Somehow, without any vote or national debate, the geeky little wrinkle in the tax code known as 401(k) has become our de facto national retirement policy, standing shoulder to shoulder with Social Security. As the first generation of workers brought up on 401(k)s is nearing retirement, it’s clear that so far, at least, the experiment is a failure. Now the 401(k) is about to undergo its next major test, and it’s on track to fail this one, too. But it doesn’t have to.
When you start to save money in a 401(k), you face a number of far-reaching decisions. When do you start putting money into your plan? How much? How do you invest? To date, employees as a whole have gotten all three answers wrong, starting too late, saving too little, and making elementary investment errors like putting too much into their employers’ stock or timing the market badly. The result is that the median 55- to 64-year-old is heading into the twilight of his or her career with what the Center for Retirement Research estimates is $67,000, total, in all retirement accounts. That’s what a retirement crisis looks like five to 10 years before it hits.
If you think it’s regrettable that the boomers flunked the accumulation phase of their 401(k)s, wait until they get to the drawdown phase. That starts at retirement, when workers are handed a lump sum of money and essentially told to figure out how to make it last the rest of their life. A retiree has to make the mirror image decisions he did as a saver — when to start withdrawing money, how much to take, how to invest — but has no margin of error. At 65 or 70, you can’t make up for market downturns, high inflation or bad investments by going back to work. You have only two options: spend less or die sooner.
Earlier this year, the Department of Labor asked for comments on how retiring 401(k) participants might be encouraged to spend some of their nest egg on an annuity. An annuity, as you know, is a kind of insurance contract that guarantees the purchaser a certain income for as long as the person lives. If 401(k) participants chose to put part of their accumulated money into an annuity, rather than taking it all as a lump sum, the feds reasoned, workers would make less of a shambles of the paydown phase of their 401(k) than they have of the accumulation phase.
Nearly 800 respondents weighed in on the fed’s request for comments. Most were strongly opposed. “The DOL was stunned at the opposition to their proposal,” says Mark Ugoretz, president of the Erisa Industry Committee, a lobby for corporate retirement plan sponsors. “I don’t think we’re ready for annuitization as a default in 401(k)s.” Industry participants made two key points:
But even as they complained about the burden of changing the rules, many in the industry admitted the benefits of offering retirees some guaranteed income plan. The big mutual fund company Vanguard appended a study of its own, showing that a retirement portfolio that included an annuity had a far better chance than a portfolio without one of meeting a retiree’s income needs through thousands of simulated market cycles. Morningstar, the mutual fund rating company, weighed in with a similar study showing that for many retirees, a portfolio with a related guaranteed income product offered far greater security through retirement than one without.
Strictly from a retiree’s standpoint, then, having the choice of some kind of guaranteed income plan makes sense. The objections that the industry raised aren’t insurmountable.
And then there’s the standpoint of us taxpayers. The 401(k) tax break costs $110 billion, according to Teresa Ghilarducci, Schwartz Professor for Economic Analysis at the New School. In return for that investment, we should expect more than we now stand to get: a generation of retirees separated into a few successful 401(k) jockeys on the one hand, and a great mass of clueless amateurs at risk of outliving their money on the other. To do better than that, we’re going to have to give more thought to the next phase of the 401(k) than we did to the first.
Reporter: Temma Ehrenfeld
Eric Schurenberg is Editorial Director of CBS MoneyWatch.com, the CBS Interactive Business Network.