Why 401(k)s Failed

July 5, 2011

As Boomers are preparing to retire, the news is full of stories about how their 401(k) plans are coming up short.  Most of the stories imply that it’s the Boomers own fault for not saving enough.  That explanation, though, grossly distorts the cause of the growing retirement crisis in the United States that was fueled by the wholesale conversion of tradition pensions to 401(k) stock market investment schemes beginning in 1981.

To understand why 401(k) plans are coming up short, it is necessary to understand how they are supposed to work. 

The basic idea is that participants will individually save for retirement through private accounts that are invested in stocks and bonds.  The accumulations from those accounts during working years are supposed to grow enough to finance living expenses during retirement years. 

Most people understand that much.  But that is only half the story. The other half is what participants are supposed to do with their accumulated savings once they retire.  There are many possibilities, but the most recommended according to the original theory of the 401(k) approach is to use the accumulated savings to purchase life annuities, which are sold mainly by life insurance companies.  In return for surrendering their 401(k) savings, annuity purchasers receive back a percentage of the purchase amount each month or other period of time for the rest of their lives.   

Life annuities are comparable to traditional pension payments since both guarantee predictable income until death, thereby sparing recipients the risk of outliving their source of income.

The ability of a 401(k) plan to provide adequate retirement security depends, it follows, on the size of the retirement savings accumulated during the working years and the payout rates of annuities at the time of retirement.   

The size of accumulated savings, in turn, depends on how much was invested in the accounts and how those investments fared in the stock market.  An account with little invested in it obviously is not going to pay off with handsome returns for retirement. 

Most people with 401(k) accounts, it is true, do not put enough in them to ensure retirement security.  The main reason, though, for them coming up short is not because of a lack of a savings ethic on their part.  It is because the savings necessary to ensure retirement security under the 401(k) approach is beyond the ability of anyone with ordinary incomes and expenses, including home mortgages and children’s college expenses.

The stock market is the other factor that affects the size of the accumulations in 401(k)s.  Since 1981 when they began, the stock market has risen greatly, leaving participants with the illusion that those rising values were ensuring retirement security. .

But as those stock market values were rising, annuity payout rates were falling.  In 1986 a life annuity purchased for $100,000 yielded a monthly retirement income of $977 for men and $931 for women—annuity companies discriminate against women by paying them lower rates to compensate for them living longer.  In 2010, an annuity for that same cost yielded only $631 for men and $531 for women–35 percent less.

Average Monthly Payouts for $100,000 Annuity Bought at Age 65

Year                Male               Female


1986               $977               $931

1990               $958               $865

1995               $808               $718

2000               $759               $693

2005               $647               $596

2010               $631               $591


Source:  Calculated from www.annuityshopper.com

401(k)s thus failed to deliver retirement security not so much because of the improvidence of Boomers, but because even if they saved a lot, the value of those savings in terms of future retirement income were continually falling due to the decreasing payout rates of annuities.  Those falling payout rates easily outpaced rising stock market values.  No one should be under the illusion that low annuity payout rates are temporary.  As the above table indicates, they have been in steady decline since 1986.    

Thirty years after its inception, it is clear that the 401(k) approach has failed working people by not delivering predictable or adequate retirement income. At the same time it has been an enormous success for the financial services industry that has siphoned off the accounts a bonanza of commissions, management fees, and profits.  Therein lies the reason why these powerful financial interests will make sure that they continue to be able to control the collective retirement savings of working people.  

James W. Russell

“Get Radical: Raise, Don’t Save, Social Security” by Thomas Geoghegan—New York Times op-ed article.

June 21, 2011

Thomas Geohegan’s “Get Radical: Raise, Don’t Save, Social Security” (New York Times, June 19, 2011) eloquently makes the argument that Social Security revenues and benefits both need to be raised, especially since 401(k)s have failed to provide sufficient retirement income.

Guest Post: Defined-Contribution Plan v. Defined-Benefit Plan by Glen Brown

June 12, 2011

 With a few exceptions, Defined-Contribution Plans were not initially created as retirement vehicles but rather as supplementary savings accounts
 With a Defined-Contribution Plan (401k, 403b, 457), only your contributions are defined
 A Defined-Contribution Plan shifts all the responsibilities and all the risk from the employer to the employee; thus, your benefit is not guaranteed
 Your benefit is based upon investment earnings
 A Defined-Contribution Plan does not have the “pooled investments, professional money managers, and shared administrative costs” that a Defined-Benefit Plan provides
 Your benefit ends when your account is exhausted
 There are no survivor or disability guarantees
 This plan does allow for portable assets
 Changeover costs to this plan would be significant
 Investment fees are paid by member
 On-going costs would be higher: in 2006, the expense ratio was 1.29%, 4.3x’s higher than a Defined-Benefit Plan; in 2004, the median cost was 1.4%, 4.7x’s higher than a Defined-Benefit Plan
 The State of Illinois will not “save money.” Most of the State’s obligation to TRS is for contributions not paid during the past several decades; therefore, the deferred cost of underfunding cannot be eliminated by switching to a Defined-Contribution Plan
 Shifting to a Defined-Contribution Plan can raise annual costs by making it more difficult for Illinois to pay down existing liabilities. The plan will include fewer employees and fewer contributions going forward
 Even with Defined-Con¬tribution Plan option, States and localities are still left to deal with past underfunding
 “There is a $6.6 trillion deficit between what 401k account holders should have and what they actually have.”

 Defined-Pension Plans are more certain
 You cannot outlive the benefit
 You are not affected by Market volatility
 Defined-Benefit Plan’s assets are held in trust and managed by professional investors
 Survivor and disability benefits are part of this plan
 This plan encourages a long-term career and stable workforce
 Since you do not or can collect Social Security, it is your retirement guarantee
 This plan is the best choice for middle-class retirement
 Teachers with a Defined-Benefit Plan are more likely to be self-sufficient and less likely to need public assistance
 Because teachers understand the value of such a plan, they are willing to give up higher wages
 TRS performance is well-diversified; it is in top ¼ of all public funds for the last 10 years
 Since 1982, the average rate of return has been 9.83 percent
 The costs for this plan are not excessive or expensive: 0.3% of total assets, and these costs are paid for by TRS.

Sources: The Teachers’ Retirement System, the Illinois Federation of Teachers, the National Institute on Retirement Security, Center for Retirement Research at Boston College, National Conference on Public Employee Retirement Systems, and Center on Budget and Policy Priorities


“Shedding Light on Excessive 401(k) Fees” – New York Times article

June 3, 2011

Ron Lieber’s “Shedding Light on Excessive 401(k) Fees” (New York Times, June 3, 2011) provides a useful concise introduction to the myriad fees embedded in 401(k) and other private retirement investment plans and how they add up to substantial losses for participants.

It is important though to note that even if courts or Congress find ways to lower those fees, which of course the financial services industry will fight with its substantial resources, including lobbyists, those plans will still not produce adequate retirement security for most.  Even in the best of situations with minimal fees, the same amount of money invested in traditional defined benefit pension plans would produce much more retirement security.

Traditional defined benefit pension plans have substantially lower overhead costs and fees than do 401(k) and other defined contribution plans.  That combined with the nature of the approach is responsible for them performing much better for participants.

See also “401k) Open and Hidden Fees” on this site.

James W. Russell

The Hammer and Anvil: Older Workers Pressured to Retire Despite 401(k) Crisis

May 29, 2011

In “Easing Out the Gray-Haired,” Nelson D. Schwartz (New York Times, May 28, 2011) describes the problem that law firms and other businesses have when older  workers resist retiring after their productivity has begun to decline.  It is in the interest of the firms, according to the article, to replace them with younger, more productive workers.

Aside from the ageism and age discrimination assumptions that infuse such arguments, a central problem is that Schwartz neglected to examine fully one of the major reasons why older workers are working past normal retirement age:  they can’t afford to retire without suffering serious plunges in their standards of living due to the 401(k) crisis.  The reader is left with the impression, rather, that these workers are simply stubborn or addicted to their professions.

Schwartz only in passing notes that 401(k) balances declined precipitously as a result of the 2008 recession, and that that may have something to do with older workers trying to hang on to their jobs.  These workers are doing precisely what financial experts are advising them to do when their 401(k) balances come up short.

The problem is not how to “ease them out.”  It is rather how to address the 401(k) crisis so that workers are not forced to involuntarily prolong participation in the active labor force. 

It is also a problem of how the failure of 401(k)s to provide adequate retirement security is aggravating unemployment since older workers cannot retire and make way for younger workers to replace them.

James W. Russell

National Teachers Strike Possible in UK over Pension Benefit Reductions

May 1, 2011


The largest union of head teachers in the United Kingdom may launch a national strike over a government plan to reduce pension benefits.  The government proposals would raise the minimum retirement age to 68 from 60 and 65, increase contributions, and base the amount of the pension on the career income average rather than final salary.

Stockman’s March to Social Madness

April 24, 2011

David A. Stockman, Ronald Reagan’s Director of Management and Budget, came right out and said it in an April 24, 2011 New York Times op-ed, “The Bipartisan March to Fiscal Madness:”  Social Security should be reduced to a means tested program that would benefit only the poor.

Instead of being the primary source of middle and working class retirement income, it would become a welfare program.

At a time when 401(k) type retirement plans have been exposed for not being able to provide anywhere near the retirement security that the traditional pensions that they replaced provided for working and middle class retirees who are now more dependent than ever on Social Security, removing that source of retirement income from ordinary people would be a road to social madness.

Stockman’s advocacy is consistent with the World Bank’s 1994 Averting the Old Age Crisis report that led to widespread disastrous privatization of national retirement systems in Latin America.

What neither he nor the Times disclosed is that since leaving the Reagan administration, he has become very rich through positions in the financial services industry, including in Salomon Brothers, the Blackstone Group, and his own company, Heartland Industrial Partners.  That industry stands to profit handsomely from all diversions of current retirement savings from Social Security to its own 401(k) like plans.

And, of course, Stockman has become so rich from the financial services industry that he has no personal need for Social Security benefits during his own retirement.

James W. Russell

Removing the Income Cap and Taxing Property Income: Two Easy Ways to Assure Social Security Solvency

April 19, 2011

The alleged long term shortfall in Social Security revenue can be easily remedied if the rich were required to pay taxes for the program based on their total incomes as they are required to for other parts of the federal budget such as defense. Right now they pay Social Security taxes on currently only the first $107,000 of their wage and salary income and nothing on their property income, which is the largest source of their total income.

As the below table indicates, for those earning under $100,000, about 79 percent of their Adjusted Gross Incomes come from wages and salaries. But for those receiving over $100,000, forms of property income – profits, dividends, interest, rents, etc. – make up increasing shares of AGI. At some point between $300,000 and $500,000 property incomes surpasses wage and salary income. As a result, those who receive more than $100,000 together receive a greater share of national income than under $100,000 earners but they collectively support Social Security less.


Income Class and Tax Support for Social Security


Adjusted Gross Income           % Income Subject to

                                                             Social Security Taxation


Under $25,000                                             78.6

$25,000 under $50,000                              82.2

$50,000 under $75,000                              79.4

$75,000 under $100,000                            78.2

$100,000 under $200,000                          63.9

$200,000 under $500,000                          28.4

$500,000 under $1 million                         11.5

$1 million under $5 million                           4.0

$5 million under $10 million                       1.1

$10 million and greater                               0.3


Source: Calculated from Internal Revenue Service, Table 1.4 “Individual Income Tax, All Returns: Sources of Income, Tax Year 2006, http://www.irs.gov/taxstats/indtaxstats/article/0,,id=134951,00.html#_pt11

The higher the income over $94,200 in 2006 – the last year for which full tax statistics exist – the greater the proportion of AGI that is shielded from Social Security taxation for two reasons. First Social Security taxes (6.2 percent for both the employer and employee) were collected on only the first $94,200 of wage and salary income. Second, no Social Security taxes are paid on property forms of income.

Social Security revenue could be significantly increased by removing the cap on wage and salary income and exposing property income to taxation.  Removing the cap, by my calculation, would have added $111.6 billion to the $677 billion collected that year – a 16.5 percent increase that would have been much more than sufficient to insure solvency. Revenue could have been enhanced a further $91.1 billion if enough of the nonwage income of those receiving over $100,000 was included so that at least 79 percent of their Adjusted Gross Income was exposed to Social Security taxation as is that of those earning less than $100,000.

These reforms would go far beyond insuring the current benefit levels of Social Security. They could and should be the first steps toward expanding Social Security benefits.

James W. Russell 


From Connecticut to Chile: The Neo-Liberal Assault on Retirement Security (article)

April 8, 2011

Reposted from This Week in Sociology, April 4-10, 2011, edition 3


Since 1981 shaky 401(k) schemes that depend on stock market investing have increasingly replaced secure, traditional pensions in the United States. The financial services industry encourages a belief that these schemes produce generous benefits. But 30 years after their introduction, the first generation of workers to retire with these plans has learned they produce less than half the benefits of the pensions they replaced.

Even before the stock market crisis of 2008, signs were everywhere that very few people would accumulate enough wealth through these accounts to ensure financial security. As a result, most people expect to work longer and experience a dramatic decline in their standard of living when they retire—if they can retire.

401(k) benefits are lower than those of traditional pensions because the financial services industry drains considerable management fees, commissions, and profits from the accounts involved; and individual plans lack the advantages of risk pooling that traditional pensions have. In the strange language of pension economics, it is a risk that someone will live longer than average, thus taking out a larger share of investment.  Of course living a long life is a good thing.  The risk is that one will outlive her or his income.  With traditional pensions, funds built up by those who die early stay in the system to add to the lifelong support of those who live longer—unlike with 401(k)s where those funds are inheritable by younger family members and thereby drained out of the systems.  In other words, because of traditional pension risk pooling, the short lived subsidize the long lived.

Those who still have traditional pensions, mainly public employees (school teachers, fire fighters, etc.) now find themselves under attack for having decent retirement plans. The financial services industry – aided and abetted by conservative think tanks – has mounted a massive propaganda campaign to convince taxpayers that public employee pensions are the primary cause of state budget deficits. They claim privatized plans would result in significant savings over public pensions and Social Security.

This attack on public pensions amounts to a massive class swindle. The financial services industry is raiding the collective retirement savings of tens of millions of people to inflate its own profits, which have grown enormously at the expense of most peoples’ retirement security. But undermining retirement security in the United States is part of an international pattern promoted by the World Bank, conservative think tanks, and the financial services industry in general.

In 1981—the same year 401(k) plans expanded in the United States—the Pinochet military dictatorship privatized the entire social security system of Chile.  In 1994, after the restoration of formal democracy in Chile, the World Bank endorsed the private model and urged all Latin American, formerly communist Eastern and Central European, and Western European countries to adopt it.  This plan had the most success in Latin America where by 2000 over half of the region’s citizens lived in countries that had partially or fully privatized their national retirement systems. By that same year, however, the first generation to retire under the privatized Chilean system realized—like 401(k) participants in the United States—that their retirement incomes would be far less than promised than those who had stayed in the country’s traditional pension system.

U.S. College professors who have TIAA-CREF and similar plans have also fallen victim to the same swindle since those are variations of the 401(k) approach. In Connecticut public university teaching and administrative employees were eligible to choose a 401(k) type retirement plan originally administered by TIAA-CREF (now by the Dutch financial giant ING) or join the state’s traditional defined benefit pension plan. Most, deceived by the claim that they would do better under the 401(k) type plan, chose it. After years in the plan, they realized that they were paying more than twice the contributions as colleagues in the traditional pension plan yet would receive less than half the retirement benefits.

As in Chile, a movement developed among Connecticut state employees to allow them to switch from their failing plan to the much better traditional pension plan.  A rank and file organization with members in several state employee unions, the Connecticut Committee for Equity in Retirement (CCER), initiated and led the campaign.

Faculty filed a grievance through their unions claiming they had been unfairly steered into the 401(k) type plan when the much better traditional pension plan was available.  On September 22, 2010 an arbiter ruled in their favor – finding that faculty had not been given sufficient information to make informed choices nor had they been told that their decisions, once made, would be irrevocable. As a remedy, the arbiter ordered that they be allowed to voluntarily transfer to the pension plan using accumulations from their defined contribution plans to purchase credit for years of employment.

The Connecticut state employees joined West Virginia schoolteachers who won a similar victory in 2008. Both were significant precedent-setting victories over the financial services industry which has succeeded in transforming the great majority of private sector retirement plans from secure traditional pensions to much less secure and adequate—but more profitable for itself—401(k) like stock market investment schemes and is seeking to do the same with public sector retirement plans.

The transfer in Connecticut was supposed to be accomplished by December 31, 2010.  However, the Retirement Commission, in violation of the terms of the Grievance Award, delayed it based on advice from an anti-union corporate law firm it had engaged.  The firm alleged that an Internal Revenue Service preauthorization through a Private Letter Ruling was needed—a complicated process that could take up to two or more years.

The delay will benefit ING, the third party administrator of the plan, which collects millions of dollars in fees for each year that it maintains control of these retirement savings. CCER is now urging their unions to contest this delay on the grounds that other states that have allowed similar transfers from defined contribution to defined benefit plans have not required IRS preauthorization.

The Connecticut struggle is part of a small but growing movement against 401(k) retirement plans. A parallel campaign exists among Massachusetts state workers. Both hope to achieve the success of West Virginia schoolteachers who in 2008 were able to transfer from their failing 401(k) type plan into the state’s much better traditional pension plan.

James W. Russell

From Connecticut to Chile: The Neo-Liberal Assault on Retirement Security (video)

March 28, 2011

You Tube video of James W. Russell speaking at the Left Forum, Pace University, New York City, March 19, 2011.  Click here.