Bad News For the Retirement Industry: 401(k)s and IRA’s Fail Compared to Pension Plans
Two of the cherished gems of the investment and retirement industries are being criticized as failing and this means more bad news for Americans planning for retirement.
The first gem to be tarnished was shown in an eye-opening research report from the Economic Policy Institute about the failure of 401(k)s and IRAs to meet the retirement income savings needs of average Americans as they retire.
Not surprisingly, the study found that retirement income gaps are only magnified in retirement by people who have not earned enough while they were in their prime working years. This means that people who were disadvantaged because they lacked a college degree, were single, widowed, or not white, only went into retirement without the savings they needed to live at their current lifestyle. In short, to people in these categories, retirement offered only more of the same or worse after they stopped working in terms of disposable income.
The Economic Policy Institute study should be read in its entirety by all retirement and investment professionals and all investors since it is a sobering view that the retirement system is seriously broken and few new solutions are on the horizon.
Among the study’s main conclusions, supported by charts, are the following:
- “Retirement wealth has not grown fast enough to keep pace with an aging population and other changes.”
- “The growth in retirement inequality has not been random—the rich have gotten richer and the poor poorer.”
- “The shift from defined-benefit to defined-contribution plans has exacerbated racial and ethnic disparities.”
- “Retirement readiness gaps have widened between workers with and without a college education.”
- Single people and women will continue to face a more difficult retirement since they lack the financial resources.
Writing in TruthOut, Monique Morrissey of the Economic Policy Institute, said “the simplest solution to the looming retirement crisis would be expanding Social Security, though that’s unlikely in a Republican-controlled Congress.” This is very true. The Republicans have a stated goal of privatizing Social Security, which would put trillions of dollars back into play for investment, mutual fund and retirement planners who would all suck up huge fees and expenses to push favored funds and insurance products.
All this would happen without the benefit of disclosure and transparency since at the same time this privatization would occur, the financial industry lobbyists would be pushing to repeal the fiduciary standard from the investment industry that was passed only a year ago by the U.S Department of Labor (DOL). This would create the loss of hundreds of billions of dollars in retiree income to the investment industry in the form of huge undisclosed fees and expenses.
Plus, given the shift from employer-sponsored retirement plans to 401(k)s and IRAs, individuals, many of whom are not sophisticated, have assumed all the investment risk of managing their portfolios over the time they are working and in retirement.
Milton Friedman Was Wrong
The second long-held touchstone to be broken is an assessment that the spending patterns of people as their income drops has been shown to be wrong. This spending pattern behavior was important to economist Milton Friedman’s theory that stated that people would continue their spending levels when they became unemployed at the same level as if they were still working. Friedman’s theory stated that people would borrow in order to maintain their living standards rather than cut back when they became unemployed.
Friedman’s mistake is evident in this interesting chart from the Economic Policy Institute which shows that retirement savings declined after the 2008 recession, most likely because average working people used up their hard-earned savings to pay for everyday living expenses.
According to author Noah Smith of Bloomberg, Friedman’s closely-held theory is wrong because when people lose their job, they spend less. “This is consistent with the credit-constraint model, since lots of people can’t borrow enough to maintain the lifestyle they enjoyed when they had a job. After that initial drop, the authors find that spending continues to drift lower,” Smith wrote.
The second problem in Friedman’s theory has to do with the big drop in spending even when people get unemployment checks. When this happens, people know when the checks will arrive and how much they will receive, but even then, unemployed people dropped their spending even more and this confused the academics. Yet in this chart (see below) from the Economic Policy Institute, the long-term and lingering negative impact of the 2008 recession is evident in the reduced amounts people are now saving for retirement and this continues today.
How bad is this situation? It’s bad: the median retirement savings amount for people aged 56 to 61 (from 1989 to 2013, in 2013 dollars) is $17,000. For other age groups, the numbers are not any better as this chart shows.
Now maybe this just shows how PhD economic academics view the world versus people who have ever been laid-off and received unemployment checks think. If you have ever been laid off, and this should not surprise anyone who has ever been in the workplace, you know the money will end soon and that you have fixed living expenses (mortgages, rent, car insurance, food, utilities, etc.) that are all constant expenses, so going to get a loan is imprudent and stupid. Pay-day loans charge interest rates that border on being usury, but monetarist and free-market economist Friedman would never be accused of living in the normal world.
The Fund Industry Ignores the Reality
Not surprisingly, anyone who has ever covered or working in the retirement industry could expect a detailed, well-constructed and twisted response from the financial industry lobbyists whose main job is to protect the status quo. This response came from the notorious Investment Company Institute (ICI), which employs at least four PhD statisticians who can logically prove that it is snowing in Hawaii on any given day.
So given the results of this Economic Policy Institute study, the ICI produced its own PhD-inspired version of the snowing-in-Hawaii scenario to show that the benefits of 401(k)s and IRAs provided and managed by their dues paying global investing firms, many of which created the 2008 recession, are working just fine.
In the past, the ICI has been a shill for the investment industry and regularly opposed the U.S. Department of Labor’s (DOL) pro-
investor fiduciary standard. In a letter to the DOL, ICI’s president Paul Schott Stevens, (who makes $1.797 million annually as ICI president), said that if the DOL’s proposed rules were adopted in their current form, “it would do great harm,” presumably to the investment industry, but not investors, since it would eliminate the conflicts of interest common in many sales practices.
Instead, Stevens and other financial industry lobbying groups, said a bill passed by Republicans in the House (H.R. 1090) would push the SEC and the DOL to develop “a harmonized fiduciary duty for all investors.” He did not elaborate on what the harmony would sound like, especially since these discussions have been going on for about a decade. In related testimony presented Sept. 30, 2015, Stevens also challenged the DOL’s data that showed high fees and expenses unnecessarily cost investors $17 billion annually.
But even as the EPI’s Morrissey noted, “the ICI’s rosy report shows that decades into the 401(k) revolution seniors received $105 billion dollars in pension income and only $29 billion from 401(k)-style plans in 2014.”
This is why both of these reports come at a very difficult time for most Americans as we face a new, reactionary and anti-average American Trump administration that is bent on Social Security, Medicare and Medicaid privatization, accompanied by revoking health benefits for millions of average Americans.
The bottom line for anyone planning for retirement and this includes every working American, is that planning for retirement under the Trump Administration environment is something that requires thinking well beyond the average, canned retirement planning scenarios provided by too many professional retirement planners.
For average Americans’ this means following a scenario that involves cutting investment and career risk and controlling what you can control. This includes controlling investment fees and expenses, investing in low-cost, passive ETFs and mutual funds, saving more and cutting consumption. Since this is presidential inaugural week, we should remember that the only thing we have to fear is fear itself and the Trump Administration.
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