Even middle-class workers who diligently save are unlikely to accumulate enough to support them in retirement. The plans may be loaded with employer stock that employees are locked into, and the accounts are collections of investing accidents that are even less likely to survive the inevitable market meltdowns. At the end of the day, 401(k)s have been a boon primarily for high-income employees, who can afford to save, and who simply move existing assets into tax-sheltered retirement plans.
These deficits have been well documented. They aren’t the only ones. Like pensions, 401(k)s have a hidden history, and a darker side. That’s why the “solutions” to improve 401(k)s won’t work.
For one thing, despite the 401(k) plan’s image as a democratic savings plan for the masses, it was never intended to be a savings vehicle for the rank-and-file. Employers first set up 401(k)s in the early 1980s so managers could defer their bonuses. The IRS stepped in, saying that taxpayers shouldn’t be subsidizing a discriminatory system. To keep the tax breaks, the plans had to cover a broad group of the rank-and-file.
If the IRS had said “all employees,” or “all employees whose last names begin with the letters P through Z,” there would be no question about who could or could not participate in the 401(k). But, as we’ve seen, employers took advantage of loopholes in the discrimination rules to exclude millions of low-paid workers, provide them with less generous contributions, and make it hard to join the plan and build benefits. In short, many companies have continued to manage 401(k)s for the benefit of the highly paid.
With this in mind, consider the employers’ proposals to increase participation among the lower-paid. One is “automatic enrollment,” enacted in the 2006 Pension Protection Act, which was sold as a way to include participation among the low-paid, because employees are automatically signed up unless they opt out. As long as employers merely offer automatic enrollment (even if low-paid employees opt out) and contribute 3 percent to their accounts, the plans don’t have to pass discrimination tests.
In the abstract, automatic enrollment sounds great. But plug in some real numbers and the picture isn’t so rosy. For a nurse’s aide making $20,000 a year, the 3 percent contribution will cost the employer just $600. That won’t exactly break the bank. But employers are now lobbying for “relief” from the mandated 3 percent contribution, citing hard times. They still want to have the safe harbor from the discrimination rules, though.
They also continue to lobby for a repeal of the contribution limits, currently $16,500 a year for an employee, saying that this would increase retirement savings. It would—for the highly compensated employees who are already saving. Employers would also benefit, because more of a highly paid employee’s savings would be in the 401(k) rather than the unfunded deferred-comp plan.
But how would allowing the highest-paid employees to save more—including those with far more lucrative deferred-compensation plans—improve savings rates for the low-paid? Employers’ answer: By giving executives more of a stake in the small-fry 401(k), they’re more likely to maintain it, not eliminate it altogether.
Not likely. Employers enjoy too many benefits from 401(k) plans.
ESOPs FABLES
We saw in Chapter 1 how many 401(k)s were created to enable companies to capture surplus money from pensions they terminated: By setting aside 25 percent of the surplus in a replacement plan, like a 401(k), they could pay only a 20 percent tax on the rest of the money, and keep it.
Companies then began using employee stock ownership plan (ESOP) assets to fund their contributions to 401(k)s, an arrangement called a KSOP. Since the early 1990s, more than a thousand companies, including Marriott, McKesson, Bank of America, Verizon, Sears, McDonald’s, Parker Hannifin, Procter & Gamble, Abbott Labs, and Ford, have quietly adopted this new hybrid structure.
One way this works: An employer that wants to build a factory might borrow $100 million from a bank, use it to buy $100 million of its own shares, and contribute the shares to an ESOP. The ESOP repays the bank, and the employer contributes an equal amount to the ESOP. The employer than taps the shares to contribute to employees’ 401(k) accounts.[21] By funneling loan money through ESOPs, employers can deduct both the principal and interest on their loan repayments, reducing borrowing costs by as much as 40 percent. KSOPs provide employers with an additional tax break: They can deduct the dividends on the company stock they contribute to 401(k)s, a move worth tens of millions of dollars a year to large companies. KSOPs demonstrate the dual purpose retirement plans often have: They enable employers to get low-cost loans while inexpensively funding their retirement plans.
There’s nothing inherently wrong with a company trying to maximize its tax savings, but it isn’t always a win-win situation for employees. Like the hybrid pensions companies were adopting in the 1990s, these hybrid 401(k)s provide benefits to the employers, sometimes at the expense of employees.
More than 10 percent of the total assets in 401(k)s is invested in employers’ own stock, and at some companies the percentage of employer stock in 401(k)s is even higher, which leaves employees dangerously exposed to the fate of their company and industry. If a money manager put that much of a pension plan’s assets into a single stock, he’d be fired for idiocy and sued for violating fiduciary standards. But retirement savings plans—where the employees bear all the risk—are exempt from “diversification rules” that make it illegal to invest more than 10 percent of a pension plan’s assets in the employer’s own securities. This lack of diversification led to some spectacular debacles, including the $1.2 billion employees at Enron lost when the tech bubble burst.
RISK DIFFERENTIAL
The miracle of the 401(k) was again put to the test in 2008. During the worst market meltdown since the dawn of 401(k)s, fifty million workers lost a total of at least $1 trillion in their 401(k)s when the market cratered in 2008.
Jacqueline D’Andrea, of Henderson, Nevada, was among them. She lost more than 60 percent of the 401(k) savings she’d built over a decade as a manager at Wal-Mart. Her account had grown to almost $20,000 by the beginning of 2008. By the end of the year it had fallen to $6,000. When she lost her job in May 2009, D’Andrea, forty-eight, cashed out her account to pay for living expenses until her unemployment check kicked in. She’s learned her lesson, she says: If she ever has a job again that offers a 401(k), she’ll steer clear. “It’s too risky,” she says. Other Wal-Mart employees did better, but, overall, the 1.2 million employees in the retailer’s 401(k) retirement plan lost 18 percent as the market plunged. Even the employee discount isn’t going to make up for that.
The outcome was different in the corner office. Chief executive H. Lee Scott Jr.’s supplemental retirement savings plan had a guaranteed return of 6.6 percent, which added $2.3 million to his account during the investment storm, bringing the total to $46.7 million.
Employees are expected to bear all the investment risk in their 401(k)s, but when it comes to the executive equivalent of 401(k)s, their deferred-comp plans, that isn’t always the case. The same year that employees were losing upward of 40 percent of their savings, one-quarter of top executives at major U.S. companies had gains in their supplemental executive retirement savings plans that year, thanks to the guaranteed returns many receive.
Comcast, the giant cable operator, provides top executives with a guaranteed 12 percent return on their supplemental savings. This produced $7.4 million in gains for executive vice president Stephen Burke in 2008, boosting his deferred-compensation account to $71 million. The 72,000 Comcast workers lost 28 percent of their savings, a total of $649 million. The average account size by the end of the year: $24,000.
“When the market went down, executives in fixed plans were happier than hogs,” said a benefits consultant in Sacramento who works with employers.
One would think that at the other 75 percent of companies, which don’t offer guaranteed returns for top management, the executives would face the same risk as the employees. Typically, they’re given investmen
t selections that mirror the mutual funds available in the employee 401(k) plans.
But they don’t necessarily face the same risk. Even when given the same investment selections as employees, some executives managed to pick only winning funds.
Don Blankenship, CEO of Massey Energy, the controversial coal company, could have elected to allocate his supplemental savings among eight investment options, including small capitalization, international, and index mutual funds. Most of these funds were down 40 percent or more in 2008. But Blankenship’s account had earnings of $909,939 that year because he apparently allocated his $27 million in savings to the only fund among the eight that had a positive return, Invesco Stable Value Trust, which was up 3.4 percent. Massey employees, who had the same fund selections as the executives, lost a total of $44 million, or 25 percent of their savings.
Top officers at Cummins Inc. also had a choice of investment options: the return on the S&P 500 Index, the Lehman Aggregate Bond Index, or 10-Year Treasury Bill + 2%. All the top executives selected only winning investment options, and had a total of $1.4 million in gains on their accounts. Meanwhile, the employees of the Indiana-based engine maker lost 12 percent on their 401(k) retirement accounts. A spokesman had an explanation for this investment success: “These are more senior people who can be expected to make more conservative investment choices than a 25 year-old in the 401(k).”
Employees who saw their retirement savings slaughtered then had another setback: Hundreds of companies stopped contributing to the 401(k) accounts at all. United Parcel Service was one of the larger ones: It suspended contribution to its 60,000 employees’ 401(k) plans in 2009. The move saved the global package delivery company $190 million that year. The company blamed the “challenging worldwide economic environment” for its decision.
But the company’s cost cutting didn’t extend to stock awards for highly paid managers and executives: It paid a few thousand of them more than $450 million in stock awards that year, an increase of almost 10 percent over the year before. “The Compensation Committee believes that the retirement, deferred-compensation and/or savings plans offered at UPS are important for the long-term economic well-being of our employees, and are important elements of attracting and retaining the key talent necessary to compete,” noted the March 2009 proxy.
UPS is part of a broader trend that hasn’t been highlighted in annual reports, analyst surveys, or benefits consultants’ reports to the media: Even as they limit or suspend contributions to 401(k)s, employers have been awarding a growing amount of stock compensation to their upper ranks. This isn’t just stock options, whose ultimate value can be a crapshoot. Most of this is in the form of restricted shares, which have an actual, defined cash value to the recipient.
Comcast’s expense for stock awards and options was $208 million in 2008, up 27 percent from the year before. The expense for the 401(k) plan: $178 million.
Honeywell employees also took a one-two blow to their 401(k)s. The 178,000 employees in the “Savings and Ownership Plan” (a KSOP) lost 29 percent of their savings. Senior managers at the engineering-and-aerospace conglomerate, however, enjoyed guaranteed returns ranging from 6.3 percent to 10 percent. The next year, in 2009, Honeywell cut its 401(k) match in half and said it wouldn’t increase it “until there is greater certainty in the economy.” By 2010, the expense for the 401(k) plans had fallen to $105 million from $220 million in 2008. Stock compensation expense, meanwhile, grew 28 percent over the same period, to $164 million.
Regardless of whether companies are suspending contributions, dozens are spending more on stock awards than they are for 401(k)s: Kraft Foods, State Street Bank, Dell, Marriott, and International Paper, just to name a few.
The trend hasn’t been studied, but it might be worth a look. Employer contributions to 401(k) plans and awards of restricted stock have a lot in common. Both are forms of deferred compensation—i.e., pay for services rendered today that employees don’t receive until later. Both are subject to vesting rules, meaning that employees and executives can forfeit the company contributions if they don’t stay long enough to lock them in. Employees don’t pay income taxes on contributions to 401(k)s until they withdraw the money, nor do they owe income taxes on restricted shares until they cash them in.
The chief difference, as we’ve seen, is that savings plans for employees don’t create a liability; deferred comp and restricted shares do. So, as companies shift more of their retirement resources from employees to executives, they’re also adding to their retirement obligations.
HELPLESS
The architects of today’s retirement mess—consultants and financial firms—have also played a non-starring role in the public pension debacle. The difference was that, while they helped private employers hide pension cuts and exaggerate their pension woes, they also helped public employers quietly boost benefits and hide the growing liabilities.
They not only helped private companies drain assets from pension plans, but also helped public employers avoid contributing in the first place, enabling legislators and politicians to conjure up cash for popular projects, without raising taxes, and look like community heroes.
And while they were helping private employers to load their retirement plans with stock, some consultants and financial firms duped many public pension managers into investing in complex and risky derivatives whose value later exploded, just like the subprime loans with low teaser rates that predatory lenders conned millions of homeowners into.
In the private sector, current and future retirees are bearing the brunt of the retirement heist; in the public sector, the carnage is being borne by the employees and by the communities around them.
The scapegoat game continues. Corporate employers are still blaming aging workers, retiree “legacy costs,” and “spiraling” retiree health care costs for their financial woes—not their own actions that squandered billions of dollars in pension assets, their thinly masked desire to convert benefits earned by and promised to retirees into profits for executives and shareholders, and their willingness to sacrifice retiree plans, and the well-being of retirees, for short-term gains.
In the public plan sector, the scapegoats are the public employees and retirees, who are beginning to have the haunted look of victims of the Salem witch hunts. The real culprits are the self-serving politicians and officials who passed the funding buck to future generations, the consulting firms that helped them do this, and the investment banks that conned local governments into investing taxpayer-funded pensions in risky, abusive investments.
The reforms employers are pushing today are the same reforms the ERISA Advisory Council proposed when it met in 1999 to discuss the “problem” of companies having too much surplus in their pension plans: Allow employers greater latitude to use pension money to pay retiree health and layoff benefits, ease funding rules, lift funding ceilings, and lift the benefits limits in 401(k)s and pension plans. The latter recommendation would facilitate discrimination in retirement plans and enable employers to shift billions of dollars of executive liabilities into their regular pension plans. More quietly, employers and insurers are looking to ease restrictions on buying life insurance on workers, which they supposedly use to pay for retiree health benefits but actually use to finance deferred compensation.
Though characterized as reforms that would improve retirement security, employers propose them with a veiled threat. They remind lawmakers and regulators—as they have for the past thirty years—that it’s a voluntary system, and they don’t have to have pension or retirement plans at all. If they don’t get their way, they might just pull the plug on their plans altogether. This often causes lawmakers to fall in line. (And besides, who isn’t for retirement security?)
But this threat is the equivalent of a five-year-old threatening to hold his breath until he turns blue. The fact is, employers can’t fold their benefits tents at will: The pensions people have earned are legally earned delayed compensation, protected by law. (Though they can be
cut or frozen going forward.) Retiree health benefits for unions are protected by negotiated contracts. Employers have put pretty much everything else—future pension accruals, retiree health for salaried retirees—on the chopping block already. Or can at any moment.
And, of course, the “pull-the-plug” threat is a bit less effective when companies have already frozen their pensions. The only move left is to terminate the plans. But they aren’t going to do this, either. Not yet. Unless the pension is woefully underfunded and a candidate for dumping in bankruptcy, a frozen pension plan is more valuable alive than dead.
Apart from all their other benefits for employers, frozen pension plans can function as shadow plans for executive liabilities. The investment returns offset the cost of the executive obligations, and the frozen plans often contain QSERPs, the mini–executive pensions that employers carve out within the regular pensions by taking advantage of loopholes in the discrimination rules.
The assets in pension plans have largely recovered from the market crisis losses, and, as interest rates finally begin to rise from their historic lows, liabilities will fall. The surpluses will build again and be available for a variety of corporate purposes. And unless employers withdraw the money, when the surplus is substantial enough, companies may pull the plug on their pensions and use the termination loophole to capture much of the surplus money. At that point, the only pensions left will be for the executives.
This is the hidden history of the retirement crisis—a story that hasn’t made it to Fox News, the Huffington Post, or even Comedy Central. This retirement heist has produced a transfer of benefits earned by three generations of post–World War II middle-class workers to a comparatively small cohort of company executives, shareholders, and the financial industry that orchestrated the plunder.
Retirement Heist Page 22
