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| The Basics | How the 401(k) system fails most people
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OK, so you actually have a 401(k). But what does that really say about the security of your retirement? Not much, according to one expert. Here are 3 big problems with the system.
By Scott Burns
Have you heard the story of "The Three Really Big Monkeys and the Fiduciary"?
Listen.
"Workers have a monkey on their back. That's why they're retiring to despair. Actually, it's a bunch of monkeys -- really big monkeys." The storyteller is Brooks Hamilton, a career blend of benefits attorney and computer geek. If his name sounds familiar, it should. Hamilton has been the source of many columns. The foundation for our jointly written paper, "Reinventing Retirement Income in America," was his deep knowledge of how 401(k) plans worked -- or failed -- for most people.
"Monkey No. 1 is a simple question," he continues. "'Do I join the plan?' That monkey beats up 30% to 40% of the people. Waiting five, six or seven years before you join still means you take a severe beating.
"Monkey No. 2 is another question. 'How much should I contribute?' Many people join plans but contribute far too little. Even 401(k) plans with automatic enrollment put you in with too little.
"The plan sponsors are too timid," Hamilton explains. "They don't have the courage of their conviction. So they put employees in at 2% or 3% of wages and guarantee failure. Worse, employees tend to assume what has been done is right when it isn't. Usually, it's a small contribution to a money market fund."
I asked how many employees put too little money into their 401(k) plans.
"In really big groups, about 70% of the employees will undercontribute," Hamilton answered.
"Monkey No. 3 is investing the money. In some plans, the default investment is a money market fund. The legal argument is that the employer can't be sued because the employee can't lose money. The fiduciary auditors don't agree with this, but that's what the lawyers say. The effect is that it commits the employee to failure.
"If the employee does make decisions," Hamilton continued, "he often does it from a menu of retail mutual funds. Typically, half of the funds shouldn't even be on the menus. And all of the funds probably have two to three times the expenses they ought to have, with half of the expenses legally hidden. The employee thinks he's getting a fair shake, but Las Vegas might be better.
"Then there are the workers' choices. Check (Vanguard founder) John Bogle's congressional testimony. Basically, there is no evidence that the average worker has any skill."
Odds of success are low
Hamilton concludes: "Any one of these Really Big Monkeys (RBMs) puts a severe whipping on the employee. It's a very tough gantlet. If you deal with all three, you're going to retire well. But if one or more beats you up, you're heading for (retirement) despair."
I asked how many workers survive the gantlet.
"Let's start with a thousand workers," he answered. "Of the thousand, about 15% won't be eligible for one reason or another. That takes us down to 850 workers.
"Of the 850, about 30% won't join. That eliminates 255 and takes the number of workers down to 595. That's RBM No. 1."
Hamilton figures that about 95 of the 595 will be "highly compensated" -- those earning $90,000 or more this year. He figures they will contribute the maximum allowed.
"But 70% (of the 500 non-highly compensated employees) will contribute too little, too late. That knocks out another 350, leaving 245 workers who have survived the second RBM.
"Then there's RBM No. 3. How many workers achieve near-market results? Ninety percent won't. That takes 202 of 245, leaving 43. In other words, 43 workers in 1,000 succeed -- but the rest have been obliterated by a sorry gang of RBMs," Hamilton says.
Whos looking out for you?
Then he is silent, waiting for the proportions to sink in.
"Now ask yourself a question. If only 5% of the people can retire in dignity, can the board of directors, the investment committee, the trustees, the accountants and all the providers claim they've honored their fiduciary duty?
"I say no," Hamilton answered.
Later in the conversation, Hamilton puts the situation another way. He likens the fiduciary to a general: "If a general took an army of 1,000 into battle and returned with 50 survivors, leaving the rest as casualties on the field, what do you think would happen?"
Before I can answer, he says, "The general would be court-martialed."
What Hamilton sees coming is worker rage as millions of workers realize the scope of the failure they are facing and the complacency of those responsible -- the fiduciaries. He calls it "a perfect legal storm."
I asked if there was any evidence of this coming legal storm.
"It has not escaped the attention of the plaintiffs' bar that a RICO violation will trigger triple damages and only requires that two or more people be involved in a conspiracy to enrich themselves by diminishing the well-being of others," Hamilton noted. (RICO, passed in 1970, stands for Racketeer Influenced and Corrupt Organizations Act and was originally intended as anti-organized crime legislation.)
"Remember," he said, "ERISA (the Employee Retirement Income Security Act of 1974) imposes a fiduciary duty that is greater than anything previously defined in western civilization -- a duty of faithfulness, loyalty and care."
Is there some overstatement here?
Perhaps. But when you consider that two-thirds of all retirees get at least half of their income from Social Security, and that the Social Security Administration itself warns of future cuts in benefits, it isn't difficult to see a darkening horizon.
See Scott Burns' Web site.
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