An Article That Doesn't Make Much Sense...

For reasons that elude me—other than perhaps because it has a “click bait” headline—the folks at Bloomberg recently published an “op-ed” titled, “401(k) Plans No Longer Make Much Sense for Savers.” Sadly, it’s gotten some attention, aided and abetted even by industry publications, some of which incredibly reported on it as a straight news item. 

Much as it pains me to give more “oxygen” to this, the author, a “former risk manager” (he now apparently writes books), basically makes a tax argument. His essential premise is that once upon a time, the tax benefits of 401(k) made that investment worthwhile, but that tax rates have dropped, and they’re not likely to be lower in the future, so you’d be better off taking that money and investing it elsewhere (more on that in a minute). Oh, and he wants the federal government to forego its deferred taxation on those 401(k) monies so that you can pull that money out and invest it elsewhere without pause (we’ll not hold our breath waiting for that one).

There are many issues with this former risk manager’s perspective on 401(k)s—not the least of which is that his primary argument is based on tax rate data that appears to be both flawed and skewed to exacerbate the impact (picking both the highest and lowest tax rates, depending on the point he’s trying to make). Then, as is the case with many mathematical “arguments,” having predicated his case on a flawed assumption, he “just” does the math—producing a result that is mathematically accurate but distorted. 

But, for the sake of argument, let’s concede that tax rates are lower now than in 1980, and may well be higher that they are today in the future. The true myopia in his argument lies with his apparent lack of understanding of the 401(k) he so blithely dismisses.

401(k) Fables?

Part of his purported “fix” for 401(k)s in this changed tax environment is to make new contributions and accumulated returns from them tax-free when withdrawn in retirement (albeit only by below-median-income households), ostensibly to help provide relief against fears that post-retirement tax rates will be higher than today’s—though it seems primarily designed to encourage the flow of funds from the 401(k) to IRAs. Perhaps someone should alert him to the Roth 401(k)—a feature that some two-thirds of 401(k) plans already make available to workers. 

And then he suggests that in 1980, a “typical” investor would have paid about the same whether savings were in a 401(k) or an IRA, 3.5%—which suggests to me that he had no experience with either. 

Moreover, while he (grudgingly) concedes that 401(k) fees have declined since then (though he will only admit to 1.5%, and manages, in a passing comment, to note that “others are stuck around the 3.5% level,” inferring that is still commonplace), he actually opines that a stand-alone IRA investment is a better deal, with fees of 0.5%. Again, one has to wonder where he is finding that “stuck” 401(k)—not to mention that bargain retail IRA.

Match Less?

And that’s not the only 401(k) feature of which he appears woefully ignorant. Perhaps his fixation on tax rates blinds him to a significant advantage of 401(k) plans; that while workers doubtless appreciate the ability to postpone paying taxes on the pay they’ve not yet taken, that doesn’t seem to be a primary motivation for their participation. 

More likely, and yet completely ignored in his “analysis” is the impact and incentive of the employer match. A match which, according to the most recent Plan Sponsor Council of America survey, is at record levels. Try getting that in your retail IRA. 

Moreover, his affinity for IRAs also seems woefully misplaced in view of data that has established that even modest income workers are 12 times[i] more likely to save when they have access to an employer-sponsored plan than left to their own with an IRA. 

What’s The Point?

In view of all this contradictory evidence, one might well wonder why a published author and former risk manager would choose to simply ignore it—and then, based on half-baked assessments, draw conclusions that 401(k)s have outlived their usefulness. 

It’s entirely possible, of course, that he’s been living under that proverbial rock, that he’s completely missed a generation worth of innovation, that he’s oblivious to the realities of behavioral finance, that he’s never actually participated in a 401(k) nor benefited from the encouragement of an employer match. 

Or maybe he’s one of those who would use the visibility of a posting in a reputable publication to lend credibility to an argument that is, at its heart, clearly designed to encourage hard-working Americans to pull their money out of the shelter and support of that 401(k) plan…

Regardless, it’s a non-sensical article that doesn’t make much sense for savers… or anyone else. 

- Nevin E. Adams, JD

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[i]Vanguard, How America Saves 2018 (DC plan participation), EBRI estimate based on 2014 IRS SOI tabulation (IRA-only participation).

6 Things That People Get Wrong About Retirement

Retirement planning can be a complicated process – and surveys suggest that most workers haven’t even attempted a guess. But even those who have can overlook some pretty significant factors that can have a dramatic impact on retirement readiness.

Here are some critical factors that are easy to get “wrong.”

The Cost of Inflation

Twenty or 30 years from now, prices are likely to be different than they are today, and for many, those prices will increase – and perhaps particularly costs of critical life aspects like health care. Consider that, overall, the average inflation rate for 2018 was 1.9%. It’s not that all prices will always go up – but they often do, and might increase faster than your income. Think of it as the “magic of compounding’s” evil twin…

There’s a calculator that you might find interesting at http://www.usinflationcalculator.com/.

The Cost of Taxes

A key part of the incentive for retirement saving in a 401(k) is the ability to postpone paying taxes on those salary deferrals. The operative word there is, of course, “postpone.” Sure enough, as those retirement savings are withdrawn in retirement, you can bet that Uncle Sam will be expecting his cut – and on a frequency dictated by the required minimum distribution schedules of the IRS.

In fact, every time I see one of those reports about the average 401(k) account balances of those in their 60s, I can’t help but think that somewhere between 15% and 30%, and perhaps more – won’t go toward financing retirement, but will instead go to Uncle Sam and his state and municiple counterparts.

After all, that’s one of those pre-retirement expenses that doesn’t end at retirement. And, while it may well be at lower rates than when it was deferred pre-tax – it may not be.

The Cost of Long-Term Care

Long-term care is one of those retirement cost variables that can be very complicated to predict – which perhaps explains why the vast majority of retirement needs projections models fail to take it into account (the Employee Benefit Research Institute’s being a notable exception). The data suggests that most of us will have some exposure to this risk – but also suggests that only a minority will get hit with a truly catastrophic bill against their retirement savings.

The question is, which group will you fall within? And can you afford to be wrong? 

What You’ll Get from Social Security

Ask any young worker today about their expectations regarding Social Security, and you’ll likely encounter a fair amount of skepticism; a recent Pew Research report notes that roughly half of Americans (48%) who are younger than 50 expect to receive no Social Security benefits when they retire. Indeed, according to the 2018 Retirement Confidence Survey published by the Employee Benefit Research Institute, today’s workers are almost half as likely to expect Social Security to be a major source of income in retirement (36%) as today’s retirees are to report that Social Security is currently a major source of income (67%).

As things stand today, Social Security’s future is far from certain, though even under a worst case scenario, retirees are likely looking at a reduction, rather than a cessation of benefits. That said, as things stand now, those who retire at full retirement age today would be looking at a maximum of….

When You’ll Retire

Perhaps the most important assumption is when you plan to quit working; today most Americans are doing so at 62, though 65 seems to be the most common assumption – and while using 70 (or later) will surely boost your projected outcomes (it both gives you more time to save, and reduces the time that you will be drawing down those savings), it may not be realistic for many individuals. The 2019 Retirement Confidence Survey found that more than 3 in 10 (34%) workers expect to retire at 70 or beyond or not at all, while only 6% of retirees report this was the case.

In fact, the RCS has consistently found that a large percentage of retirees leave the workforce earlier than planned (43% in the 2019 RCS). Many who retired earlier than planned did so because of a hardship, such as a health problem or disability (35%), and a similar number did so due to changes at their company (35%) – in other words, events not within their control, and likely not foreseeable (admittedly, 33% did so because they could afford to do so).

The bottom line: Even if you plan to work longer, the timing of your “retirement” may not be your choice.

How Long Your Retirement Will Last

Needless to say, the sooner your retirement starts, the longer it might last. But the length of retirement is also a function of what the academics refer to as “longevity,” and what regular people call “life.” 
Indeed, the good news we are living longer – but that means that retirements can last longer, and medical costs can run higher. And while we’re living longer, studies indicate that we tend to underestimate how much longer we will live. The Social Security Administration notes[i]that a man reaching age 65 today can expect to live, on average, until age 84; a woman turning age 65 today can expect to live, on average, until age 86.5.

But those are just averages; about one out of every three 65-year-olds today will live past age 90, and one in seven will live past age 95.

Though it’s also worth noting that the averages include a fair number of individuals who won’t make it that “far.”

Ultimately, of course, it’s not what you get wrong about life and retirement – it’s what, and how much, you get right.

 

- Nevin E. Adams, JD

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[i]The Social Security Administration has an online calculator that, based only on gender and birth date (and there are a lot of additional factors to consider), can provide a high-level estimate.

Compliance “Deportment”

Recently, the Internal Revenue Service (IRS) announced that it was sending a questionnaire out to about a thousand 401(k) plan sponsors. The IRS said it developed the questionnaire because of the “critical role 401(k) plans play in our private retirement system” (see “IRS Provides 401(k) Questionnaire Details”).

Make no mistake: It’s going to take some effort to respond to the questionnaire—and respond you must. Described as a “compliance check,” the IRS notes that “failure to complete the Questionnaire will result in further enforcement action.” So, what does the IRS want to know?

Well, there’s a lot of information to be gathered about the plan from plan years going back to 2006: the number of employees, participants, their deferral levels, eligibility standards, service and age requirements, the existence and administration of loans and hardship withdrawals, the results of nondiscrimination tests, the determination of top-heavy status, the level(s) of match, and any changes to those levels.

The more interesting part of the questionnaire, IMHO, is the other questions the IRS asks; things like, Have recent financial conditions led to an uptick in hardships and loans? Does the plan allow for Roth contributions (and how many participants have opted for that feature)? Can participants use a debit card to take a loan? And, for plans that embraced automatic enrollment, did they do so retroactively or prospectively? And I’m curious not only about what plan sponsors have to say about the impact of factors like age, compensation, matching levels, and plan communications on participation levels—but what the IRS might do with that information.

There are, however, some areas that seem a bit like a baited trap: questions about if notices are provided timely, if excess deferral contributions were returned within the legal timeframes, even if the respondent as a SIMPLE plan exceeded the contribution limits.

And, make no mistake, this is a prelude to something deeper. In unveiling the project, the IRS noted that its Employee Plans Examinations previously conducted a baseline study of 79 market segments, and “the findings indicated that 401(k) plans are by far the most non-compliant plan type in the retirement plan universe,” going on to note that “since these plans make up over 60% of the retirement plan universe, it is important to the future of the private retirement system that these plans maintain the highest level of compliance possible.”

What will the IRS do with the information? It says that it will “ultimately result in a report published by the IRS describing the responses and identifying those areas where additional education, guidance, and outreach is needed”—and, perhaps somewhat more ominously, help the IRS focus its enforcement efforts “to address and/or avoid non-compliance related to these plans.”

All in all, I wish the IRS questionnaire wasn’t quite so long, complicated, and—for lack of a better word—intimidating. For plan sponsors, I’m sure it’s going to wind up being one more thing that has to be done when they already don’t have enough hours in the day—and one that could serve to plant a big red flag on their plan, to boot.

Here’s hoping that some good comes out of it—that the IRS does indeed discover some areas in which they can help plan sponsors do a better job of keeping these important programs in compliance—and that, perhaps, it will find that the programs are in better shape than they seem to think they are.

—Nevin E. Adams, JD

More information is at http://www.irs.gov/retirement/article/0,,id=223440,00.html

A version of the online questionnaire is online HERE