Retire2Enjoy : Teresa Ghilarducci on the 401(k), View from the GAO Amidst Economic Meltdown

The 401(k): The Error of Its Ways

Critics of 401(k) accounts as an approach to financing retirement don't mince their words.

"Clearly, the system is not working and in my view is a national disgrace," says Dan Solin, author of The Smartest Retirement Book You'll Ever Read. Teresa Ghilarducci, an economics professor at New York's New School for Social Research, notes that "The 401(k) system was created as a minor footnote in the tax code — not a major piece of financial security.

"It was never intended to be the second layer for retirement savings on top of Social Security," says Ghilarducci, who's also an adviser to the United Auto Workers retiree medical plan. "It needs to be drastically reformed."

Nancy Hwa has some news for you. "It was a tax shelter for end-of-the-year bonuses for bankers," says Hwa, spokeswoman for Retirement USA, a group working to improve retirement plans. "The 401(k) was never even intended to be a retirement plan."

"Given the way 401(k)s are structured, they're fundamentally flawed for most people," says spokeswoman Nancy Hwa. "If that's their only retirement savings vehicle, most people will not be able to save enough for retirement."

"The 401(k) system looks good on a spreadsheet when you assume that you save only for retirement and do it for your whole career, but real life isn't a spreadsheet," says Ghilarducci. "There's not any other country that has relied on a voluntary system of retirement savings. The 30-year experiment with do-it-yourself pensions is a failure."

"You have to figure out how much you should be saving and have a financial goal," says Bill Schultheis, author of The New Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get on with Your Life. "You're asking too much of investors to figure out how much money they need in retirement when they're 25, 35 or 45. I am an adamant believer that the 401(k) is going to be one of the biggest debacles in our history."

401(k): The Demise in Real Terms

By the end of last year, the average 401(k) balance dropped to $57,200, down 28 percent from $79,600 in 2007, according to consulting firm Hewitt Associates. Forty-four percent of workers lost at least 30 percent.

At the same time, more than 200 employers — including all of Detroit's Big Three automakers — cut matching contributions to more than 700,000 workers in 401(k) plans since 2007, while any of the 14.9 million unemployed workers who had 401(k) plans when they lost their jobs also lost their ability to continue investing in those retirement accounts.

Has the 401(k) Ever Been Suitable?

Even before the financial meltdown, financial planners, retirement advisers and public policy experts were citing proof that when it came to providing for any kind of meaningful retirement nest egg, 401(k)s and similar accounts weren't working.

At the end of 2006, with the Dow Jones index above 12,000 and booming toward its 14,165 peak the next October, half of private-sector workers in 401(k) plans had account balances of less than $25,000.

Half of the workers with less than 10 years to go before hitting the traditional retirement age at 65 had nest eggs of less than $40,000. Over the course of a typical 20-year retirement, that would yield $204 a month, before taxes, all this before the stock market crashed.

Teresa Ghilarducci Recommends

Teresa Ghilarducci, Economics Professor at New York’s School for Social Research, feels the 401(k) “needs to be drastically reformed."

The first change she wants is an expansion of a mandatory retirement savings and investment plan that covers all U.S. workers. Right now, only about 51 percent of all workers qualify for 401(k) and similar defined contribution accounts.

Ghilarducci has proposed a nationwide system of guaranteed retirement accounts (GRAs) before Congress. Workers would be required to save 5 percent of their salaries. The federal government would then guarantee a 3 percent return annually, after inflation,  with subsidies to low-wage workers. The plan would not eliminate 401(k) plans, but would be financed by lowering tax breaks on retirement accounts to a $5,000 annual limit.

"A total of $110 billion is spent in terms of tax breaks,” Ghilarducci points out, “and 76 percent goes to the top 20 percent of taxpayers. That's probably not where we want to spend our billions for retirement security."

GA0 Report on Retirement Savings

A forthcoming federal report on retirement savings recommends easing a penalty for hardship withdrawals from 401(k) plans and that workers receive better education about the consequences of such decisions.

The Government Accountability Office report, slated for release Friday, suggests ways for Congress and federal agencies to reduce the long-term impact of early withdrawals, or "leakage," from retirement plans.

The GAO study says Congress should consider changing a rule that prohibits 401(k) participants from making additional contributions for six months after a hardship withdrawal. The suspension also includes employer matches. The requirement, the GAO report said, may in fact make the leakage problem worse "by barring otherwise able participants from contributing to their accounts."

In addition, the GAO said the Labor Department should encourage employers to give workers "understandable and useful information" about the adverse long-term consequences from hardship withdrawals, loans and cash-outs.

An additional feature of the recommendations would enable participants to view projections of their account balances when left in a tax-deferred portfolio versus the results if they cashed out.

The Economic Meltdown

In last year's financial meltdown, millions of Americans saw their savings wither, just as they were eyeing retirement.

The decline in 401(k)s and other investment accounts will force many of retirement age to make difficult choices. Some will work longer than they expected. Others will forgo about buying a second home in retirement or traveling as much as they had planned.

The crash and its effect on baby boomers highlight the risks that came with the revolution in how people finance their retirement.

For decades, a company pension was the key to the good life. With a defined-benefit pension, workers contribute nothing and receive a guaranteed monthly payment, or a lump sum at the start of retirement. Since 1980, pensions have been gradually replaced by 401(k)s. These are tax-deferred savings plans in which workers, and sometimes employers, make contributions and the retirement payoff depends how well the money was invested.

The number of families with only a company-provided pension fell from 40 percent to 17 percent from 1992 to 2007, according to one study. Those with a 401(k)-type savings plan reached nearly 80 percent from 32 percent.

"We've moved so much of the burden of saving onto the individual worker," says Blaine Aikin, CEO of Fiduciary360, which offers advice on overseeing retirement plans. "We also expect them to be able to manage it in a situation where even the professionals were baffled."

How Much Did Pre-Retirees Lose in the Economic Meltdown of 2008/2009?

People between the ages of 55 and 64 saw 20 percent of their retirement savings evaporate during the meltdown, though a six-month rally in the stock market and continued contributions have restored much of that. Still, the average 401(k) account balance for this age group was down 2.6 percent on Sept. 1 from the same date a year ago.

How May Lost Assets Best Be Restored?

The question for many is how to restore some of the losses. A study by asset management firm T.Rowe Price indicates that a person with a salary of $100,000 can increase retirement income from investments by as much as 28 percent by postponing retirement from 62 to 65.

Another option to increase retirement income is to delay claiming Social Security benefits. Each year you keep working, the monthly check would increase by about 8 percent.

Adjust your investments the closer you get to retirement. To retain some earnings potential, a safe figure for those within a few years of retirement may be 20 to 30 percent in stocks with the rest in cash and bonds.

How Much Do You Need in Retirement?

Is the 70% to 80% Ratio True in All Cases? Not really.

According to a study by Aon Consulting and Georgia State University, the exact amount you will need also depends on several factors, chief among them your income level and your gender.

In one scenario, according to the study, someone with a gross income of $60,000, retiring at 65, would need $47,000, or 78 percent, to maintain the same standard of living. The reduction reflects expected changes in taxes and work-related expenses. The $47,000 could come from a mix of savings, Social Security and employer benefits.

The percentage needed is higher on either end of the salary scale. Those making $40,000 or less will need at least 85 percent of their income in retirement. Lower-paid employees save the least and, while working, pay the least in taxes as a percentage of income. So they spend more of their gross income while working and need a high percentage to maintain their lifestyle in retirement.

People earning $150,000 or more should plan to replace 84 percent or more of their income. They face relatively heavier taxes, in part, because the bulk of their Social Security benefits are taxable. Savings also need to be more substantial because Social Security makes up a smaller percentage of their necessary retirement income.

Those examples don't include spending on Medicare or supplemental insurance, which would increase costs by thousands of dollars.

The bottom line is that men will need to have 4 to 6.8 times their annual salary in the bank, separate from Social Security. Women should aim to have 4.5 to 7.5 because they tend to live longer, according to the study.

So based on a multiple of 5.2, the man earning $60,000 would need $312,000. Based on a multiple of 5.7, a woman at the same income level should have $342,000.

How Much Should You Save and Withdraw from Your Retirement Accounts?

One good way to look at retirement spending is to separate the necessities from the nonessentials and save for them separately, says Jean Setzfand, director of financial security for AARP.

Make sure the necessities, such as housing, transportation, food and health care costs are paid for through a guaranteed income stream, such as Social Security or a pension fund, if you have one, she says.

The optional expenses, such as entertainment and travel, should be paid out of invested savings, the value of which may fluctuate. This method gives you much more security meeting your basic needs. If your investments do well, you can spend more on nonessentials.

Retirement vs Children’s Education

Canadian parents are struggling to strike a balance between saving for their children's education and their own retirement, according to a poll by Edward Jones Canada. The survey found that 15 per cent of parents with children under the age of 18 are favoring their child or children's education over their own savings. They thereby are putting aside little or nothing for their retirement. On the other end of the scale, 26 per cent of parents polled said they are primarily saving for retirement and only a little for post-secondary school for their offspring.