In the myriad of conservative think tank writings, including newspaper columns, so-called research papers, and hand-wringing diatribe, one would believe that the status of public pensions and their funding is a crisis upon us that demands immediate and dramatic action. At least that is what is wanted by those who see dollar signs in their eyes over the potential for the billions in public pension dollars in this country to be channeled into 401(K) plans and other investment vehicles that banks and other Wall Street interests can tap with an array of fees and charges. The goal of these investment management interests is to convince the public that a crisis exists, and then get their hands on the billions that are in the funds to produce a new source for the levying of fees and charges for the foreseeable future. A potential cash cow.
Two of yesterday’s elections were significant tests of whether the public is ready to buy into the premise being advanced by these interests – The City of Stockton where a tax increase for a bankruptcy recovery plan that protected city employee pensions was on the ballot, and the City of Cincinnati, Ohio where a pension reform proposal backed by out of state billionaires would have, according to a on line report from Governing, “Affected 7,500 workers, retirees and their beneficiaries and shut off the city’s defined benefits plan to new hires to enroll them in a 401(k) style plan. “
The Stockton tax increase was approved by 52% of the voters there in an abysmal turnout of only 21% of the voters, which signals that 79% aren’t that concerned about the issue. In Cincinnati the voters rejected the pension overhaul proposal by a margin of 78% to 22% (I have not yet seen numbers about what percentage of voters there actually voted).
We can expect the pension reform spin-doctors are at work to develop explanations of why they were trounced in these two elections, but for now the results seem to indicate that the voters are skeptical of their agenda and so-called analysis. The Cincinnati result is especially noteworthy given that some of the same out of state interests are backing a proposed pension reform initiative here in California. That’s the one two Orange County Mayors – Miguel Pulido of Santa Ana and Tom Tait of Anaheim are backing. Undoubtedly paid signature gatherers are at work now seeking enough signatures to qualify their idea of California Pension reform for the 2014 ballot.
Interesting results given the level of hysteria surrounding the subject. I’d imagine the spin doctors will blame “union money” for the “reformer’s” defeat. The truth is, most public employee collective bargaining groups aren’t unions in the way most people perceive them. Rather, they are in-house organizations led by employees who volunteer their time (to be fair, most local governments allow some paid time for collective bargaining activities, like contract negotiations). The bogeyman of the power-mad public union boss is a myth created by “reformers” to bolster their spurious arguments.
The doomsday predictions of most public pension reformers are based on pretty unlikely assumptions; that all public employees will retire at the earliest possible age (few do); that they will all live a very long time (some won’t); that once in the system, they will stay (some leave the public sector for private employment before reaching vested retirement age). All investment plans, including CALPERS, are based on an acceptable level of assumed risk; its accepted business practice that plans won’t totally eliminate unfunded liabilities (the conservative catch-phrase because its sounds so scary). If everyone with a deposit account at B of A or Wells Fargo showed up tomorrow and asked for all their money, the banks would not have nearly enough cash to pay everyone; they assume on any given day, only a certain number of people will withdraw all their money, so the banks use the rest to invest. How many of us have enough cash on hand to pay off our mortgages, or even cars, by the end of the week? If you take the time to access CALPERS website and read some of the entries in the “CALPERS Responds” section, you’ll see that almost all of the reformers’ arguments are hollow. CALPERS invests for 20 to 30 years, so even a hit as severe as the Great Recession will pass.
Now, if people want to have a reasonable and informed debate about public employee compensation in general, and the part pensions play in that compensation, that’s great. But you can’t start out my demonizing employees and making fear-filled, emotional arguments. Because eventually, the truth will make itself known, and the arguments will fall apart. What’s really sad is that there’s so much noise around this issue, people aren’t noticing the potential threat of a wholly possible financial catastrophe; the failure of the 401(k) system. A few months ago, I read a non-partisan, non-union, financial analysis that estimated that as many as 50% of Californians with 401(k) plans won’t have enough money to live above the poverty line when they retire. This is not because, as Wall Street pundits would have us believe, that people aren’t saving enough. First, because wages have stagnated for so long, a lot of people simply can’t afford to give up 15% or more of their salary to invest in a retirement plan. Second, 401(k)’s are based on the assumption of steady growth in investments over the long-term. Depending on the advice you’re given, that may or may not work out. And “safe” investment yields are so ridiculously low you may as well stuff your money in a mattress
I am unsure as to the bash against 401K’s. You get what you put in plus or minus investment return when you retire. From my experience with 401K’s or more appropriately all type of defined contribution plans, those that follow a methodical and long term approach will achieve reasonable results. The bigger item with the “as many as 50% of Californians…” representation is the wage stagnation factor and not the investment vehicle. If done properly, the 401K will serve its purpose. If done improperly, like so many other things in life, it will fail to deliver desired results.
I am not as familiar with the investment side of defined benefit (DB) plans, but someone has to be making fees off of that money aren’t they and not just if the DB money went into 401K type plans? Often big DB money is invested in hedge funds, real estate investments, direct stock holdings, mutual funds, etc…which most all carry fees (except possibly direct stock holdings if purchased/sold appropriately). The fee question is a very sincere question too, which if someone has knowledge of that would be great. I have to imagine that DB fund managers also make a living and pay their expenses of which comes out of the fund assets.
Boutwell – I have read some reporrts, including some produced by the so-called Wall Street 401K industry, that acknowledte that DB plans are more efficient and less costly than 401k plans, in part because of economies of scale and also because DB plans are managed by professionals and do some investing in vehicles that the average investor does not have access to, nor the kowledgte to effectively manage their own 401(k) fund. I have concluded that 401K plans have their place, especially for high earners and those who own a business, but that for the average wage earner they are unlikely to lead to a so-called secure retirement. You might want to read this newsletter of the Employee Benefit Advisor dated June 4, 2013 titled “DB Plans Outpoerform DC PLans” – http://eba.benefitnews.com/news/db-plans-outperform-dc-plans-in-2011-2733768-1.html?ET=ebabenefitnews:e7223:2509073a:&st=email&gpt_units=/DCDB –
I suspect this comment of mine will produce some challenges to what I have said here, so let’s see what comes next, but that’s my take..
Thanks OBNO, unfortunately the link requires registration which I can’t do right now. Economies of scale will always come into play. Large 401K plans will generally have a bit better fees than small plans. Large investors will receive better pricing than smaller investors. Buying in bulk at costco…you get the idea. 401K’s are usually managed by professionals, just like DB plans. Some IRA’s can be self-directed, but generally not 401K’s or other non-IRA DC plans.
I definitely agree with your assessment that 401K’s work best for higher earners…it will lead to increased likelihood of secure retirement compared to lower earners, but the same is true with a DB plan. Someone that makes a lot of money will get a better DB payout compared to low wage earners in a DB plan. Higher earners will inherently have a higher likelihood of secure retirement because they have a higher earning base and presumably a higher savings base/rate (although I definitely see my share of totally irresponsible high earners too).
However, for the average wage earner, I am not so sure that it is the 401K that is the problem but instead the actions of the 401K participant. I participants who take loans out of 401K’s which is generally not good. I see participants who take distributions from their 401K instead of rolling them to IRA’s thereby taking retirement money away and paying tax and penalties also. I see participants who do not take an active role in defining beneficiaries in their accounts. I see participants who do not take the time to meet with their investment adviser of the 401K plan (which pretty much is always offered). I see the above with multiple income levels, but in general the higher earners are, as a whole, making better decisions. This tells me that we need to as a whole, have better financial literacy in this country. Yes, this conversation is leading towards personal responsibility.
The DB plan makes it much more difficult to do some of the things listed above…most don’t allow loans, early distributions, require beneficiary designations, and take the investment decisions away from the participant and it is borne by the employer from a risk/reward perspective.
It would be like if we took away FICA payroll tax and said, “everyone should invest it on their own” and then be surprised that those who make more money would be more likely to invest the money compared to those who make less money. The reason is not simply that DB plans do a better job than DC plans…it is also that the DC participants are not making the best decisions for a secure retirement. Instead, they are making what they feel is the best decision for today. It is tough to leave money in a 401K plan when you have trouble paying the rent. It is tough to not take a loan out of your 401K plan when the car breaks down and you don’t have an emergency fund.
The 401K or any DC plan is just a vehicle that should be considered and utilized as part of a diversified retirement plan which I would hope would also include non-tax deferred accounts, real estate, and Soc Sec…obviously, only a pipe dream for many Americans. Yet, I don’t necessarily think it is the 401K’s problem in and of itself. If every company were to switch to a DB plan, most would simply fund what they are funding now by back end calculating the future defined benefit. Those who make a lot of money will still reap significantly more than those who make less in the DB plan.
Will a 401K lead to financial peace? It certainly can, IF certain objectives are defined and then steps methodically followed in order to achieve those goals- and there is sufficient earning base to follow along. Are there ways that 401K’s can be improved? Yes…for example, don’t allow loans (especially on employer contributions) which is more like most DB plans. Should investment choices be much larger than we have no…ABSOLUTELY. The investment choice is the biggest item IMO, but that will generally not help the lower income earner as much as it will the higher income participant. I may be just telling myself this (i.e. no data to back it up), but I imagine that as one accumulates more and more wealth that one gets more comfortable with risk and they are able to shoot for a higher rate of return and weather the storms.
To me it is not so much a DB vs DC plan issue as much as it is a earning issue.
Many good points Boutwell . A bottom line issue is that in a DB plan the employer assumes the investment return risk, in a 401K/DC model it is the employee who bears the risk. And, as the recession has shown, employees tap their 401k’s to survive tough times, resulting in a low likelihood of having enough retirement savings in that plan to be able to retire comfortably.
Here are some articles/reports of inerest:
http://www.newyorklife.com/nyl/v/index.jsp?vgnextoid=9cd02f5a919d2210a2b3019d221024301cacRCRD
http://www.taxpolicycenter.org/briefing-book/key-elements/savings-retirement/defined-contribution.cfm
Thanks OBNO…quite familiar with the generalities of DB and DC plans (i.e. the general links) as I live in that type of world professionally. Folks pulling money out of their 401K is a personal choice though. Should we make it harder for them? Maybe. Should we all take personal responsibility? For sure. Is it harder for lower income folks…without a doubt, which is why I think it is a bigger issue than just DC vs DB; people need good jobs while saving for the future.
Keep the pensions, but have a rule that the pensions can not be higher than the salary of Governor of our state. Remove the bulk of the high end pensions, while still keeping money to fund all the other pensions. If you make 300k a year as a school superintendent, you should be able to pocket 10-15k a year in your own private retirement account as well.