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401(k) and the Financialization of Retirement

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Labor economist Teresa Ghilarducci: The whole 401K structure has a fatal flaw and older workers are going into retirement with not enough money to maintain their living standards.

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Baltimore.

With all the recent discussion and debate about President Obama’s proposed reform to Social Security in his new budget—one of the fears of which by some people is any reform begins to open the door to either more cuts to Social Security benefits, or even open the door to privatization of Social Security, something that’s been the dream of some people, including President Ronald Reagan and others that came after him, and especially President Bush, the idea that everybody would have a private Social Security account that they would then invest. And as some people have said, that’s almost a wet dream of Wall Street. Well, at any rate, there is already financialization of retirement taking place that’s not getting much discussion.

And now joining us to talk about that is Teresa Ghilarducci. She’s a labor economist and a nationally recognized expert in retirement security. She taught economics at the University of Notre Dame for 25 years, is currently the director of the Schwartz Center for Economic Policy Analysis at the New School for Social Research. And her most recent book is When I’m Sixty-Four: The Plot against Pensions and the Plan to Save Them.

Thanks very much for joining us, Teressa.


JAY: So while privatization hasn’t yet hit Social Security, it has hit much of American seniors’ retirement funds. So what exactly has been happening?

GHILARDUCCI: Well, over the past 35 years, the United States has embarked on an experiment. And the experiment I like to call the do-it-yourself retirement system. So that experiment was aided and abetted by employers and by Congress and many presidents that enabled a transformation of people’s pensions from what’s called a defined benefit or a traditional pension, where your pension was based on your years of service and your salary at the time. The employer made contributions, but of course workers gave up implicitly some wages so those contributions could be made. But when you retired, you knew that you would get a set amount of income for the rest of your life. It was paid in an annuity.

And over time, workers’ bargaining power, because a lot of unions had been lost and a lot of new big employers came on the scene, like Walmart, that never had a traditional pension, just had what—the system is called a 401(k) system. That system was built in the 1970s for executives to put on top of their defined benefits system, and it’s a way to save pretax money at work into basically a whole suite of mutual funds that are chosen by your employer. So the idea is that you, as a worker, trigger a contribution from your employer into your 401(k), and then your employer chooses a bunch of investments that you can invest in.

And then you’re on your own. You decide where to put your money and how much money to put in that retirement plan. If you leave, you can take the money with you, or you can keep it at your company, or you can withdraw it—and a lot of people do. And in many companies, if you have a hardship, you can withdraw the money.

The whole structure of this system has been played out. We’ve seen how it has happened in the past 35 years. And the whole structure at almost every point has a fatal flaw. And so now older workers are going into retirement with not enough money to maintain their living standards and actually not enough money to live as well, relatively as well as their parents or grandparents. So I am looking at and many other researchers are looking at a real retirement crisis [crosstalk]

JAY: Well, hang on. Before we get into that further, just explain just what’s wrong with the 401(k). The basic issue is that it’s shifting, basically, a risk, essentially, of the stock market onto individuals who, one, have no experience to make these kinds of decisions. And why should you risk your retirement income?

GHILARDUCCI: So if you’re lucky enough to have a 401(k) system—and I’ll go back to that part—you are required to decide what Wall Street fund to put your money in and what amounts and, you know, what proportions. So all of a sudden, instead of having your company’s pension fund managers manage your money professionally, you, whether or not you’re an insurance agent or a professor of humanities or something else, you’re required to actually invest your own money. It’s as if the country said, okay, for the next 35 years, you have to pull your own teeth or you have to do your own electrical wiring or you have to do your own home building. You are asking people to be an expert in areas where we’re not trained.

You know what that means? That means you have the same results as you would if we pulled our own teeth or did our own wiring. We have a lot of botched up portfolios out there, and people are paying very high fees to Wall Street firms for mutual funds they should never have had anyway. So that’s one big problem with a 401(k).

JAY: And why should your retirement be linked to speculating on Wall Street anyway? I mean, this is a great boon for Wall Street. It opens up all the fees and all the money for them to take that money and then go speculate with it. But we saw what happened in 2007 and 2008, how great they are at making these kinds of speculative decisions, and then people have lost their retirement.

GHILARDUCCI: Yeah. I mean, you’re right. The 401(k) system was fairly popular because people thought they would get double-digit returns forever.

JAY: Yeah. It’s the same way American real estate is never going to go down.

GHILARDUCCI: Right. And at the same time they were actually looking at, fondly, their 401(k) balances, they were also getting themselves into debt buying homes that would never go down in value. So the 2008 financial crisis really hurt people in very real ways, but it also woke us up and let us look at this system, this experiment. And I deem it a failure.

JAY: So for workers that still have a defined benefit plan—and a lot of them, there’s fights taking place still in various negotiations and even strikes that are taking place, or workplaces that have lost it. I mean, is one route to try to get back a defined benefit plan or defend the one you have?

GHILARDUCCI: Well, certainly, to defend the one you have, it’d be hard to have your employer who’s been, you know, used to a 401(k) platform to go back to a defined benefit plan. But it has happened. There were experiments with the West Virginia teachers, with Nebraska state employees, with Indiana employees of the Bureau of Motor Vehicles. Those are three employers that went to a defined contribution or a 401(k) type system, and they scuttled that to the DB system. So it can happen. Mainly people who have defined benefit plans at work, in big corporations, in public employment, should fight to keep them. And employers, if they take a second look—and many, many have—realize that it’s actually cheaper to invest $1 of retirement assets in a defined benefits system than it is in a 401(k) system. You get a better bang for your buck if you put money into a DB system than you do in a 401(k) system.

And the reason for that is simple: 401(k)s are managed by individuals who are not trained to manage money. And so, many mistakes are made on the road to retirement, and it just dribbles out in big chunks, in little chunks, retirement assets, in fees and withdrawals, and you get to the finish line and you get to your retirement day, and you have many more big chances of having really good, adequate retirement in those traditional plans than you do [crosstalk]

JAY: Okay. I just want to just once more, especially for younger viewers that may not have encountered this yet at work, the defined benefit plan means when you get to retirement, you know that a certain percentage of the salary you’ve earned is going to be your retirement income. And it doesn’t matter what happened to the investments; you’re going to get that much money. The other plan is you define how much you pay in, but you have no idea what you’re going to get out of it.

GHILARDUCCI: Right. I mean, you put money into it, so you have an idea how much you want out of it and kind of estimate you’re going to get a certain rate of return. But people don’t estimate, don’t really appreciate how much the fees are draining their retirement assets. But the average fee takes 20 to 30 percent of a person’s retirement assets. They pay—an average household can pay up to $200,000 over their work lives in fees with no commiserate increase in the rate of return.

JAY: So I go back to my earlier question: why should any of this be financialized? In fact, even the defined benefit plans, you wind up with these enormous union-run pension funds. But why even that? Why not people just pay more into Social Security and have a guaranteed payout when they retire?

GHILARDUCCI: Well, some of it’s an historical pass, which is that we would have a base of income coming from retirement, from Social Security, which is, you know, our baseline. Most people get most of their money from Social Security when they retire, especially lower-income people. It’s a good base. And if you have more dependents or if you have a disability, you’re covered more than other people. If you live longer, you get more. There’s partial insurance and partial income support.

On top of that, we have always added a tax-favored funded system. So the idea is that if you put $1 in now, that $1 will earn a rate of return, and then you can actually retire with partial contributions and partial earnings. So it’s a little cheaper to actually put money into financial assets. Now, if you put it into government bonds, then the income you would get would come from taxpayers paying interest on government bonds. If you buy a General Electric stock, then when you retire it’s the shareholders, the consumers of General Electric who will pay you when you retire, so it’s basically the same thing. You rely on the productivity and the full employment and the wages of the current generation to pay for the older generation’s retirement. You need—it is an intergenerational compact. We just happen to arrange it so that Social Security is pay-as-you-go and the other layer is fully funded.

JAY: But I’m just saying the other layer embroils you in the financialization into Wall Street, into how, like, your life is so linked to the markets.

GHILARDUCCI: But you know what? So is—and we’re linked to our markets, but in many arrangements, we are more protected than others. So think about homeowners insurance. I live in an area that was hit by Hurricane Sandy. I got a lot of money from my insurance company to replace my car and some damage to where I live. That money was financialized. It was in insurance markets. That insurance company invested in the private markets. But the deal with me is that if I lost something, they would pay me, and they had to deal with the ups and downs in the market. If I had a defined benefit plan—and part of my pension is in a guaranteed asset—those assets will go up and down, but I don’t feel that variation.

So, many of our lives are financialized anyway. If we have private insurance, that’s where it is. It’s actually how exposed we are to that risk is what’s at stake.

JAY: Well, I guess it’s partly another discussion. There certainly is—like, in Canada, there’s various provinces that have public auto insurance.


JAY: And, in fact, the public auto insurance, when you compare the public to the private auto insurance, the studies I’ve seen is the public auto insurance is actually more efficient. There’s paying out premiums as well or better. But it’s a somewhat different discussion we’re having. So what would you like to see? What do you think is the way people should be dealing with their retirement savings?

GHILARDUCCI: Well, you know, actually, your comment that there are a lot of ways to arrange our insurance, you know, and people’s desire to have a certain amount of money for the rest of their lives is actually quite pertinent, what they do in Canada.

So let me talk about, you know, a better plan, which is that all Americans—you know, and most Americans are not in a 401(k) system or a defined benefit plan. So let’s not forget the people listening to this program or people you know who don’t have any kind of plan at work to save their money. That’s—a big part of the 401(k) system doesn’t even cover everything.

JAY: And let me just quickly interject a stat I learned from reading your article, and tell me if I’m remembering it correctly. Is it 75 percent of Americans have less than $30,000 of savings when they hit retirement?

GHILARDUCCI: It’s really hard to even remember that number because it’s so low. That’s exactly right. Most people have next to nothing, and very few people have over $100,000, $200,000. Those are the very rich. So the average turns out to be around, you know, $30,000, $35,000, which will get you a dinner and a movie if you smooth that consumption out for the rest of your retirement life, a dinner and a movie once a month. So it’s really nothing.

What I would like to see is that everybody have access at work, because that’s the best place to save a little bit of your paycheck every paycheck, have access at work to save money for retirement in a safe and secure way. People are not saving for retirement to play the stock market or to get rich. They want that money guaranteed, the principal guaranteed, and a modest, steady, safe return.

Some of us have such a pension plan. These are often privileged workers have those kind of guaranteed retirement plan. A DB plan is sort of live that. Federal employees, members of Congress have that kind of a plan.

All Americans deserve that option. So I propose that everybody have a chance to save more on top of their Social Security. Social Security really forces you to save 12.4 percent. Half is paid by your employer, half is paid by you. Experts, including myself, have estimated that everybody really needs to save about 7 to 10 percent on top of that. People who are on decent pension plans already do that.

So people need a place to save more money into their retirement, and it needs to be guaranteed, and it needs to be guaranteed by the entity that is best able to smooth out the ups and downs of the stock market over a many-decade process. So you need a big, big financial company or you need the federal government or a state government to say, hey, if the stock market’s flat in the 2000s, it’ll go up again perhaps in 2010s, and it was way up in the ’90s. We can—we’re going to survive, you know, for many, many decades [crosstalk]

JAY: Wouldn’t the quick fix be to open the federal plan to everybody?

GHILARDUCCI: I think it’s a really good plan. That’s part of—that’s one of the options.

California is not waiting for the federal government to act. California in September passed a law that will lead to the ability of Californians who might work for a small private company or a large private company to be able to save their money in a California government-managed plan, and they would get a guaranteed basic return on their retirement assets. They wouldn’t be able to withdraw the assets to buy a new house, to put a kid through college, to bail a kid out of jail, for all the things that, you know, face all of us because we’re human beings; that money will be set aside only for retirement. So California and many other states have moved first. But a lot of other states are going to follow California’s example and let people just save on top of their Social Security in a state guaranteed account, much like your comment about Canada was much more pertinent than you thought, much like some of the provincial governments of Canada are doing.

JAY: Okay. Well, this is just the beginning of this discussion. We’re going to do a lot more work on this with Teresa. So if you have some comments or questions you’d like Teresa to address, she’s going to come back again. So just send your comment to contact (at) therealnews (dot) com. And we’ll make that the basis of the next time we do this interview.

Thanks very much for joining us, Teresa.


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