No ‘Magic’ in These 401(k) Retirement Numbers

 Last week, a new report claimed to find a big jump in a so-called “magic” number for retirement, based on what survey respondents said they thought they’d need. As though they’d know.

It garnered quite a bit of coverage, including an article in The Wall Street Journal (and a comment from none other than Teresa Ghilarducci). While the “magic” number of $1.46 million didn’t seem astronomical (Professor Ghilarducci even commented that people often OVER-estimate their needs), that number jumped dramatically from $1.27 million a year ago—something the authors attributed to concerns about inflation.

There are many problems with reports like this—none of which the breathless reporting of the conclusions acknowledged:

(1) It’s an average—while we get some breakdown on age brackets, we know nothing about their incomes, where they live, their health, etc.  What someone needs (or thinks they need) living in New York City is (or should be) considerably different from the projections of someone living in Dubuque, Iowa.   

(2) It’s based on what people “think” (who have probably not given this any real thought).

(3) It’s surveying completely different groups of people a year apart, so drawing a trendline is a predictable, but dubious reality.

The good news is—this time—most industry “voices” pushed back on this “magic” number, albeit for different reasons. Mostly they cast shade on the notion that any one number would be right for everyone, and/or they preferred to rely on a percent of pay gauge. But those struck me as “nibbles” around the edge of the report; valid criticisms to be sure, but more about the result than the process used to produce it. 

Meanwhile, stories like this serve mostly to fuel the concerns that responsible human beings already have as they try to look ahead to a future decades ahead in a time of tremendous uncertainty. If they weren’t nervous before they saw these headlines, they surely are afterwards.

Now, those of us in this industry see—and produce—reports like this all the time. We look at those gaps (even the misperceived ones) as a challenge, an opportunity, a goal to strive for, a gap to close.  And thank goodness we do.

But while I wouldn’t for a moment suggest that those gaps don’t exist for some, nor would I advocate obscuring those realities, it would be naïve to think that those who want to shut down or “defund” private retirement plans don’t see these types of reports as an admission of failure, if not guilt. 

There are plenty of good stories to tell—and every day there’s an individual (perhaps many individuals) who confidently step off into retirement, buttressed by a history of consistent saving and encouraged by the support and guidance of a qualified retirement plan advisor. It’s a story that nobody seems interested in covering, but one in fairness that we don’t spend much time sharing, either.

I’d ask today that, in the future, you pause before sharing this kind of “the sky is falling” headline with your networks. Let’s start sharing the realities of the plans you work with, the retirement successes of the workers you support, the impact that holistic focus on financial wellness is having on the finances and emotional stress of those you serve… 

It may not be “magic”—but it sure matters.

- Nevin E. Adams, JD

"Broken" Premises

 Perhaps because of the recent full moon, the nation’s 401(k) “haters” were out in force.

Yes, last week we were “treated” to a Bloomberg op-ed with ideas on how to “fix” America’s broken retirement savings system, a back-handed compliment (of sorts) on SECURE 2.0 in Forbes from Teresa Ghilarducci, and the trifecta was completed with an academics op-ed in the Washington Post alleging that the current retirement system is “built for the rich.” 

Most of the criticism was focused on the same old myopic view on taxes and tax preferences—all flavored through the prism of a highly biased preference for the involvement of the federal government in such matters, rather than the private sector.

Key Points

So, let me take a couple of minutes to make a few points that always seem to be glossed over:

1. Tax deferral is not tax avoidance. Those contributions and earnings will be taxed (though generally outside the 10-year budget scoring window Congress uses).
2. The ability to save for retirement on a pre-tax basis is a powerful incentive—even, and perhaps especially, for those that academics argue have no rational reason to do so (because, on a net basis, they have no federal income tax liability). 
3. Tax preferences encourage not only plan participation (though it does that), but also the creation/existence of retirement plans—in which lower income workers are 12-15 times more likely to save than on their own. 
4. Non-discrimination tests and legal contribution limits work (as designed) to keep an effective balance between the benefits of higher-paid and other workers. In fact, actual data proves that while higher-income individuals have higher account balances, those balances are in rough proportion to their incomes. They are not “upside down.” 

Now, with those elements in mind (we’ll return to them throughout), what did the “haters” have to say?

The ‘Fixes’

Well, the Bloomberg editors’ “fix” to the system they claim is “broken” involves: (1) making access universal (but wait, what about Social Security?)—with a 3% auto-default rate with an opt out (they cite the UK’s NEST opt-out rate of 8%, though the opt-out rate for comparable state-run IRA programs in the U.S. is three to five times larger); (2) making it “simple” (the federal government’s Thrift Savings Plan, or TSP was cited), ostensibly with an abbreviated fund menu—or perhaps just because it’s a government solution; (3) making it “portable” (actually, they want it centralized, presumably with the federal government, so that it never has/get to be moved/rolled over), and (4) they want it to be “progressive,” which basically means shifting the current deferral of taxes to a straight-up government match to “the lowest earners.”[i]

There’s really nothing new here—the solution seems to be, more or less, a “nationalization” of retirement savings—with a program focused on helping those at the lower end of the income scale, but completely ignoring the vast sea of middle-income savers—for whom Social Security alone likely won’t come close to replicating their retirement income needs. 

The Washington Post op-ed was crafted by Daniel Hemel, a professor at the University of Chicago Law School and a visiting professor at New York University School of Law. He seems quite angered at the bipartisan support for SECURE 2.0 (actually the Securing a Strong Retirement Act of 2022) as some kind of sell-out by Congress to the financial services industry. He has an issue with “mega-IRAs,” but he also takes aim at Roth contributions, the extension of the required minimum distribution timeline, the non-tax refundability of the Saver’s Credit, as well as the scaled increase in the catch-up limits—all of which are characterized as either a giveaway to the rich, a budgetary “gimmick”—or both. He offers no solutions to any of this—though he does suggest that a focus on a strengthened Social Security would be a better use of their time (I, for one, would support that). Nor is there an acknowledgement that somewhere along the way this system “built for the rich” has somehow managed to wind up with roughly two-thirds of its participants in tax brackets that by most measures would fall significantly lower than that label would encompass. Groups for which this “broken” system is a lifeline beyond the baseline of Social Security and the pension benefits they never had. 

And then, just ahead of that article, Teresa Ghilarducci, a familiar critic of 401(k)s, pens an article ostensibly focused on the provisions of SECURE 2.0 (even taking the time to try and explain why it garnered such strong bipartisan support) on her way to pointing out why her proposal (now labeled the Ghilarducci/Hassett/EIG retirement proposal) is superior. Now, most of us would think that legislation—any legislation—that passed the U.S. House of Representatives by a margin of 414-5 would have to be on something as innocuous as naming a post pffice—that it would advance so many aspects of retirement security instead is a testament to the importance of the issue(s), and the potential to make strides in addressing them. 

Well, Ms. Ghilarducci seems to think that while SECURE 2.0 is perhaps better than a poke in the eye with a sharp stick (my words, not hers), but she claims the fixes it provides are too little (and probably too late), compared with her solution (if bipartisanship in the U.S. Congress is quickly dispensed with, she takes great pride in her alignment with conservative economist Dr. Hassett) that would build a TSP-like program for—well, everybody—or at least those who don’t already have a retirement savings plan at work. This particular article doesn’t go into the details of her solution, but we’ve seen (and written) about it before. Mind you, she’s not really worried about what you and I might consider middle-income workers—her focus is on the lower end (less than $52,000 median household earnings). It calls for a government (rather than an employer) match—but one that is only 3%. Now, that’s a number that has appeared in previous proposals she has put forth—and Jack VanDerhei, while at the Employee Benefit Research Institute, projected that it comes in well under where the status quo brings that same group in the current system.[ii]

‘Broken’ Premises

Now, those of us who actually work with real people know that this so-called “broken” system works amazingly well—for those who have access to it—including, most especially, those at the lower end of the income scale. The academics routinely target the well-off in their criticisms, but ignore the needs of middle-income households for whom Social Security will almost certainly not be… enough. And completely discount/ignore the role that the current tax preferences play in fostering the formation and maintenance of these retirement plans. 

Indeed, underneath all of the criticisms, the real issue seems to be that—as we’ve noted repeatedly—not enough working Americans have access to that system. What these critics don’t seem to appreciate is that, rather than closing that gap by encouraging more plan formation and participation, these random op-eds—often based on myopic views and faulty premises—only serve to undermine that goal. But then, perhaps there’s a reason… 

There are plenty of success stories out there—I’ll bet every single one of our 35,000+ readers know one, ten, a dozen, perhaps hundreds… it’s past time we started telling them.

- Nevin E. Adams, JD

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[i] Weirdly, as a throw-in they suggest that folks should be able to “tap their accounts for the occasional emergency expense”—which they claim would “save billions more that would otherwise go toward interest on often-predatory payday loans.”

[ii] My thinking is that, like earlier proposals, her math works because she assumes that any balances not actually withdrawn by the individual (and perhaps their spouse) would be absorbed into the “pool” and used to fund other payouts.

‘Might’ Makes… Wrong?

 Sometimes the motivations of those attacking the 401(k) are pretty obvious.

The most recent was an article by a Maurie Backman at the Motley Fool titled, “Why a 401(k) isn’t the wonderful savings tool you think it is.” I tried to ignore it when it first (to my eyes) appeared on Forbes (which seems to have a pretty low threshold for contributions these days), and I was no more inclined to read it when it showed up a couple of days later on Fox News. But then folks started sharing it on both LinkedIn and Twitter—some ostensibly to hold it up for ridicule,[i] others as an affirmation—and, with some reluctance, I finally clicked on the article. 

Oddly, considering the title (and, in fairness, editors have been known to tweak headlines such that they bear little resemblance to the article they are attached to), the article spent almost as much space outlining the virtues of the 401(k)—specifically that they are “easier to sign up for” than an IRA, and that they have (much) higher annual contribution limits, even for catch-up contributions.

So, what’s their beef(s)? Backman makes three points:

1. That investment choices in a 401(k) can be limited (specifically that you generally can’t buy individual stocks).
2. That fees in a 401(k) can be high (the issue here seems to be the inclusion of actively managed funds alongside index offerings—and an assertion that “401(k)s plan come with administrative fees that generally are not negotiable. The administrative fees you'll pay with an IRA are typically much lower”—an assertion that doesn’t align with my experience, but is offered without data).
3. That a Roth option isn’t guaranteed (this factual assertion despite the fact that the most recent data from the Plan Sponsor Council of America that more than two-thirds of 401(k)s do currently provide the option).

To sum up: According to the article that claims the 401(k) isn’t a wonderful savings tool, the suboptimal aspects of a 401(k) are: (1) the options might not include individual stocks; (2) the fees can be high; and (3) you aren’t guaranteed to have the ability to save for retirement on a Roth basis—even though, by the author’s own admission, 401(k)s have much higher contribution limits and are easier to access, and thus are much more likely to be used (recall that data indicates individuals are 12-15 times more likely to save in a 401(k) than in an IRA on their own). Oh—and there’s only a passing reference to the employer match, which arguably also isn’t “guaranteed,” but is certainly more likely to be found in a 401(k) than in a stand-alone IRA.  

Perhaps it should come as no surprise that an article penned by the Motley Fool—a platform that purports to help individuals make stock picks—thinks that you’d be better off utilizing a retirement savings plan[ii] that would more readily accommodate their services. 

Yes, sometimes the motivations of those attacking the 401(k) are pretty obvious. The motivations of those choosing to publish such silliness? Not so much.

- Nevin E. Adams, JD

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[i] Memo to those who did—clicking on the article is the whole point; sharing it only exacerbates the problem.  

[ii] To add to the irony, the article sums up its advice thusly: “What you should do in that case is contribute just enough money to your 401(k) to snag your full employer match, if one is offered, but then put the rest of your savings into an IRA. Doing so could help you invest more appropriately, avoid high fees, and enjoy the perks of a Roth saving option.” 

The Enemy of the ‘Good’

 A reader recently commented, “Nevin: You are continually berating those who question various aspects of 401(k) plans as if the current structure is ‘perfect.’ It isn’t.”

That comment was inspired by a recent column of mine critical of a proposal rumored to be under contemplation by the Biden campaign—one that would “trade” the current tax preferences of 401(k) deferrals for a flat government tax credit. It’s a proposal that is intended to direct more of the same amount of government expenditure (when the government doesn’t take money from your pay, it’s considered an expense) to lower income individuals, in that a flat dollar credit would ostensibly be worth more to lower income individuals than the deferral of taxes under the current system. 

Now that reader went on to offer a comment in support of that intent, explaining that “…one of the biggest challenges we face is getting lower paid people to participate. Credits will give bigger benefits to these people, and maybe, just maybe, spur increased participation,” closing by challenging me to “…work to make 401(k) plans BETTER, and not simply berate those who challenge the current system. It ain’t perfect, my friend. Far from it.”

Now, as it so happens I know this particular reader. And so I know that he cares deeply about retirement savings and retirement savers, that he’s one of the many out there who are truly working every day to make things “better.” 

That said, if he read my criticism of this proposal to be an assertion that the current system has no faults or shortcomings—well, that wasn’t my point. I have never said the current system was perfect, and in fact, dedicate any number of these columns to highlighting needs/opportunity to make it better.

Beyond that, my experience has been that when those kind of assertions are published[i] (even as an “op-ed”) by a reputable news organization—well, left unchallenged, the assertions are often assumed to be accurate. Indeed, every time something like this makes its way into circulation, I will hear from a half dozen different advisors (or more) telling me that the article has been passed on to them by plan sponsor clients (or participants), looking for comment, or response (and often asking me for assistance in that regard). Indeed, those are the kind of things that tend to get routed to those in academia and on Capitol Hill by those who see it as an affirmation of their notion that the current system is inadequate or biased in favor of the well-off. 

However, it’s one thing to press for change, but something else altogether to do so without fully thinking through (or at least acknowledging) the potential implications of that change—what are generously referred to as the “unintended” consequences, but sometimes seem more a willful and deliberate disregard. In this particular case a federal tax credit at the expense of having a workplace savings plan or an employer match doesn’t seem like a good trade-off to me. Moreover, making broad generalizations about fees (that don't seem supported by data) to justify a call for undermining valuable support for participants and employers doesn’t strike me as being a well-reasoned argument for change/improvement. 

To me the biggest shortfall of the current system is that too many working Americans don’t have the opportunity to take advantage of it. Oh, there are plans that still pay too much in fees, that either don’t avail themselves of the services of a plan advisor, or rely on the counsel of one that isn’t qualified, plans run by fiduciaries who either aren’t aware of that responsibility or fail to fulfill it. The system, in total, isn’t perfect—but those who pick at those imperfections to justify its wholesale demise should be challenged and held to account for misstatements and exaggerations, and they should be willing—and able—to consider and respond to questions—and data—about the ripple effect of unintended consequences. 

Never forget that “perfect” is often the enemy of the good. 

- Nevin E. Adams, JD

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[i] Warning: I’ve been at any number of symposiums or roundtables—and even read the occasional op-ed—where the words of a well-intentioned industry leader are served up as an “admission” of failure of the current system. 

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The 'Cutting' Edge?

Are employers necessary for a successful retirement system? A new proposal suggests that their role be “jettisoned.”

Not one to simply “bash” the 401(k), and to his credit, Morningstar’s John Rekenthaler, who recently opined that the 401(k) had outlived its usefulness,[i] now offers an alternative that he considers to be a superior alternative, something he titles “the New American Retirement Plan.” Despite the shortfalls his previous column attributed to the 401(k), this proposal in most of its elements seems relatively modest, at least structurally. It’s (basically – in 25 words or less), a national DC plan for all employers, probably with mandatory employee contributions, no requirement for employer contributions, and tighter restrictions on withdrawals.[ii]
Make no mistake, though – the devil, and there’s mischief aplenty here – lies in the details.

Rekenthaler’s basic premise – one that he describes not only as “the first,” but the “most important” step – is to “jettison the employer’s responsibilities,” noting that “expecting companies to sponsor retirement plans is like demanding that a dog dance; it may comply, but neither well nor happily. Companies run businesses. That is what they are created to do.”

I get it. How much simpler would business be if you, as an employer, didn’t have to worry about the cost, aggravation, and yes – liability – associated with providing benefits? But let’s set aside for a moment the impact that benefits clearly have, in terms of not only job choice, but job retention.[iii] Let’s turn our attention to a program already in existence that, as Rekenthaler suggests, “jettisons” the employer’s responsibilities. Specifically, let’s consider for a moment the OregonSaves program – the longest running, and arguably quite successful – state-run programs for private sector workers. Two years in, and admittedly absorbing a part of the workforce – smaller businesses – that is perhaps lower paid, and less tenured – that program has a participation rate of approximately 70%, and an average deferral of 5.5%. 

Now, that’s 70% better than the participation rate of those individuals previously, and that 5.5% saved is almost certainly an improvement from the 0% these workers were likely setting aside from retirement before the advent of the program. Those results, however, pale in comparison with those reported in the 62^nd annual Plan Sponsor Council of America (PSCA) 401(k) survey. We’re talking record high contribution rates of 12.2% (5.2% of that from employers, by the way) and opt-out rates of generally less than 5%, compared to the 27% or so in the state-run program. 

And yet while Rekenthaler’s initial premise regarding the 401(k)’s “expiration” claims the current system has failed to deliver on its promise, here there’s not even an attempt to quantify what this “new” approach would produce in terms of retirement income adequacy, nor any notion of what level of mandatory employee contributions might be required to offset the loss of employer contributions. Could an unmandated employee contribution-only account produce “enough?”
Rekenthaler leaves open for “discussion” whether employee participation should, in fact, be mandatory, or mandatory only up to a certain level, and whether there should be a voluntary employer match or not. But adequacy of retirement funding isn’t even mentioned.

Despite the concerns raised (and acknowledged in a subsequent post) regarding the adequacy of the current system, he seems content to put forth a program he considers to be superior in design, apparently assuming it would also produce superior, if not sufficient, results – leaving it to the rest of us to work out – and presumably live with – the details.

Indeed, with as many opportunities for misuse, abuse, and underuse as the current voluntary system contains, it’s nothing short of amazing just how successful it has been in helping provide, in conjunction with Social Security and personal savings, the prospects for a financially secure retirement, nurtured by select tax incentives and bounded in by nondiscrimination rules and eligibility tests.

Sure, there’s still room for improvements in the current system – but mostly it seems to me that the problem with the current system seems to be that there’s not “enough” of it. As for the wisdom of cutting the support of employers from the current system – well, that seems to me like cutting off your nose to spite your face…

- Nevin E. Adams, JD

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[i]His columns are generally thoughtful and thought-provoking, his perspectives rational and well-reasoned, his commentary nearly always not only interesting, but entertaining. But on this one – well, let’s just say we disagree.

[ii]As for leakage – well, Rekenthaler’s solution there is a simple one: “Forget tax penalties; they do not sufficiently deter foolishness. Instead, ban early withdrawals outright. After all, retirement-plan investors receive a benefit from the government for deferring taxes. It is only fair that they give something back.” Only consider for a moment – if you knew as a matter of course when the money was being automatically deducted from your paycheck that you would never again be able to access it for anything pre-retirement – how might that affect your  opt-out decision? (My guess is you’d hold back some, if not all.)

[iii]Not to mention the widespread availability and applicability of Social Security, which, though technically an insurance, not an account-based program, ostensibly already has many of the attributes Rekenthaler prizes, while drawing 12.4% of all wages up through $137.700/year.

An 'Educated' Guess

It’s not hard to find scary headlines about 401(k)s – seems as though every week you read how people aren’t saving enough, are worried that they aren’t saving enough, aren’t saving enough and aren’t worried that they aren’t saving enough… Then in the past couple of weeks, a new twist.

First a headline that proclaims that “The 401(k) is Wreaking Havoc on Retirement.” Then one that purports to share “Why 401(k)s are bad for people without a college degree.” As it turns out, the articles are both about the same study, “Disadvantages of the Less Educated: Education and Contributory Pensions at Work.”

The authors of that study (ChangHwan Kim of the University of Kansas and Christopher Tamborini of the Social Security Administration) offer a basic premise – that less educated workers aren’t as well served as college graduates by the current defined contribution-centric plan structures (notably 401(k)s) that predominate the retirement landscape today – which is to say that they are less likely to be covered by those plans, less likely to take advantage when they are covered, and inclined to save less than their degreed counterparts even when they do take advantage.

They present evidence that less-educated workers save less, even when they make the same money as those with college educations. How much less? They say that college-educated people are 1.2 times more likely to be enrolled in a DC plan than high-school graduates are – and that’s even after controlling for income, access to a retirement plan, occupation, job tenure and other factors. Those with college degrees also contribute 26% more to their retirement, on average, according to the report.

But, not content to leave it there, they go on to suggest that less-educated workers were better off in a defined benefit structured environment where they didn’t have to make the decision to participate, and where they didn’t have to decide how much to save. (The most significant distinction – that in the private sector they generally didn’t have to contribute – isn’t mentioned.) Indeed, if the DB system had been as pervasive as many assume – or as generous in result as it was in design – they might have a point.

Wreaked Wrought?

But has that result – and the very existence of the 401(k) – truly “wreaked havoc” on the nation’s retirement system? In fairness, the authors of the study don’t make that claim – that’s left to the journalists looking for a catchy headline (or hoping to press a specific agenda). But those who retain this fond notion of the way things were tend to gloss over the reality that it’s one thing to be covered by, or even to participate in a DB plan, something else altogether to work there long enough to accumulate any real benefit. While some workers did spend their working career at a single employer (and some still do, especially in the public sector), the data show that for the most part we have long been a nation of relatively short-tenured workers.

How short? Well, the median job tenure in the United States has hovered around five years for the past three decades. Indeed, according to the nonpartisan Employee Benefit Research Institute (EBRI), in recent years it has ticked up, to about 5.5 years, but that’s because women are staying in their jobs longer; job tenure for men has actually been dropping. What that means is that even workers who were “covered” by a pension plan in the private sector – particularly back in the time before there weren’t 401(k)s – were highly likely to walk away with… nothing.

While I get that a system which relies on workers to take action, to make decisions and, yes, even to set money aside from their pay to fund their retirement, might not work as well for those who don’t take advantage of it as a system that asked nothing of them other than to remain employed, the realities of American job tenure probably undermined those advantages – and then some.

The less educated may indeed be at something of a disadvantage in a voluntary savings system relative to those who are more inclined to take advantage of its opportunities – but that shouldn’t be equated with a presumption that they were better served by a system that depended on job tenure levels that never existed for most.

- Nevin E. Adams, JD