Suggested 401k Reform

The following is an excerpt from America, Welcome to the Poorhouse: What You Must Do to Protect Your Financial Future and the Reform We Need, courtesy of FT Press, imprint of Pearson. Originally published in "America, Welcome to the Poorhouse." I don't agree with everything that's written in this book (you'll be able to see pretty clearly where we differ -- on many points in this particular piece), but I thought that this excerpt would certainly get the conversaion going. Hold on to your hats!!!!!

The bad news is that currently most Americans can’t afford to retire from a 401(k) plan. The good news is that there is a new administration in the White House and President Obama seems to understand that most Americans are under severe financial stress. On January 30, 2009, he announced the initiation of a Middle Class Task Force, headed up by Vice President Joe Biden, to address the financial stress facing most Americans, with its five goals including “protecting retirement security.” We need to communicate to Vice President Biden that the task before us isn’t simply “protecting retirement security” but to boost retirement savings so that people can actually afford to retire.

The reform that we need:

401(k) Security Act: “The 9% Solution”

1. Coverage mandate. Every employer with ten or more employees who doesn’t offer a regular pension plan—or whose plan is frozen to new hires—must offer a 401(k) plan and contribute the equivalent of 9% of pay as of 2010. If the 9% contribution rate is challenging in these recessionary times, then we should take a phase-in approach similar to Australia’s: start at 5% in 2010, increasing to 7% in 2016 and 9% by 2020.

2. Employees working in companies with fewer than ten employees would be enrolled in a Universal 401(k) featuring a government contribution. A new entity, a clearinghouse akin to the Federal Thrift Savings Plan (TSP), which manages very low-cost 401(k)-style accounts for three million federal military and civilian personnel, would receive all deposits.

3. Get rid of the low ceiling on 401(k) contributions: The limits are $16,500 for those under age 50, $22,000 for those over age 50 in 2009, indexed to inflation. It makes absolutely no sense to limit how much people can contribute, especially since most of us will have to contribute more to make up for lost time. Baby Boomer Australians can sell a home or another asset and add the proceeds to their accounts; workers over age 60 can make after-tax superannuation contributions of $150,000 a year, or $450,000 over three years.

4. Disclose the necessary employee contribution “co-pay.” Participants must be informed what their contribution rate should be depending on their age when they start to save, based on the new requirements. For example, even with the implementation of the new contribution equal to 9% of salary by employers, individuals who start contributing to their accounts at age 25 need to know they should contribute an additional 4%, another 7% if they start at age 30, another 11.25% at age 35, another 17.25% at age 40, and another 42% at age 50.

5. Employer contributions must start when the employee joins the company, not after one year. Twenty percent of employers surveyed by Vanguard require eligible employees to have one year of service before the employers match contributions to “minimize compensation costs.” This practice could deprive someone who changed jobs every four years of a total of 11 years of investment returns, causing a huge hit to the nest egg.

6. All employer contributions must be in cash, not company stock. As was the case with Enron employees, a stock match carries the risk that the contribution will be worthless if the company goes out of business. While the Pension Protection Act has required employers to allow employees with company stock in the plan to gradually diversify out of it, a recent Vanguard study of its clients showed that 8% of employees had more than 80% of their account balances in company stock, revealing a lack of understanding of the risks of not diversifying.

7. All employers must offer a Roth 401(k) option and the ability to transfer current balances to a Roth account.

8. Get rid of discrimination testing: If highly paid people have waited too long to start saving, they should have the opportunity to save.

9. Prohibit access to retiree balances until retirement: At the same time we want employers to contribute more to nest eggs, we want to limit opportunities for employees to “shoot themselves in the foot” by tapping into vested balances before it’s time to retire. There should be no loans, hardship withdrawals, or ability to “cash out” when changing jobs. Nearly half of job changers surveyed by Hewitt Associates cashed out of their retirement plans rather than leaving the balances in the old plan or “rolling them over” to an IRA or new plan.

10. All plans must include an index fund option.

11. All plans must include a target fund option, which gradually shifts from stocks to fixed income investments as the participants get closer to retirement. This should also be the “default” investment if the employee prefers not to choose an investment. Otherwise a participant may make an unwise decision to have a too high allocation in stocks or fixed income investments depending on his or her investment time horizon.

12. Employers must communicate to workers that they cannot afford to retire unless they have accumulated 10 times their salary in their accounts.

13. Workers who have accumulated enough should be encouraged to invest in a managed payout account rather than an annuity.

Action Plan: First, we need to send a message to Vice President Biden, who heads up the Middle Class Task Force, that the fix that’s needed is not simply automatically enrolling Americans in 401(k) plans or IRAs. Americans must deliver the message that only if employers are forced to kick in higher contributions will most folks be able to afford to retire. Along with contacting your own congressperson, go to the contact page on the White House website (http:/ /www. whitehouse. gov/ contact/) and submit an email asking Vice President Biden to support the Security Act mandating 9% employer contributions to 401(k) accounts. Here is the URL to the page on my company’s website that describes the proposed legislation that can be cut and pasted into your email: http:/ / www. retirement-solutions. us/ 401k-nightmare. htm.

Second, contact Rep. George Miller (D-CA), who is chairman of the Health, Education and Labor Committee, which oversees pensions, to seek his support: http:/ /georgemiller. house. gov/ contactus/ 2007/ 08post_1. html.

Third, we also need to send a message to AARP that the advocacy group for retirees needs to do more for would-be retirees who are currently can’t-be retirees. When I spoke with a spokesperson for AARP about the retirement crisis, he said that AARP has not been actively involved with retirement security because there hasn’t been a hue and cry from the general population. The spokesperson said that to date they have explored “ways in which we can expand access...such as the automatic IRA. We have promoted auto-enrollment. Adequacy is a tougher nut to crack.”

Sorry, AARP, as I pointed out in the first chapter, automatically enrolling people in an inadequate savings scheme, whether an automatic IRA or a 401(k), is like giving a cancer patient aspirin instead of chemotherapy. We need to send a “hue and cry” to AARP that if Australians can “crack tough nuts,” we need to as well. Contact AARP at http:/ /www. aarp. org/ about_aarp/ contact/ a2003-01-28-contact-issuesform. html and urge them to support my Security Act.

Finally, contact a new organization called Retirement USA that supports retirement reform and is looking for input. While the organization appears to have bought into Ghilarducci’s flawed assumption that 401(k) plans are risky, it does favor considering Australia’s superannuation system. I urge you contact them at [email protected] and ask them to consider my proposed legislation.

Comments

[Mark B.]

I love this piece, simple solutions to complex problems. You have to make these things mandatory if you ever want them to be adopted across the board. This is a much better solution than having to support everyone in retirement.

I can already see the other side of the argument saying "government can't tell me what to do". These are the same folks that oppose a workplace smoking ban that has been proven to save lives, etc. There seems to be a growing base of people in this country that would say "NO" to anything the government does, even if it makes perfect sense.

[rdub98]

If we mandate 9% by employers, you will see salaries plummet and small businesses going out of business left and right. I do believe in some sort of mandatory contribution, but a more gradual contribution percentage (even more gradual than he mentioned, but more robust than the federal minimum wage increases).

[garyatk]

There is very little that the government does that makes perfect sense. Especially if you consider the limited government idea of our founding fathers for this country. But since we have abandoned that thinking 150 years ago, I can't help but agree with the concept that was mentioned in this article. The only addition to the idea is that since every dollar that we are forced to pay into the bankrupt Social Security mistake, maybe we should divert all of that money, including our employers portion into these private accounts. Then the government should take a good hard look at their spending and prioritze it like we have to at home, and support our retirees Social Security obligation instead of all the money we spend overseas.

OK, I am a dreamer!

[Patrick]

Thankful, the gov't is going to step in and help us. I can't budget for food - can they force me to contribute a percentage to a food fund and then reload my food card that can be used to by groceries each month? Same for clothes, utilites, etc. I can't afford a new car or a house - how about giving me $4500 and $8000 so I can get started going into debt.

[Andy]

While many of these are financially sound ideas, I do not want the government determining what I do with my money and when I do it. What's next, they take out 3% of my pay and give it to me only to be spent on food? Then 5% to be spent on gas and automobile costs? How about we start offering classes in middle schools and high schools that teach real life math lessons. I remember learning how to prove certain theories in geometry, but never was I taught about compound interest or amortization or basics of investing. Probably because most of my teachers didn't understand those concepts either. More government control is not the answer. It is an answer, but it is not the right answer. If people can't learn to control their own finances, they deserve poverty. It's not that hard, but this article assumes that people are too stupid to fend for themselves. As an intelligent person, I can't live with a government that does my thinking for me.

[David]

Hopefully the government can step up and create my entire budget for me also. While they are at, they can follow me to the store to make sure I don't buy something I don't need.

The message we need to send to the government is to stay out of our affairs. We need to learn to accept responsibility for ourselves.

[Mark B.]

Each of you makes a good point about responsibility by the individual. However, the problem occurs when people that don't save end up old, disabled, unable to work, and with zero dollars. Then we are forced to support them with our tax dollars.

If we force them to save, then when they get old they can be supported by their dollars, not ours.

[Tyler]

The government is locked in a battle against deflation right now... pretty sure there is minimal support for anything that forces savings.

[Apex]

Don't worry people. Nothing on this list is going to get implemented.

401k's generally work well, are broadly accepted and implemented across the country and while most people probably are under contributing they are doing ok in them.

Could they be improved? sure.

Are the things on this list a good idea? Some probably are.

Are they going to pass laws to mandate these kinds of changes. No way. Now how. Changing things in government takes a lot of time and effort. Any big change requires huge momentum, a very dedicated populace, a belief by huge majorities that something must change, and then agreement by a large swatch of legislators on what that change should look like.

None of those things are remotely in place concerning 401k's and people's retirement money. There is zero momentum behind doing something about 401k accounts. Who even talks about that topic. Poll Americans and give them a list of 100 things the government should be working on fixing and I guarantee 401k's comes in in the bottom 5 every single time no matter what you put on that list. No one thinks we have a 401k crisis. So not only do we not have consensus on a solution, we don't even have minimal awareness of any supposed problem.

This is a dead issue and a waste of a topic unless you are interested in hypothetical things like the fairy dust of abolishing income tax and switching to a national consumption tax. Sure it might be fun to talk about it but don't pretend there is any chance of anything happening, cause there is not. This is simply not a problem in any real important sense compared to many other much more real issues.

[Todd]

Am I missing something? Isn't the mandatory 9% from the employer going to come from the employee in the form of lower salary? I know this was posted earlier but the article seems to ignore this fact. This is my main point of contention. Mark B. though makes an excellent point of why the contribution should be mandatory.

I agree with the ending or at least raising of the contribution cap. That sounds like a plan.

I don't know. This is where my freedom ideas get squashed. The idea of the government telling me how much to save or dictating these terms to employers makes me sick but then again Mark B.'s point of the person who does not contribute and then we have to support for their current stupidity.

[Ross]

#9 Scares the shit out of me... what if it makes more sense for me to tap my money from 401(k) rather than lose my house? Am I really that big of an idiot, I can't have the freedom to decide what to do with the money I worked for?

[TMS]

"Get rid of discrimination testing: If highly paid people have waited too long to start saving, they should have the opportunity to save."

Now I know what it's called and why legally I can't put more than about 4% of my salary in my company's 401K.

[Mile High Todd]

Amen to David and Andy (forced budgeting for food?). This is the worst idea I have ever seen. Next, the government is going force me and my employer to each pay 7.65% of my pay to a governmment fund that is going to provide me a guaranteed retirement. First, the promise will be made (Wink Wink) that those distributions, when I retire, will be tax free. Oh wait, change of mind, let's gradually increase the tax to up to 70% of the distributions...

In Washington, politics comes first and everything else comes second. Everything! That includes my life, liberty, and pursuit of happiness. That is why I personally stopped making contributions to a Roth IRA account. I just don't believe the government will ever let those distributions go tax free. I know some will say that a politician wouldn't do that to a group that votes, but I strongly disagree. If the government is in enough trouble ($11 trillion deficit and growing) then don't be surprised when they stop at nothing to generate the necessary taxes to keep the government afloat.

Socialism is one step closer to communism.

[Terry]

HAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHA!

As if minimum wage employers are going to cough up an additional 9 percent.

Who dreams up this stuff?

[Terry]

Todd -

Not if the employee is paid minimum wage! No room to cut wages! Employment will be cut instead.

Who dreams up this stuff?

[Terry]

Mark B -

I earn minimum wage. How much do you expect me to save?

[LeanLifeCoach]

In general the theory sounds interesting. Unfortunately many businesses today are already operating with a 1-2% net profit margin. With 50% of expense going to payroll and taxes they would be forced to reduce salaries or increase prices... Just another form of tax to fund a quasi-government run entitlement program.

I'll be the first to stand up and say our population needs help, but do we give them a fish or teach them how to fish?

Our government can't even handle their own finances, when they can I will be more open to listening to what they think we should do with ours.

[Financial Samurai]

There's a simple solution, RAISE pre-tax contribution limits to $50,000!

How on earth are we supposed to live off $16,500/yr for 30 years when we retire?

We don't.

[Rob]

They are killing the middle class in every way possible with increased taxes and then they create a "Middle Class Task Force". The public really needs to wake up and see how we are being fleeced in so many ways.

[Julie]

And do what, Rob?

[JimL]

While we might not all agree on the various points, it is good to discuss possible solutions. I am all for situations in which we try to encourage savings.

[kitty]

rdub98 and Todd and others who mentioned that employers will need to cut wages or employment are absolutely right. 9% have to come from somewhere since as far as I know none of the businesses has access to the printing press. This means both lower salaries and fewer jobs. Some small businesses probably wouldn't be able to afford it at all and may go under.

I would say that stable value should be a required part of any plan. Whatever "experts" think - based on past history - it's still person's choice to be "too conservative" or not and when. There has to be a fixed income option and nope, bond funds aren't enough as their value fluctuates as well - they carry both credit risk and interest rate risk. If someone has a low risk tolerance and just cannot sleep at night having any money in stocks or just doesn't want to be in stocks in specific time - e.g. smart people who moved money to stable value a couple of years ago, it is this person's right not to risk any money. So yes, index funds should be part of it, international funds, but so should be stable value. Whether financial analysts agree with it or not. Really, if a small company cannot provide nice set of options, this company should simply allow brokerage account for 401K.

I don't like any required contribution. Nobody said that 401K or IRA is the only way to save for retirement. As long as you don't spend your after tax investments, they will still be there when you retire. Half of my money is in taxable accounts. Whether this money is labelled specifically "for retirement" or not, I can still use it in retirement. And nobody really knows what the taxes will be in the future. If someone feels for whatever reason that his taxes may be higher in retirement or if a particular 401K doesn't have good choice, it's entirely person's choice. Also, there can be a period of time in anybody's life when they simply don't have extra money - e.g. illness in a family.

As to allowing to contribute more e.g. 50K. As much as I'd love to remove even more of my income from taxes - especially in the year like this one when I have capital gains, this would cause a huge outcry. Anybody who can afford to contribute 50K has a fairly high salary. There are already posts and articles on how 401K is a way for "rich" to shelter money from taxes. Imagine the kind of class warfare a limit of 50K would create.

[Kira]

Kitty - not true at all. There are many people who could contribute 50K per year because they live on considerably less than they earn (odd idea, I know.) 50K into the 401K per year is about 35K after tax money. Paying cash for your cars, zero credit card payments, and a house that you could easily afford on a single income (of a couple) puts many people into this category.
I agree with most of the comments here that this is a VERY bad idea, and will kill small businesses. For every rule you put in to punish those big bad corporations, there is an equal backlash to the small business owner down the street that you happen to like.
Big brother should have taken the time to educate us on personal finances when we were in school, not treat us like small children as adults. Any mandatory retirement program will just end up like Social In-Security - a joke!

[FMF]

Terry --

The next comment you leave along the lines of "I make minimum wage, so what can I do?", I will ban you from the site. You've left too many of the same comments over and over on this blog. We get it, move on.

[lincmercguy]

Pretty simple that if employers are forced to make a 9% contribution to the 401k, then everyone's salary will simply be cut by 9%.

The only one I agree with would be eliminating the ceiling for contribution. I don't think we have a severe problem of letting people save too much in this country, so why not let those who want to save a bunch, do so.

[imelda]

This is a fantastic proposal. I'm amazed at all of the BS arguments against benefits that people buy into. Mandated contributions to 401Ks will cause businesses to lower salaries or fire staff? Can you explain to me, then, why pensions disappeared in the 80s while median wages, adjusted for inflation, have barely gone up at all?

The same old arguments are trotted out when any reform is proposed that would protect workers. 'If we impose a minimum wage, all the small businesses will fold!' 'If we abolish slavery, the US economy will collapse!' Give me a break. Yes, it's true, some companies will go out of business. Some people will lose jobs. But eventually better-managed companies able to balance costs will pop up, everyone will get a new job, and they'll actually be decently compensated and able to survive in old age this time around.

Why people in this country consistently believe that it's more important to protect companies than individuals is beyond me.

[Santos]

Mark B.

I rather pay to feed the part of the population that could not or would not contribute to their retirement than to have the government take more of our freedom.

It is unbelievable to me how so many people look to the govermnent for everything. Government should stick to defense and infrastructure. Going beyond that is stepping in areas for which the govenment has proven to be utterly incompetent.

[Santos]

Imelda

"Mandated contributions to 401Ks will cause businesses to lower salaries or fire staff? Can you explain to me, then, why pensions disappeared in the 80s while median wages, adjusted for inflation, have barely gone up at all?"

Let me help you out ;-) Companies are in the business of making money. You do that by serving a need. Employment is a by-product of serving that need effectively. Salaries is an expense for the company and reducing any expense helps the business make money. If the government artificially increases the cost of hiring people through mandates the companies will almost certainly take that into account when determinig the salary of employees (i.e. will decrease their salaries). This may not happen over night but it WILL happen if the company wants to stay competitive (i.e. make as much money as the competition).

But this logic does not work in the other direction. For example, if the government GIVES money to a company (e.g. the bailouts) the company does not all of the sudden start paying more to its employees. This explains why a company can eliminate the pension and still pay the same to its employees (this assumes the employees can't go somewhere else).

I hope this clears your confusion.

[holly]

I am going to get really really crazy and buck the trend here of hammering out the details. I personally think that right now in the U.S. there is a large percent of the population not utilizing their offered 401k plans to maximize their retirement accounts. I can't imagine that the government has devised an intensely intelligent plan that will secure every american with optimal retirement salaries - we would all be rendered quite dumb and ill prepared.

They should identify a plan that works for both the employers and the employees prior to mandating change. The more small businesses we squeeze dry the less opportunities for employment we have.

The proposed changes would most likely have a very negative impact on employers and a negative impact on employees. I am a huge supporter of the old way of thinking - keep it simple stupid - just maybe as a nation we need to do a better job of knowledge sharing and discussing different/alternative options for retirement planning. If a company does or doesn't offer a corporate managed 401k then it is well within each and everyones right to go outside of the employer and take advantage of other investment and saving plans.

Mandating corporations to donate to your personal retirement is quite rediculous. I think it's a terrific perk, but in no way shape or form should it be considered a right. If that is what you seek from an employer than you should seek an employer that offers a company match as a benefit. If your company doesn't currently offer a wide range of options then you have the option of opening your own personal brokerage account or combination with Roth IRA. Everyone has different needs and living requirements and everyone should save and plan for their individual/family retirements. It would not be an effective use of the company cash flow to stuff money into retirement plans for individuals that have no interest or for individuals who personally want to save far above and beyond.

This day and age we live in, with limitless possibilities - we should all be seeking unique ways to achieve our personal goals, we do not live in the era of pension plans and 30 yr. careers. We live in the era of roth iras, 401ks, fast moving, always changing economic and market conditions and we should all be seeking new ways to utilize the tools we already have available. I think that the cap on 401k should be eliminated. I also think that any employees not contributing should be questioned - maybe those employees would like to give up their right to someone who does have an interest but no access......

my two cents.