The rise and fall of 401(k)

Mike Ivey  —  11/14/2008 10:09 am

Gretchen Lowe was understandably in no hurry to open the third quarter statement from her personal retirement account.

"I knew it wasn't going to be good news, so I just let it sit on the table for a couple of days," said Lowe, 70, an east side Madison resident.

When Lowe finally got up the nerve to look, she discovered her $100,000 account had lost more than $20,000 in value. And that didn't even include October, the worst month for stocks in 20 years.

"Everybody tells you not to panic, that it's all going to come back," said Lowe, a retired Dane County Circuit Court employee. "But that was money I was planning to give to my grandchildren, and now it's gone."

Millions of Americans, many exposed for the first time to the risks of global markets, have seen the value of their 401(k), IRAs or other personal savings accounts nosedive in the wake of the current economic downturn and Wall Street implosion.

In just the past year, the value of stocks in 401(k) plans or other individual retirement accounts has fallen by nearly $2 trillion, according to Sept. 30 figures -- the most recent available -- from the Center for Retirement Research at Boston College.

And given the ongoing sell-off -- stocks were down another 4 percent last week -- that decline is surely greater today. Many investors are now seeing retirement account losses, albeit on paper, in six figures.

Of course, younger workers who stay the course could well have time to recover, although critics note U.S. stock market returns have failed to keep pace with inflation over the past decade.

"To be honest with you, I haven't even looked at my 401(k) account balance in over a year," said Don Rogers, 48, chief financial officer at Demco International in Madison and father of three. "I figure I have at least another 15 years to wait it out."

But those nearing retirement or already retired may no longer have time on their side. Some could be facing difficult choices in their golden years: going back to work, moving in with family or simply living in poverty.

"None of those are particularly attractive options," said Keith Bender, an economist at UW-Milwaukee who specializes in retirement issues.

Savings rates low

That Americans aren't saving enough for their old age is hardly a new story. Savings rates on average have fallen from 12 percent of personal income in 1980 to less than zero today.

As a result, only three in 10 workers expect to have enough to live on comfortably in retirement, according to a 2008 survey from Bankrate.com. One in five fear they will have to work until they die.

Part of the blame can certainly be placed on people for spending beyond their means and not putting enough aside for the future. But an equally important issue is the tremendous shift in how retirement benefits are provided for working people in this country.

In the 1960s, more than 60 percent of the private-sector workforce enjoyed a guaranteed "company pension" linked to their earnings. The company would manage the money, handle the paperwork and hire professionals to make investment decisions.

Retired workers would then get a fixed payout each month, usually based on their salary level in the final few years of employment. Those payments continued until the worker died or sometimes even continued to a surviving spouse.

Today, however, fewer than 10 percent of private-sector workers can look forward to a company pension when they retire, according to the U.S. Department of Labor. Government employees -- including school teachers, police officers and firefighters -- are about the only group that still enjoys a traditional pension based on earnings and years of service.

Now, instead of a company pension or "defined benefit" plan that pays retirees a fixed amount until death, most employers typically offer a far less generous -- and much riskier, from a retiree's point of view -- "defined contribution" plan such as a 401(k) or some other type of personal account.

These plans allow employees to set aside tax-deferred income for their retirement. In some cases, employers match employee contributions. Withdrawing funds before a specified age usually results in some kind of a penalty tax.

These accounts stay with workers throughout their lifetime and belong to the employee, not the company. If workers change jobs, they can take their account with them. Plus, workers with a personal account are protected if their former employer goes out of business or declares bankruptcy.

The downside, however, is that 401(k)-type accounts can run dry once a worker retires and starts drawing out money. In fact, federal law requires that participants start making 401(k) withdrawals by age 70.

Personal accounts also put the onus on the employee to manage for their old-age security.

For some, that isn't such a bad thing.

Donette Beattie, 47, is the vice president of purchasing for Kitchen Investment Group Inc. of Madison. When she left another job about 10 years ago, she took her 401(k) account with her and rolled it over to Retirement Solutions, a local investment firm.

Beattie said she enjoys researching various stocks and making her own choices rather than being bound by the investment options offered in the company plan.

"I've probably lost about 10 percent in the 401(k) from my old job, but the one at my new job is down over 30 percent this year," said Beattie, who estimates she has more than $500,000 in her various retirement accounts.

Looking for a bargain, Beattie recently purchased shares of Covance, the drug testing firm that has major operations in Madison.

"It's gone up since I bought it, which makes me feel like I made a good decision," said Beattie.

But there is plenty of evidence showing other Americans aren't doing a very good job managing their 401(k)-type accounts. Investors tend to panic at the wrong time, selling at the bottom and missing out on the upswings, which can come quickly when buyers start jumping on the bandwagon.

"Economists have long known that the success of 'do it yourself' savings plans is severely hampered by the underlying investor psychology, which often leads individual investors to buy and sell low in crises like these," Christian Weller, a senior fellow at the Center for American Progress in Washington, D.C., said during testimony before Congress last month.

Some get help managing money

At Demco, a Madison company that sells school and library supplies, employees participating in the 401(k) retirement plan do get some independent help managing their money.

Demco for the past several years has contracted with Francis Investment Counsel of Pewaukee, a firm that offers unbiased advice to individuals who have a company 401(k) or other self-directed account.

Since Francis sells no investment product, it promotes its service as free from any potential conflicts of interest. That's not always the case when advice comes from the plan's custodian -- such as a Merrill Lynch or a J.P. Morgan -- which has a vested interest in steering participants into investment choices with the highest fees.

"Hiring those guys was probably the best decision we've made in terms of helping our employees manage their accounts," said Demco's Rogers.

Not all workers are so fortunate, however. Most are left to make their own decisions.

"It's not that people are necessarily dumb," said UW-Milwaukee economist Bender. "But to do it well, you really need to take some time. And not everybody wants to think about this kind of stuff."

With a traditional company pension, workers didn't have to worry about whether the market was going up or down. Their employer hired professional managers to decide on the mix of stocks, bonds or other investments.

Moreover, the sheer volume of a traditional company pension, where all assets are pooled together, offered workers enough insulation to ride out market swings.

The State of Wisconsin Investment Board, for example, manages the retirement funds of more than 550,000 current and former government workers in the state. It is widely respected as one of the best public pension funds in the nation.

In Wisconsin, monthly pension payouts to retirees are calculated based on five years of market returns, which helps to smooth out the inevitable ups and downs of Wall Street. Even with the unprecedented stock market decline of 2008, participants in the Wisconsin retirement system are likely only looking at a 3 percent cut in their monthly checks beginning in May 2009.

"That's the beauty of the system," said SWIB spokeswoman Vicki Hearing. "It's about sharing the risk and spreading it among thousands of people."

Unfortunately, fewer and fewer workers enjoy the benefit of a company-managed pension.

Corporations have been doing all they can to shed their pension obligations, which have proven a tremendous financial drain in particular on the U.S. automobile and airlines industries. The company pension is often the first thing to go when a firm starts making cuts or declares bankruptcy.

At Madison Gas & Electric, ending the company pension was the major issue in negotiations over a new contract in 2006 with the International Brotherhood of Electrical Workers.

MGE officials were determined to replace the company pension plan with a 401(k)-type plan for new hires. On that key point, the company refused to budge and the union had to go along.

"We weren't alone," said Dave Poklinkoski, president of IBEW Local 2304, which represents about 250 MGE workers. "Pension plans are under attack all across the country."

The standard line from employers is that younger workers who might be changing jobs every few years want to take their retirement account with them.

But Poklinkoski said having a company pension remains a major recruitment tool in the competition for skilled workers: "From our perspective, the issue is who is better able to manage risk: an individual or a multimillion-dollar corporation?"

Expectations have changed

The expectation among an entire generation of Americans was to work hard, maximize the contributions to their 401(k) account, sit tight and watch their nest egg grow.

That wasn't such a bad concept during the 1980s and 1990s, when the U.S. economy was humming along on cheap oil, an emerging technology sector and easy credit.

For instance, $10,000 stuck in an S&P 500 index fund in 1988, with dividends reinvested, grew to $70,000 by 1998. But the same $10,000 invested in an S&P 500 index fund in 1998 is worth just $8,300 today.

Still, Brent Pahnke, a principal at Retirement Solutions, said stocks remain the best vehicle to grow a retirement account.

"This downturn has been compared to the Great Depression, however, it is not as severe and today's communication is much better," he said. "The most difficult thing for investors is to force themselves not to panic and stay invested."

Pahnke said the biggest mistake investors make is selling at the bottom and missing out on the upside. "If, at this point, one would panic and place all of their money in a money market, for example, they would be handing out carts at Wal-Mart within a few years as they spend down their assets while not even keeping up with inflation," he said.

Sticking with stocks might hold for someone in their 40s or early 50s. But what about older people who are already retired or nearing retirement age?

Research from the Employee Benefit Research Institute suggests that far too many retirees still have lots of money at risk in the stock market. This comes despite the fact that most experts urge older people to shift some funds into bonds or fixed-income investments.

Based on the most recent figures, almost one-third of 401(k) participants in their 60s had 80 percent of their money in stocks, including mutual funds or shares of their employer. In the 55 to 65 age bracket, over half had 70 percent or more of their 401(k) invested in stocks.

This kind of market exposure is now causing real pain for real people.

In the case of Lowe, the market downturn has come at exactly the wrong time. At age 70, she must starting making withdrawals from her 401(k)-type account or risk penalty.

"It really ticks me off," she said. "We have all this money for foreign wars or to bail out banks or pay these outrageous CEO salaries, but then hardworking people are asked to make all the sacrifices."

Not that Lowe and her husband, former Dane County Supervisor Darold Lowe, are headed to the poor house. Lowe said she feels fortunate to have money coming via the state retirement system from her government job, along with a monthly Social Security check.

At the same time, it comes with a touch of sadness.

"I feel like we're the last generation that's going to do better than our parents," she said.

---

WHAT'S A 401K ANYWAY?

Named for a section of the Internal Revenue tax code, the 401(k) plan came about from a 1978 congressional provision intended to give taxpayers a break on deferred income.

Since then, the 401(k) has grown into the most popular savings vehicle in the country, with over 65 million Americans holding accounts.

The 401(k) offered many workers for the first time a chance to easily invest in stocks and bonds, often with their employers providing a match. Companies liked the concept since it was far less expensive than offering a traditional pension.

The popularity of the 401(k) also gave a tremendous boost to the financial services industry, as money poured out of savings accounts into the stock market via mutual funds offered in the various retirement plans.

But at the same time, millions of people began to discover that money invested in stocks was not as safe as, say, a passbook account at the local credit union.

During the technology boom of the 1990s, for example, employees at fast-growing companies were often paid in company stock, with some having all their 401(k) invested in shares of their own firm. When the dot.com bubble burst in 2001, a lot of people saw their nest egg blow up, too.

The implosion of WorldCom and Enron alone took more than $800 million in employee savings accounts with them.

The latest financial meltdown, coming just six years later, has trimmed another 20 percent from 401(k) accounts nationwide and sparked debate -- not unlike the debate over privatizing Social Security -- about whether the stock market is the best place for average working people to put their money.

Said California Rep. George Miller during an Oct. 7 congressional hearing on retirement savings: "Unlike Wall Street executives, American families don't have a golden parachute to fall back on."

Mike Ivey  —  11/14/2008 10:09 am