The (401) Gamble

I  barely know a straight from a flush, but I won several hands at a friend’s poker party recently. After a couple of cosmopolitans, I howled at the moon, stacked up my handfuls of chips and cashed in. A measly 20 bucks was all I’d won. In my tipsy excitement, I’d lost sight of the fact that the white, red and blue chips were only nickels, dimes and quarters.

    That’s where we are today with 401(k) plans. Employers and workers are under the illusion that successful retirement planning is taking place, but in reality, it’s yielding penny-ante returns. When boomers start cashing in their chips, there will be howls indeed.

    In theory, employees are doing fine in the land of defined contribution–better than they would under a defined-benefit pension plan. According to investment simulations, workers in the 55-64 age bracket have a median of $289,073 in 401(k) retirement savings. But that is, after all, a Sim 401(k), and it bears as much relation to reality as the Sims video game does to your life.

    Retirement-age workers actually have amassed only $42,000 in their 401(k)s, according to Alicia H. Munnell, director of the Center for Retirement Research at Boston College. Munnell is co-author with Annika Sundén of a recently published book, Coming Up Short: The Challenge of 401(k) Plans.

    The problem is that 401(k)s are all about choices, and at every step of the process, employees make bad ones, Munnell says. “Roughly 25 percent don’t join the plan. Less than 10 percent contribute the maximum. Only half the people diversify their investments. The others put it all in stocks or all in bonds. A significant fraction overinvest in company stock.” Yes, even after Enron.

    And on and on, with behaviors all too familiar. More than half cash out their plans when they change jobs, despite all the chiding and chivying by employers and the IRS. They also take their money in a lump sum at retirement, and have no clue how to spend it. The stereotype is of giddy retirees blowing their money on canasta and cruises, but Munnell says they’re much more likely to under-spend. It’s the cat-food-and-toast syndrome, and I’ve seen it firsthand.

    Traditionally, the cure for all these very human lapses has been employee education. Munnell just groans at that. “I think that if I were queen, and wanted to make all employees into mini-investors, it would not be a good way to use our resources. They should go coach little league, or read a book, or go to church, but it won’t enrich our nation to have everyone learn to invest their portfolios. To be anti-education is such an abnormal thing, but I am.”

    Instead, Munnell and some economists and investment companies propose that employers put the power of human inertia to work. The tool is the “autopilot 401(k).” Vanguard calls its version One Step. MassMutual has a small piece of the puzzle in place with a new age-based asset-allocation option, the MM Destination Retirement Series.

    It works this way: Employers put workers into the 401(k) automatically. One study shows that doing so increases participation from 37 percent to 86 percent. They set a high contribution level. They set an immediately vested employer match. They make investment choices with an appropriate fund mix for an employee’s stage of life, and change it as the employee nears retirement. They automatically roll the money into an IRA if the employee leaves. They pay the retirement benefit as a joint-and-survivor inflation-indexed annuity. The employees can opt out or choose something different at any stage. But the law of human inertia indicates that they’ll just leave everything where it is, and then that $289,073 could be reality.

    This may sound like a throwback to company-knows-best days. So what? The alternative is having your offices haunted by “a bunch of 60- and 65-year-old employees who don’t have enough money to live on,” as Munnell says.

    The snag is fiduciary liability. And until the IRS and Department of Labor offer some protection, companies won’t run the risk of being sued. Munnell says that recent IRS and DOL decisions show they’re willing to stand behind prudent employer choices. “It’s all possible,” she says. It sure beats losing at 401(k) poker.

Workforce Management, June 2004, p. 10 — Subscribe Now!