Today we are discussing one of our favorite financial products…the 401k. We really wish you could see the red hot glow of the sarcasm light in our studio.
If you've been listening to the Financial Procast for any length of time, you will surely be familiar with our disdain for the 401k. It's not necessarily that we think the product or idea is bad, we just think there's been way too much emphasis placed on it as a tool to solve the retirement income woes of America.
Those who think the 401k will save them from the meow mix diet during retirement are surely destined to be disappointed. We have witnessed firsthand the problems that are created by having too much of your liquid net-worth invested in qualified plans of any kind.
But today, we're not even going down that road. No, we've stumbled upon some recent research that was released by ,Haig Nalbantian, a labor and organizational economist and senior partner at one of the Mercer companies, and that uncovered one of the unintended consequences of people relying solely on 401ks to fund their retirement. In other words, the effect of having to depend on a bucket of money that you accumulate from your own savings versus being able to rely on a guaranteed pension from your employer.
The research showed that when you have a 401k plan that has replaced your traditional pension plan, your employees tend not to save as responsibly as they should. Which means the employees are not all that eager to quit working at the traditional retirement age.
Why? Because they can't afford to retire–they don't have enough money.
These people essentially retire at work. They are physically at work but the rest of them has already retired.
According to research, the average retirement age of employees who have a pension is 60 and the average retirement age for those who only have a 401k is 64. In other words, it would seem that those with only a 401k are having to work until they can draw social security income.
The problem this creates is that this has begun a cycle of people staying in the workforce that aren't terribly productive anymore. And it prevents employers from promoting and retaining younger, talented and more productive employees.
But is this just another example of us all whining about something that's not really a problem? We've (Brandon and Brantley) talked many times in the past about how the real answer to America's retirement “crisis” is for people to stop retiring so early. With increased life expectancies comes the need for extended productivity.
Should we just re-institute pensions to get rid of people–force them to retire?
Pensions would certainly solve myriad problems in our country. However, that's a solution that has no teeth. The Genie is out of the bottle and there's no way companies are going back to offering defined benefit pensions. The expense is unrealistic for most companies.
Two other problems
So we touched on it a little bit earlier in this post but another unintended consequence is that when younger employees don't get promoted as fast as they think they should, they move on. And that gets expensive in a couple different ways:
1. Health insurance premium costs go up as the group is now comprised of older people who generally spend a good bit more on healthcare and prescriptions.
2. Employee turnover is expensive. Most employers say that it takes them at least 2 years to get an employee's productivity to at least a break even on the cost of employment. The goal of all employers is that have an employee's value exceed their cost–that is fundamental. Otherwise, why keep them around.
But could the pension be brought back?
I actually think it could but with some major modifications:
1. We can't use unrealistic assumptions for the rate-of-return to calculate how much money should be put into a plan to produce x amount of income in the future. In the past, many pensions used something like an 8% assumed rate to calculate funding–this proved to be very bad.
2. People are just going to have to work longer. You can't work for 25 years and then draw income for a pension for 40 years. That sort of system is not sustainable and anyone what can do basic math can figure that one out.
One last thing to add is that you can definitely build your own pension. I encourage you to read a post that I wrote a couple of years ago that will show you how to do it.
And if this is something you'd like to do for yourself, please get in touch with us.