Gil Thibeau
That last point was crucial. Some people are good at it. Some are terrible.
The 401(k) was made for Gil Thibeau, who, like high-level executives, made enough money to save easily and who had a knack for investing. A tall, quiet-spoken New Englander who had moved to Texas, Thibeau was trained as an industrial engineer, plus he had an M.B.A. in business administration. For National Semiconductor, he was a technical troubleshooter for big corporate clients.
Thibeau’s job paid well—$90,000 to $100,000 a year. Not only did he religiously pump 6 percent of his salary into the 401(k) plan, but he put another 5 to 10 percent into National’s employee stock option program. Thibeau loved researching stocks on the Internet. His picks were good and his timing was lucky. He bought National stock when it slumped to a low of $8 a share and saw it climb to $30 plus. In fourteen years with National, Thibeau built up a solid retirement nest egg. By the time National laid him off in 2001, his retirement funds were a bit under “half a million,” he said half apologetically. “If I had started earlier, I would have set my target at a million. But I waited too long….”
When he was laid off, Thibeau was not yet eligible for Social Security. Rather than use his retirement savings, he swallowed his pride and took a new job—at a huge pay cut, working at Aetna Insurance for $30,000 a year, plus health insurance. When he retired from Aetna in 2008 at sixty-seven, Thibeau decided to tap his Social Security, but he earned extra money as a part-time high school teacher. The financial crash of 2008 took his 401(k) assets on a roller coaster, but, he told me later, “I am still ahead of what I put in.” By taking other jobs, Thibeau had protected his main nest egg for the future.
Winson Crabb
Winson Crabb could have used Thibeau’s luck and head for money. Crabb worked for sixteen years at National Semiconductor as a skilled maintenance technician, making $50,000 a year. Like Thibeau, Crabb said, he made his 401(k) contributions every month, assuming the 401(k) would pretty well run itself.
Crabb is a solid, salt-of-the-earth guy, good with his hands, smart about machinery and guns, but not quick at math and finance. “My assumption was that when I got to be 65, well, there would be a large amount of money in there for me to take cash out to put in our bank to utilize for whatever,” Crabb said. “Well, that didn’t work out.”
The biggest problem, said his wife, Bess, was the sudden sharp market plunge during the two years before her husband retired in 2003. Before that, she said, Crabb had about $120,000 in his 401(k) plan. “That was our goal, and that’s what was there,” she said. But when the market fell, the Crabbs lost more than half of their 401(k) balance. “It went down to forty-five [$45,000], and we built it back up to sixty-four [$64,000],” Bess recalled. “And then … the day that he drew out the 401(k), it was fifty-two [$52,000].”
In fact, the Crabbs had less than the $52,000 that showed on his 401(k) statement, because Crabb had twice borrowed money from his 401(k)—$20,000 for his daughter’s medical training, which he paid back, and another $10,000 to buy a motor home, which he had not paid back. So that reduced his total. Worse, Crabb got socked with a hefty tax bill when he cashed out his 401(k) in one lump sum instead of rolling it over into a tax-sheltered IRA. “I just went with the information that I had and thought I was doing the right thing, which I wasn’t,” Crabb said sheepishly. In the end, his 401(k) was down to just $26,000.
“It was a jolt when we got to counting funds,” Crabb admitted, rubbing a weathered hand through his white hair.
“Well, I thought when he retired, it was going to be a lot different, you know, money-wise,” Bess Crabb added.
“So, how do you manage financially?” I asked.
“Well, you do what you have to do …,” Crabb said. “I had a couple jobs in between there, and my wife works.”
In bits and pieces, the Crabbs were cobbling together barely enough to keep afloat and hang on to their brick rambler home in Cleburne, Texas. Bess Crabb’s job in a local real estate office was bringing in some money. Crabb was drawing Social Security and getting $400 a month from a lifetime pension at an earlier job covered by a steamfitters union contract. Now and then, he would get temporary jobs doing repair work or driving a truck. To help make ends meet, Crabb sold off his prized gun collection for $12,000. “Broke my heart,” Crabb said in a whisper.
The big news during my visit was a job offer as a safety officer in a computer chip plant in New Mexico. So at sixty-eight, Winson Crabb was heading out to Albuquerque alone, without his wife, for a temporary job. For how long? He didn’t know. The Crabbs had no long-term plan.
Financial Cancer in the System
The stark contrast between Gil Thibeau and Winson Crabb left me wondering whether these were just two random cases or whether they told a larger story. Both had worked for the same company, enrolled in the 401(k) plan, faithfully made contributions, and benefited from a good company match. Of course, the two men had made different salaries, and that would explain why one would have twice as much saved as the other. But the gap was far larger: Thibeau had twenty times more than Crabb. Why such wildly different results?
Brooks Hamilton, the Dallas pension consultant who had been advising major companies on their benefits programs for fifty years, gave me the answer. Hamilton is a high-energy brainstormer with a law degree and a mathematician’s mind for figures. He loves statistical puzzles. When 401(k)’s first appeared, Hamilton believed in their magic. He was an early apostle, persuading companies to buy into the 401(k) concept and then helping them set up and run their programs. But by the late 1990s, Hamilton was troubled by the different results he noticed among employees in the fifteen corporate 401(k) plans he was then running, each with thousands of participants and each with total balances of $100 million to $200 million or more. Hamilton dug into the records of every single employee to find out what was going wrong.
The huge gap between Thibeau and Crabb was no aberration, Hamilton told me. It mirrored a wide and disturbing pattern. Their track records were dots on a chart, and when Hamilton connected those dots with thousands of other dots, he was shocked. Year after year, in one 401(k) plan after another, he saw a similar pattern that totally changed his views of the 401(k).
“In every case, the 20 percent at the top not only had the highest investment income, like 30 percent or whatever, they also had the highest pay,” Hamilton told me, “whereas the bottom 20 percent not only had the lowest investment income, 4 percent, they had the lowest average annual pay.”
To Hamilton, this was a systemic flaw. The best-educated, best-paid employees and executives were getting investment returns that were six or seven times greater than the returns for average workers. That gap was compounded year after year. The top brackets were not only able to put away much more money each year, but they got far better returns than rank-and-file workers like Winson Crabb. They didn’t borrow from their 401(k)’s or make Crabb’s mistake of pulling out their retirement fund in one lump sum, triggering a tax penalty. They left the money in and let it grow. They knew how to get the best results and how to avoid costly pitfalls.
“I label this [the] ‘yield disparity,’ ” Hamilton said. “I thought, ‘We have a yield disparity that is a financial cancer in this, in our great beautiful 401(k) movement.’ And I had never seen it before, but it was everywhere I looked.”
“What do you mean, a financial cancer?” I queried.
“It would destroy the opportunity for ordinary workers to retire in dignity,” Hamilton declared. Then he said very slowly, underlining each word: “They can’t get there from here.”
Rough Ride Ahead for Baby Boomers
Hamilton’s conclusion is reinforced by other retirement experts, and that points to a critical problem for middle-class baby boomers nearing retirement and for the next generation.
Half of America’s workers get no retirement plan from their employers. About 40 percent are enrolled in a 401(k) plan, an account balance plan, or a similar s
ystem where the employee makes a regular contribution, partially matched by the employer, and the employee picks investments from a basket of mutual funds offered by the employer. Ten percent have a mix of lifetime pensions, 401(k)’s, or variations on the 401(k).
The 401(k) track record is not good. After twenty-five years, the typical account balance was just $17,686 on January 1, 2011, according to the Employee Benefits Research Institute (EBRI), which tracks 401(k) records for twenty-two million people. The typical 401(k) nest egg of people in their sixties, who have been in a 401(k) plan for twenty years and are nearing retirement, is $84,469. The Center for Retirement Research at Boston College puts the figure at $79,000 for those between fifty-five and sixty-five.
Either way, that’s far, far short of what people will need. Those balances represent less than two years of pay for a typical American family, when average life expectancy for people retiring at sixty-five is seventeen years. Even adding Social Security, which replaces about 35 percent of the pre-retirement income for a typical individual, many middle-class Americans are far below what’s needed.
By the estimate of EBRI’s Jack VanDerhei, 45 percent of the next generation of retirees are seriously “at risk” in retirement, which means that they will fall short of meeting their basic financial needs—not a comfortable retirement, but basic needs. “They will not have enough money to afford the basic necessities of life and necessary medical care,” said VanDerhei. “They will still have Social Security and maybe something from a defined benefit program [a lifetime pension]. But it won’t be enough to cover their basic expenses…. I would say unless you’re fortunate to be in the upper-income quartiles that you’re probably going to be in for a very rough ride.”
Alicia Munnell’s Center for Retirement Research at Boston College estimates that more than half of American families (51 percent) are “at risk” of being squeezed into a lower standard of living in retirement. That’s without adding in medical costs.
The number jumps to 65 percent of American families at financial risk when analysts add in typical medical costs during retirement.
Even for people on Medicare, average health costs are a huge item. Financial analysts project that most retired couples will spend $200,000 on supplemental insurance, Medicare premiums, co-pays for chronic illnesses or serious accidents, and drugs, glasses, and other items only partially covered by Medicare.
“They are not going to be penniless because they have Social Security,” Munnell told me. “But it’s a very serious situation. Middle-class people are going to be very hard-pressed. People will feel destitute, absolutely forced to cut expenditures, maybe forced to sell their houses, forced to dramatically change their lifestyle. Making ends meet is going to be a consuming task. It will be the focus of their lives. And that is not what it was supposed to be. After a lifetime of work, that is a terrible state for older Americans to end up in.”
The Pitfalls
The puzzle is how did we, as a nation, wind up with such an enormous shortfall from a system that seemed so attractive to millions of average Americans who were eager to manage their own retirement savings?
After a quarter of a century, the reasons are now clear. Success requires discipline over a lifetime of work, but most people lack sufficient discipline, especially in the New Economy, where periodic layoffs force many average Americans to change jobs, employers, and 401(k) plans.
Retirement specialists like Brooks Hamilton and Alicia Munnell question whether, in this turbulent economy, the task of financing retirement is too fraught with risk and too complicated for most average Americans, especially the millions who are gun-shy about financial markets.
“The individual has to make a choice every step along the way,” Munnell observed. “The individual has to decide whether or not to join the plan, how much to contribute, how to allocate those contributions, how to change those allocations over time, decide what to do when they move from one job to another, think what to do about company stock. And then the hardest thing is, what are they going to do when they get to retirement and somebody hands them a check? How do you figure out how to use that money over the span of your retirement?”
These are the most common pitfalls that Munnell identified:
• No plan: Half of U.S. workers get no retirement plan from their employers.
• Failure to sign up: Historically, roughly 25 percent of those who are eligible have not signed up. Prodded by a new retirement law in 2006, about 40 percent of employers instituted automatic enrollment for new employees. That reduced nonparticipation to about 15 percent.
• Low contributions: Among eligible employees, 23 percent made no contribution in 2010. With automatic enrollment, typical contributions have declined and only 10 percent typically contribute the maximum.
• Leakage: People start out with good intentions but later drop out. The biggest leakage comes when people change jobs. Munnell reported that half of the millions of Americans who changed jobs in recent years also fully cashed out their 401(k)’s. Typically, that money never shows up again in retirement savings.
• Borrowing: Many other people use their 401(k) as a rainy day fund. They borrow from it to buy a pickup truck, remodel their home, get new furniture or appliances, send kids to college, or pay medical bills. “Now, they may even use [the money] for something good …,” Munnell observed, “but it means it’s not there when they come to retirement.” Even if they repay later, they have already lost the interest the money would have earned if it had been kept continuously in the 401(k). That defeats the vital compounding effect of long-term savings.
Even experts have trouble juggling all those problems, including Munnell, who has imposing academic credentials as a tenured professor of management sciences. “I have made virtually every mistake that I look out there and see other people doing,” Munnell admitted candidly. “We live busy, complicated lives. Saving for retirement is a really hard thing to do.”
When I asked her what went wrong, she laughed. “Everything! Everything has gone wrong …,” Munnell confessed. “I wish I could say that I’ve stopped making mistakes…. I’ve stopped taking money out because my children are grown. But I still buy high and sell low, because I get panicked when the stock market collapses and think, ‘God! I can’t lose all my money,’ and get out.”
In Bad Times, Companies Back Off from 401(k)’s
That panicky reflex during market collapses can hurt long-term retirement saving. Even for steady savers, recessions are a jolt. During the market collapse of 2008–09, 401(k) plan holders lost an estimated $2.8 trillion in savings—roughly 30 percent of their assets. By January 2011, they had recovered considerably, but they were still $800 billion below their 2007 savings levels.
People’s panicky reflex in bad times can compound losses. If, understandably, they decide to cut down or stop their 401(k) contributions, they lose an opportunity to make investments when stock prices are at bargain levels.
Many employers cut back, too. During the Great Recession, several hundred companies cut their 401(k) match contributions, including General Motors, Eastman Kodak, Saks, Sears, Motorola, UPS, FedEx, Hewlett-Packard, Resorts International, and National Public Radio. Overall, one in five employers reduced or eliminated their match; 30 percent reported a drop in employee contributions, according to the Profit Sharing/401(k) Council of America. A few reported that 30 percent of their employees had increased their contributions, and 10 percent of the companies increased theirs.
In June 2011, more than two years into the recovery, Corporate America was still pinching retirement pennies. More than half of the companies that had slashed their 401(k) matches still had not restored them. Their cutbacks and those of employees during the market lows of 2009 permanently hurt the long-term performance of hundreds of company 401(k) plans.
False Expectations
One basic problem that has come back to haunt many in the middle class, according to Jack Bogle, founder and longtime CEO of the Vanguard G
roup, an investment management company specializing in mutual funds, is that people had totally unrealistic expectations of stock market returns because of what Bogle called “the phantom gains” of the abnormally hot stock market of the 1990s. “The phantom wealth of the stock market gains fueled the notion that 401(k) investing was easy,” Bogle said. “Then the market went bust.”
By “phantom wealth,” Bogle means that stock prices were inflated by speculative fever that exaggerated the actual growth of the economy and individual companies. Bogle explained it this way: If a company generates 4 percent income a year and grows 6 percent, that’s a real gain of 10 percent; but if the stock price goes up 17 percent, speculative fever added 7 percent of phantom wealth. “The market in the 1980s and 1990s was going up 17 percent a year for two decades, year after year,” said Bogle. “We’ve never had that before and we’ll never have it again.” When the phantom wealth bubble burst, Bogle said, the 2008 market crash cost investors $8 trillion and sixty million 401(k) holders took an icy bath.
A reasonable growth rate, based on long-term market performance, Bogle averred, is 5 percent a year from an equal mix of stocks and bonds. With steady, patient investing over long periods, said Bogle, 5 percent a year delivers astounding results: $1 over forty years becomes $7.04, or $100,000 becomes $704,000. For retirement savings, the length of time is crucial. Over twenty-five years, Bogle calculated, that same $1 in savings goes up to only $3.39, not $7.04. The growth is slow at first, but it shoots up steeply in later years, said Bogle, “like the shape of a hockey stick.”
Who Stole the American Dream? Page 19
