November 14, 2008
Why are 401k’s popular? Where did 401k’s come from?
This snippet in an editorial in the WSJ caught my eye:
Targeting Your 401k – WSJ.com
Tax breaks alone hardly explain the popularity of 401ks. Over the past 30 years, the number of individuals covered by them nearly trebled, up to 65 million accounts, while the number under defined-benefit pension fell 30%. People are attached to their 401ks because it is their property, which they can carry with them to new jobs unlike traditional pensions, manage as they see fit and bequeath to heirs.
My interpretation of this snippet is that “401k’s are popular not just because of the tax breaks, but because it is the property of the person.” Is that your interpretation?
If so, that’s pretty silly. It’s not like employees have a choice of whether they get a 401k or a pension plan – they get whatever the employer offers them, and few offer pension plans anymore.
Here’s another interesting snippet:
The main liberal objection to 401(k)s seems to be that they let average Americans control their own investment decisions for retirement.
I think there’s actually two issues here:
1. Is it really true that the main liberal objection to 401k’s is because it allows average Americans to control their own investment decisions? Are there other objections? I don’t know.
2. This supposes that it is a good thing that average Americans control their own investment decision for retirement. Is that really true?
In fact, this Wall Street Journal article from August 2008 tells the tale where 401k’s went horribly awry, forcing taxpayers to bail out teachers:
Seventeen years ago, West Virginia school employees joined millions of workers nationwide in a shift from a pension plan that guaranteed a monthly check, to a retirement-savings plan that would make the teachers, bus drivers, custodians and other staff responsible for their own investment accounts.
“It was horrible,” says Judy Hale, president of the West Virginia Federation of Teachers union. Most felt poorly informed, and they invested too conservatively, putting the largest sums of money into a fixed-rate annuity, a safe but low-yielding option that typically is inadequate for building a nest egg. As employees began to retire, most balances were pitifully small. So on July 1, after a vote authorized by the state legislature, 14,871 school employees, or 78 percent, switched to the old-fashioned pension plan.
After the vote, teachers were “jumping up and down and crying in the halls,” Ms. Hale says.
The school employees put their mistakes behind them, but their experience stands as a cautionary tale for employers and employees across the country. As large numbers of workers are starting to retire with 401(k) or 401(k)-like plans to support them, what happened in West Virginia is a window into exactly how things can fall apart for workers, and it serves as a wake-up call for figuring out how to avoid having plans go as badly off track as this one did.
[snip]
The West Virginia plan initially offered stock and bond mutual funds, a money-market fund, and an annuity, in this case from Variable Annuity Life Insurance Co., or Valic, a unit of American International Group Inc. In addition to the Valic annuity, current offerings include funds from Capital Group Cos.’ American Funds unit, Federated Investors Inc., Fidelity Investments and Franklin Resources Inc.
From the start, most employees favored the annuity. Some say they were swayed by Valic’s sales force, which included former educators and school employees who went into the schools during the workday to talk about the option. “These people came during your lunch or during your planning period basically to sell the program,” says Debra Elmore, a third-grade teacher in Ansted, W.Va.
Ms. Elmore acknowledges knowing little about investing. “Oh, Lord no,” she says. “I had no idea.” She set up her account so that 85 percent of her contributions would go into the fixed-rate annuity. “I just thought, ‘Well, these are safe. Let’s stay there.’”
Here’s a pretty interesting list of interviews about how 401k’s came to being. Some snippets
The 401(k) plans were originally introduced as supplemental plans. No one ever said, “Oh, let’s end these traditional pensions and replace them with 401(k) plans.” What happened was these 401(k) plans came in at the same time the stock market took off. People liked them because they liked having their own accounts that they could look at, and they liked being able to control their investments, particularly in an environment where stocks go up every year. And employers liked these plans because they didn’t have to worry about the risk and what it might do to their earnings. …
Apparently, the 401k was a one line change to benefit a few execs at a certain company.
On the other hand, 401k’s are better for people who change jobs regularly.
Suffice to say, there’s plenty more to 401k’s, the pros, the cons, the possible reforms than exist in the soundbites you hear in the news and from politicians.
