount.   But they don't have to put aside money for retirement in the first place.

Now, having said all of that, The 401(k) and IRA are not going to go away.  We are not going to "go back" to an era of defined pension benefits.   In fact, fewer and fewer jobs will have these, even with the government, schools, military, and old-line manufacturing companies.   This is the harsh new reality and we have to live with it.

And we still have individual choices, too.   We can choose not to do any of the dumb things outlined above in #1 through #7.   We can choose to save and live on less.   It is not easy to do and requires a level of maturity.

In fact, it requires that we all grow up for chrissakes.

And that right there is why defined pensions and other forms of cradle-to-grave socialism are flawed.   They treat people like children, who in turn live up to those expectations.

We are becoming a more immature culture - we live like children, indulging ourselves with the latest electronic toys and online gossip.  We dress like infants and eat as though we were at a six-year-old's Birthday party (cakes, chips, soda, and pizza).   Think about it for a moment - our ancestors were never this irresponsible.

Because if you go back about three or four generations, there was no Social Security and there were no defined benefit pensions - or 401(k) plans or IRAs.   People had to save money without incentives from the government, and someone trying to scratch a living from dirt farmland had to be as serious as a heart attack, if they hoped to survive at all.

But since then, a lot has changed.   Maybe it is time we all grew up.