Most of us are willing to help out those who are less well off. Whether it comes from religious belief or a sense of basic decency we feel are an obligation to provide the basic necessities of life for the poor. But how would we feel about being taxed $1,000 a year to provide six figure salaries to people in the financial sector? Although no candidate to my knowledge has ever run on this platform, this is the nature of the retirement system the federal government has constructed for us.
Twenty or 30 years ago, most middle-class workers had defined benefit pensions. This meant that they could count on a fixed benefit that was some fraction of their average salary during their working years. For example, a person who spent 30 years at a company may be entitled to a pension that was equal to 60 percent of their average salary over their final five years of work.
With a defined benefit pension system, most of the risk was born by the employer. The worker did not have to worry about the stock market being down when she chose to retire. Nor did it matter to her if the pension made bad investment choices; the employer was liable for the promised benefits, unless it went bankrupt.
The virtues of the defined pension system can be exaggerated, although recent research indicates it provided more retirement income than we had recognized. Workers who changed jobs frequently or worked part-time rarely qualified for pension coverage. This excluded many women, African American and Latino workers. But for those who were eligible the defined benefit system provided a substantial degree of retirement security.
That is not the case with the system of 401(k)s and IRA(s) that replaced the defined benefit system. Many workers are never able to put enough into their retirement plans to accumulate much towards retirement. In addition, there is no way to completely avoid the risk that the stock market can take a plunge as workers approach retirement. And some people will inevitably make bad investment choices.
However, there is one item that can be controlled. This is the fees that workers pay on the money they have in these accounts. These fees average 1 percent a year on the almost $6 trillion in 401(k) accounts managed by employers. There is a wide range for the fees on the $8 trillion held in IRAs, but many people pay more than 1 percent annually on these accounts as well.
If a 1 percent annual fee seems like a small deal, then you should probably let someone else manage your account. Suppose you have accumulated $100,000 in a 401(k) or an IRA, a reasonable amount for a middle class person nearing retirement. A 1 percent fee means you are paying $1,000 a year for someone to hold your money and send you quarterly statements telling you how much money you have in your account.
It’s important to realize that this 1 percent fee is not for actually managing the money. These accounts typically offer a range of funds, each of which charges its own fee to cover the cost of managing the fund. For example, a 401(k) might offer a variety of stock, bond and money market funds in which you can invest your money. Each of these funds will charge a fee that covers the cost of investing the money placed in the fund. The 1 percent fee charged by the 401(k) is an addition to these fees.
What is the actual cost of holding your money and sending out quarterly statements? Vanguard, the biggest of the investment funds, doesn’t charge its customers anything to manage their accounts. They skim a small amount off the fees charged by the individual funds to cover overhead costs. This means that the 1 percent, or $1,000 a year, that 401(k) holders pay to manage their account is entirely an excess charge.
Think of it like going up to a person asking for money on the street and handing them $1,000. Only in this case, the person getting the money probably has more money than you do.
There are ways to rein in these costs. Several states — including California, Illinois and Oregon — have passed legislation that allows workers in the private sector to buy into low cost funds managed through the state. These public systems are supposed to go into operation over the next few years. Presumably, other states will follow this model if these systems prove successful.
At this point, the biggest question is whether these programs will get off the ground. The Trump administration has been trying to sabotage them, using an interpretation of the Employee Retirement Income Security Act (ERISA) that would ban the state-run funds. Apparently Trump is concerned that his friends in the financial industry could not survive if they faced competition from the government.
The future of these publicly-run systems is unclear at this point. It would be a huge step forward if 401(k) and IRA managers simply had to disclose their fees in their quarterly statements, but like cockroaches, they want to remain in the dark.
For now, you should just get used to the idea of these big handouts to the financial industry. You can console yourself with the thought that these are people who probably could not earn an honest living without help from the government.
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Our task is formidable, and it requires us to ground ourselves in our principles, remind ourselves of our utility, dig in and commit.
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