Archive for the ‘Background’ Category

Why does retiring in “dignity” seem to be a problem for the current generation?

February 13, 2007

America’s new “Retirement Income” strategy since 1980 or so, based on phasing out DB pension plans in favor of DC 401(k) plans, is not working.

First, half of all workers are not even offered a retirement plan by their employer;

Second, of the half which are, one-third of the employees eligible to participate in a 401(k) plan decline to do so;

Third, most employees who do elect to participate contribute far too little far too late; and

Fourth, most employees who both participate and make material and timely contributions achieve dismal investment results.

Consequently, most employees (perhaps over 90%) are on track to retire in despair and run out of money before they run out of living.

While employee benefit gurus differ as to whether any one factor is the dominate cause of this PROBLEM, most agree that the following bundle of factors play the major role:

First: We are living much longer. In 1900, USA life expectancy was 47.3 years; by 2002 it had soared to 77.3 years – a 63% increase. And future increases in life expectancy may accelerate and dwarf this sharp increase. If retirement years exceed working years, what does such a demographic tsunami portend?

Second: A sea change occurred in corporate America’s retirement income strategy since ERISA became law in 1974 with Section 401(k) soon added in 1978; that is, from a DB pension plan “model” typically costing a company 6% to 8% of payroll to a DC 401(k) savings plan “model” generally costing a company 2% to 3% of payroll. When ERISA was enacted in 1974 companies made 89% of what was then a relatively higher total contribution to retirement plans; today they make just 49% of a lower total contribution, with employees now picking up the tab for this seemingly 40% company contribution reduction by means of a stealthy cost-shifting.

Third: Participants in 401(k) plans are achieving lousy annual investment returns. On November 3rd, 2003, John C. Bogle, founder and former CEO of the Vanguard Group and now President of the Bogle Financial Markets Research Center, addressed the United States Senate Governmental Affairs Subcommittee on Financial Management, the Budget, and International Security. Bogle testified that from 1984 to 2002 the overall stock market returned an average of 12.2% annually, mutual funds earned 9.3%, yet the average fund investor earned just 2.6%. This testimony is a must read, and is at

Fourth: The soaring cost of health care is “crowding out” budgets for retirement in America’s employee benefit garden, resulting in far too little being saved for retirement by both companies and employees over the past generation.

Fifth: ERISA has imposed a federal fiduciary duty and responsibility on corporate executives and directors who serve as “ERISA Fiduciaries” requiring them to act exclusively in the best interest of plan participants and beneficiaries. A growing chorus of benefit industry gurus believe that such executives and directors had a pre-existing fiduciary duty and responsibility to the owners of the business. Query: has Congress unintentionally crafted an incurable conflict of interest? That is, can any person faithfully serve two masters? Plan participants may believe they are safe, as fiduciary oversight is mandated by ERISA, but increasingly this appears to be a watchdog that doesn’t bark. And fiduciaries created by ERISA may now sleep well at night, but as the plaintiff’s bar comes to fully understand the failure of these fiduciaries to measure up to even simple responsibilities (like knowing a Plan’s true fees and expenses) fitful nightmares may soon dominate dark times.

Sixth: Since the early eighties there has been a seismic shift in how vital retirement decisions are made, from experienced professional and institutional providers engaged by an employer in DB plans, to the workers themselves (i.e., mostly financial novices) in DC plans. One result is that several strains of an insidious “yield disparity” financial cancer have been detected but ignored. Furthermore, the qualitative change from a DB to a DC paradigm has also shifted inflation, market, and all similar financial and economic risks from the employer to the (novice) worker. Students of history weep at the thought.

Seventh: Middle class lifestyle expectations have rapidly accelerated, and have also tended to “crowd out” (that is, along with soaring health care costs) a worker’s ability, even willingness, to save for retirement. One example is that the country’s savings rate in 2005 and 2006 – that is, the percentage of household income that consumers don’t spend – slipped to a minus 0.5% in 2005, making it the third-worst savings rate in U.S. history. But then is slipped even further to a minus 1.0% in 2006! A negative saving rate has happened only twice before: in 1932 when the savings rate was a minus 0.9%, and again in 1933 when the savings rate was a minus 1.5%. One explanation offered: consumer spending for today’s “essential luxuries” (IPods; flat panel HDTV; et cetera) has significantly diminished a worker’s mental disposition to save for tomorrow’s “essential necessities” (like food et cetera) which retirement income will have to provide.

The various CAUSES of our PROBLEM include exploding life expectancy; a stealthy 40% cost shifting from employers to employees; lousy investment returns; soaring health care costs; fiduciary watchdogs which don’t bark (especially regarding excessive [and often legally hidden] plan fees and expenses); decisions now made by novice workers instead of pension professionals; and a national negative savings rate driven by the exuberant and irrational purchase of “essential luxuries” which have overwhelmed an employee’s motivation to prudently save for retirement.

Will this set of causes combine to spell doom for America’s current “Retirement Income” strategy which has been built upon a 401(k) plan foundation?


Reinventing Retirement Income in America

February 12, 2007

The initial purpose of this blog is to encourage an honest dialog between 401(k) Plan Participants regarding a very simple issue – i.e., whether or not they will be able to retire in dignity! While this issue can evolve into a Rubik’s cube of extremely complex issues bridging many disciplines, the intent here is to focus on fundamental simplicity, not rocket science. The following “Executive Summary” of an N.C.P.A. Policy Report #248 illustrates a few of the key issues.


Reinventing Retirement Income in America
by Brooks Hamilton and Scott Burns

NCPA Policy Report No. 248
December 2001
ISBN #1-56808-112-X
National Center for Policy Analysis
Web site:

Executive Summary

Traditional defined benefit pension plans, which are managed by employers and which promise workers a specific monthly payment on retirement, are disappearing. Instead, more than 42 million workers now participate in defined contribution retirement plans, primarily 401(k) plans, which specify the annual contributions to an employee’s pension fund.

A worker’s contributions to these plans, the employer’s vested match, and any interest or dividends reinvested in the plan are the worker’s property. Workers are responsible for choosing among investment options, and the account can be moved when the worker changes jobs and can be passed on to heirs.

As now constituted, however, defined contribution plans are performing poorly. The consulting firm Watson Wyatt found that among 503 employers sponsoring both a 401(k) plan and a defined benefit plan uring 1990-95, the defined benefit plans averaged an annual return that was 1.9 percentage points better than the 401(k) plans.

Even the 401(k) plans sponsored by firms in the financial services industry have often had below-average returns. An examination of plans sponsored by five leading financial services firms reveals that from 1995 through 1998, none had returns that matched a simple index of 60 percent stocks and 40 percent bonds.

Although these companies offer investment advice to the public, the investment choices made by their own employees underperformed the market index by 3.2 to 10.5 percentage points.

Companies offer little assistance in making wise investment choices, fearing they will open themselves to lawsuits charging them with responsibility if employees have investment losses. Many employees with limited understanding of investing make uninformed investments that reduce their retirement income.

For example, in examining a number of large plans we found:

Regardless of years studied or geographical location, the lowest-paid 20 percent of Participants receive the worst returns and the higher the participants’ average pay, the higher their returns.
 Almost two-thirds of the money in the lowest-income quintile was in a money market fund or bonds.

 By contrast, about 85 percent of the money in the highest-income quintile was in equities.

If designed properly, defined contribution retirement plans offer the best hope for a comfortable retirement for most workers. The changes that are needed are both politically and economically achievable.

To remedy the flaws, this study proposes that employers be encouraged to offer a new type of plan – the American Freedom 401(k) plan. In exchange, employers would enjoy “safe harbor” protection from certain kinds of lawsuits. To take advantage of the American Freedom 401(k) plan, employers would have to:

1. Give participants the opportunity to have their funds invested in efficient portfolios (e.g., market index funds) or in portfolios managed by investment professionals.

2. Automatically enroll all employees (both new and current) unless they opt out. Also, set a minimum contribution rate of 4 percent to 6 percent of income by the participant, that is, an amount that could prudently be expected, when combined with the employer contribution, to provide a reasonable retirement income — unless the employee specifically opts for a smaller amount.

3. Require plan sponsors to pay all plan fees and expenses, and to disclose them fully.

4. Prohibit cashouts of 401(k) accounts by the plan or the employee following termination of employment and allow all funds to be rolled over into another qualified plan or to remain in the previous employer’s plan if the new employer does not have a plan.

5. Make evsting 100 percent and immediate.

6. Prohibit loans or hardship distributions from an individual account but allow “hardship loans” from the plan’s trust fund.

The American Freedom 401(k) plan would maintain the advantages of defined contribution plans, while producing higher returns and encouraging more saving for retirement.


Future postings will discuss more fully these as well as other issues.