Americans are not saving enough for retirement. In lieu of accepting that the standard fiscal state for the majority of retirees is poverty, some states are trying to help people get their financial acts in order. This week, California became the latest of those states (see what’s happening in your state here), with the “Secure Choice Retirement Savings Program” bill to create a state-run retirement plan for roughly seven million private workers passing the Assembly – one step closer to becoming reality. This would make California the eighth state to establish such a plan.
There are 55 million workers who don’t have a way to save for retirement at their workplace, and of those, only 5% take the steps to open an IRA, according to the AARP.
Here’s why the bill exists, according to its fact sheet:
- 55% of young workers age 25-44 have projected retirement incomes of 200% below poverty, compared to 33% of workers aged 55-64. (UC Berkeley)
- At least 62% of retirees rely on Social Security for more than half of their income.
- The average monthly Social Security retirement benefit is $1,328.
- 7.5 Million Californians work for employers who do not offer a retirement plan. 2/3 of them work for businesses with less than 100 employees. 2/3 of them are workers of color, almost half of which are Latino. Fifty-eight percent are women.
- Workers with access to a workplace retirement plan are 15x more likely to save for retirement (AARP)
- Two-thirds of small business owners in CA support a state retirement savings program that would help small businesses and their employees save for the future.
Today, Companies Aren’t On the Hook to Provide Retirement Support
When I graduated from college and obtained my first full-time job as a magazine reporter, I was one of those Americans. It wasn’t even the smallest company I worked for, but it was just too much of an administrative hassle for the executive team to launch a 401(k) plan. They went so far as bringing in the benefits agency to discuss the launch of one, only to change their mind without telling us why. My next few roles in startups with under 20 employees also did not provide access to a 401(k). I was limited to investing in a traditional or Roth IRA ($5500 a year maximum) even though my employer didn’t offer a 401k, which would enable much greater savings per year.
The question remains – should employers be responsible for offering some kind of retirement plan, and how much should the government get involved in this matter anyway? Many states are against state-sponsored plans to begin with, but some are pushing towards requiring businesses to offer these plans to their employees. The California plan which is getting closer to reality would require any company with more than 5 employees to offer access to the state-sponsored plan if they don’t have their own 401(k). Some states even want to auto-enroll employees in these plans, putting aside 2% to 5% of their income in the account. The California plan starts at 5% per year increasing one point per year up to 8 percent.
Do States Have the Right to Auto Enroll Employees in Retirement Accounts?
Auto-enrollment is a tricky subject – if you’re just going to auto-enroll employees in the plan and choose their investments for them, it seems like an extension of social security with forced additional savings versus an actual self-guided retirement plan. Even with a company match (which wouldn’t be required and would be unlikely if these companies aren’t providing any sort of retirement plan to begin with), is it fair to auto-enroll employees in retirement plans? Isn’t it better to invest in education?
Every day in California, 1,000 people reach the retirement age of 65, according to the governor’s office. About half of those will retire into poverty because they do not have access to retirement options, according to the University of California Berkeley Center for Labor Research and Education.
I’m often amazed when workers in their 20s who are clearly very intelligent are lacking a basic understanding of investment or retirement savings knowledge. If there is any education provided in companies – even those with 401(k)s, it’s extremely limited and offered by the same people who come in to discuss all of your benefits. In the Q&A sessions of those meetings, the 20-something employees are clearly bewildered but afraid or too shy to ask questions. When they do ask a question, the advice they get is very basic and often unhelpful. Sometimes an older employee will ask what kind of funds are available, but no one gives investment advice (this isn’t allowed.) I find myself jumping in to try to provide some insight into the details around investing for retirement and how a 401(k) works (everyone is afraid to ask this and no one bothers to explain.)
Auto-enrolling people in a state-sponsored retirement plan is not an ideal solution for our nation’s retirement savings woes. The California plan – for its first three years anyway – would be limited to investment in Treasury securities or similar low-risk, low-yielding alternatives. Treasurys today are yielding less than 1-2 percent. This is below the rate of inflation. This is not a good investment. As SFGate points out, annual fees capped at 1% “could eat up most of the return from a Treasury-only portfolio.”
Are 401ks / Retirement Plans Even Good For Us?
James Altucher, who is a brilliant personal finance (/ life / being-a-weirdo-and-yet-being-successful) guru who I’m mildly obsessed with, explains why 401(k)s are a scam here. He explains that the only real pros of a 401(k) are that they let you invest pre-tax money (which inspires more savings early on), that you can get a match from employers sometimes (though “free” money is never really free), and you get to take the money out like an allowance when you turn 59.5 after it’s grown at 7% per year if it even manages to do that.
And, here is his much, much longer list of the cons of the 401(k):
- Your tax rate 30 years from now may be… well… anything. Taxes may go up. They may go down. When you retire, you may be in a higher tax rate – or a much lower tax rate. Who knows? Altucher notes that most likely your tax rate will be higher because you’ll be taxed at the rate of your income, including that 401(k) money you’re taking out to pay for your retirement.
- Employer matches are a game that is not set up for the employee to win. I’ve never had access to an employer match, but the way Altucher explains it, I’m lucky that I haven’t. Companies with matches tend to have lower salaries. They also spread out the match over 4-6 years so you don’t get the full match unless you stay that long. Who stays that long in a job these days?
- 401k plans are really expensive. Fees are ridiculous and with 401(k) plans they ought to be outright criminal beyond a nominal, reasonable amount. But that isn’t the case.
- 401k plans’ success is based on market returns over time. The market has returned somewhere between 7 and 10 percent per year over the last 40 years. Not bad. But active managers (those managing funds in a lot of 401(k)s) tend to make a lot of bad decisions, pulling out of investments right before they go up. The average “investor” investor has returned just 1.8% over the past 40 years. Ouch.
James isn’t the only reputable source who thinks 401(k)s are bonk. Because they are.
- In 2013, Mother Jones wrote about how much they suck. Poor people miss out no matter what. Middle class people get fucked with fees. And the rich folks get a tax cut but they need it the least.
- Rachel Maddow called them a scam.
- USA Today reminds us that plan managers are “either bad investors of bad actors” (acting in their personal interest vs the interest of their clients) — 16% of 401(k) plans charged fees so high that they actually negated the ENTIRE TAX ADVANTAGE of the 401(k) for YOUNG investors.
- Dan Solin wrote in a contributed article on The Huffington Post that while the retirement plan for government employees, which offers low-fee index funds, is the ideal 401(k) – most retirement plans for private employees feature actively-managed mutual funds with high fees.
Then, this week, another flair of hoopla over the 401(k) being the heaping pile of shit that it is fizzled up on Bloomberg. Ben Steverman makes the case that the 401(k) is making income inequality worse – nevermind that 401(k)s are actually crap-tastic investment vehicles (he doesn’t cover that) but merely that college-educated workers invest more in them. A recent report from University of Kansas sociology professor ChangHwan Kim and U.S. Social Security Administration researcher Christopher Tamborini found that workers who hold similar jobs and make the same amount of money are not saving the same amount for retirement, based on their educational background. College graduates save 26 percent more in their 401(k)s than those with just a high school diploma.
The median private sector worker without a college degree is contributing nothing to a retirement plan, while the median college graduate pitches in more than $2,000 a year, the study found.
Andrew Briggs over on Forbes shot back that this argument makes no sense – that pre 401k days when Pensions were all the rage, most poor employees had no access to them and they weren’t even guaranteed for any employee – and most required employees to stay in the same company for 15+ years (who does that today?) Briggs also highlights that 401(k)s cost less for companies to run and therefore more people have access to them.
Even at their peak of traditional pension coverage in the mid-1970s, only about 4-in-10 workers were covered by such a plan. And since 401(k)s weren’t introduced until the early 1980s and didn’t become widespread until the 1990s, the majority of workers without a traditional pension had to patch together retirement savings on their own. That’s not easy, even today.
So, with pensions out for better or worse, we have the 401(k) – a very inefficient vehicle for retirement investment – and then only college-educated, privileged folks even managing to invest in it anyway despite it maybe not being the best place to invest for retirement?
State-Sponsored Plans: The Good, the Bad, the Very Ugly
At worst, California’s plan would cripple under the weight of its own fees. At best, an entire generation of employees would be forced without their knowledge into inefficient retirement investments. Those who need help with retirement savings the most – lower-income employees – would be the same people who would hurt most from automatically being enrolled in these programs.
Like it or not, saving for retirement is not about simply locking away savings each month. In order to be able to afford retirement (unless you win the lottery or happen to be employee #3 at the next Facebook), you have to leverage the magic of compound interest. You need that 7-10% interest increase year over year, with very minimal fees, to build a healthy portfolio. Saving 1-2% YoY with a 1% fee is not going to help other than get people in the habit of saving. With all the bill’s supporters, I wonder if they just don’t understand how this bill, while well-intentioned, doesn’t really help. The problem is much bigger.
Of all the plans launched to date, Connecticut seems to have the wisest model, at least with security of employees in mind (read a useful review of Washington and Connecticut’s plans here.) Its model focuses on a mix of growth opportunities and largely ensuring retirement income with low-risk investments and annuity models:
- Any employee 19 or above that has at least 120 days of service to the company will be enrolled.
- Employees can “opt out” of the plan by “opting” to defer 0% of their paycheck.
- Participants will be invested in “age-appropriate” target date funds – BUT:
- the law requires 50% of retiring participant’s assets be invested in annuities that provide lifetime benefits (*cough*additional social security*/cough*)
Still, the amount that can be saved in these accounts is – for most people – not enough for retirement (esp depending on when you start saving.) Few people realize just how much they actually need to retire. Heck if I know how much I will need to retire – other than “a lot.” Retirement calculators – like this one by NerdWallet – help provide a basic estimate.
- 21 with no savings and an income of $50k a year – save $500 per month ($6k) and you can retire at 66 years old. (It will be very hard for a 21 year old to save $6k a year on a $50k salary, but it’s doable.)
- 30 year old with no savings and $50k salary? Now you have to save $900 a month to make it to your retirement goal, or $10800 a year.
- 30-something year old earning $180k a year with $300k saved to date needs to save $2000 a month ($24k / year) in order to make the retirement goal of living on $10k per month.
But this doesn’t mention WHERE to put these savings. Is a 401(k) really the best place? Is a taxable account better? Should I be opening up a business in the Cayman Islands like the rich folks do?
No matter what, normal folks (even if I’m much more privileged the average normal folk) are working against a system designed to make the super rich lots of money and make the rest of us happy with being able to eek out a retirement as our primary goal.
And we’re all fucking confused about how much we should save and where. A recent survey by Schwab Retirement Plan Services (biased as it may be) found that fewer than half of the respondents, 43 percent, had an ideal retirement savings target identified. Participants were more likely to know their ideal credit score, weight or blood pressure than they were to know how much they would need for a comfortable retirement.
According to the survey, the 401(k) is the largest or only source of retirement savings for most people — 90 percent of respondents called it a “must-have” benefit in their workplace. Yet only 51 percent said that they felt on-top of their 401(k) and 35 percent said that they felt stressed about choosing the right 401(k) investments.
Respondents expressed an appetite for assistance around their 401(k) plans — while only 10 percent currently access professional 401(k) help, 70 percent said they would like some personalized advice for their plans.
I’d like some help. The problem is, I don’t trust anyone to provide financial advice. I guess I have to hone up on my math skills and figure this out on my own. If I learn anything you’ll be the first to know, my ever-faithful / first time / long-time / how-did I-end-up-here readers.