Tag Archives: retirement

The Absurdity of Fifth Third

By James Kwak

No, I’m not talking about the fact that a major bank is named Fifth Third Bank. (As a friend said, why would you trust your money to a bank that seems not to understand fractions?) I’m talking about Fifth Third Bancorp. v. Dudenhoeffer, which was heard by the Supreme Court last week.

The plaintiffs in Fifth Third were former employees who were participants in the company’s defined contribution retirement plan. One of the plan’s investment options was company stock, and the employees put some of their money in company stock. (Most important lesson here: don’t invest a significant portion of your retirement assets in your company’s stock. Remember Enron? Anyway, back to our story.) As you probably guessed, Fifth Third’s stock price fell by 74% from 2007 to 2009—this is a bank, you know—so the plaintiffs lost money in their retirement accounts.

The claim (I’m looking at the 6th Circuit opinion)  is that the people running the retirement plan knew or should have known that Fifth Third stock was overvalued in 2007, and they breached their fiduciary duty to plan participants by continuing to offer company stock as an investment option and by failing to sell the company stock that was owned by the plan. The suit was dismissed in the district court for failure to state a claim, so on review the courts are supposed to accept all the plaintiffs’ allegations as correct.

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The Desperation of the Vanishing Middle Class

By James Kwak

I recently finished reading Pound Foolish, by Helaine Olen, which I discussed earlier (while one-third of the way through). The book is a condemnation of just almost every form of personal financial advice out there, from the personal finance gurus (Suze Orman, Dave Ramsey) to the variable annuity salespeople to the peddlers of real estate get-rich-quick schemes to Sesame Street‘s corporate-sponsored financial education programs. (Of them all, Jane Bryant Quinn is one of the few who generally come off as more good than evil.)

A lot of what’s going on is just semi-sleazy entrepreneurs trying to make a buck, taking “advice” that is equal parts routine, wrong, and contradictory and packaging it into attractive-looking books, TV shows, and in-person events. A lot of the rest is marketing by the real financial industry, which either (a) wants to make a show of promoting financial education so people will think they are good or (b) wants to teach people that they need their products. (You pick.)

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Retirement Inequality

By James Kwak

The Economic Policy Institute put out a series of charts detailing inequality in retirement savings across several different demographic characteristics. The most obvious picture is that the shift to 401(k) plans has produced vast increases in retirement inequality across income groups.

Here’s one:

Screen shot 2013-09-12 at 9.23.15 AM

 

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The Problem with 401(k) Plans

By James Kwak

Apparently my former professor Ian Ayres has made a lot of people upset, at least judging by the Wall Street Journal article about him (and co-author Quinn Curtis) and indignant responses like this one from various interested parties. What Ayres and Curtis did was point out the losses that investors in 401(k) plans incur because of high fees charged at the plan level and high fees charged by individual mutual funds in those plans. The people who should be upset are the employees who are forced to invest in those plans (or lose out on the tax benefits associated with 401(k) plans.)

In their paper, Ayres and Curtis estimate the total losses caused by limited investment menus (small), fees (large), and poor investment choices (large). Those fees include both the high expense ratios and transaction costs charged by actively managed mutual funds and the plan-level administrative fees charged by 401(k) plans.

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Yes, We Should Worry About Public Pensions

By James Kwak

In the wake of the Detroit bankruptcy, Paul Krugman has a post pooh-poohing concerns about public pensions. His conclusion:

“Nationwide, governments are underfunding their pensions by around 3 percent of $850 billion, or around $25 billion a year.

A $25 billion shortfall in a $16 trillion economy. We’re doomed!”

(Yes, that’s sarcasm.)

I know why Krugman wants to argue that this isn’t a problem. If everyone believes that public pensions are a big problem, then the austerity crew will convert that belief into a push to cut public pensions—just like they have tried to use future shortfalls in the Social Security and Medicare trust funds to insist on privatizing or voucherizing those programs.

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Yet Another Proposal To Raise My Own Taxes

By James Kwak

In chapter 7 of White House Burning, we proposed to eliminate or scale back a number of tax breaks that I benefit from directly, including the employer health care exclusion, the deduction for charitable contributions, and, most importantly, tax preferences for investment income. We did not, however, go after tax breaks for retirement savings, on the grounds that Americans already don’t save enough for retirement.

Well, in my latest Atlantic column, I’m going after that one, too. I changed my mind in part for the usual reason—the dollar value of tax expenditures is heavily skewed toward the rich. But the other reason is that the evidence indicates that this particular subsidy doesn’t even do what it’s supposed to do: increase retirement savings. Instead, we should take at least some of the money we currently waste on tax preferences for 401(k)s and IRAs and use to shore up Social Security, the one part of the retirement “system” that actually works for ordinary Americans.

Of course, this isn’t going to happen anytime soon. President Obama proposed capping tax-advantaged retirement accounts at $3.4 million, which is a step in the right direction. ($150,000 would be a better limit, since most people reach retirement with far less in their 401(k) accounts.)* But even that was attacked by the asset management industry as theft from the elderly.

* Yes, I know about the issue of small business owners who only set up accounts for their employees because they want to benefit from them themselves. It’s a red herring. First, if an employer doesn’t have a 401(k), employees can contribute $5,000 to an IRA—and $5,000 is a lot more than most middle-income, small business employees are currently contributing. Second, the right solution would be to default everyone into a retirement savings account instead of relying on employers to decide whether or not to set up 401(k) plans.

Memo to Employers: Stop Wasting Your Employees’ Money

By James Kwak

Now that I’m a law professor, people expect me to write law review articles. There are some problems with the genre—not least its absurd citation formatting system and all the fetishism surrounding it—but it’s not a bad way to make arguments about how and why the law should change in ways that might actually help people.

That was my goal in my first law review article, “Improving Retirement Options for Employees, which recently came out in the University of Pennsylvania Journal of Business Law. The general problem is one I’ve touched on several times: many Americans are woefully underprepared for retirement, in part because of a deeply flawed “system” of employment-based retirement plans that shifts risk onto individuals and brings out the worse of everyone’s behavioral irrationalities. The specific problem I address in the article is the fact that most defined-contribution retirement plans (of which the 401(k) is the most prominent example) are stocked with expensive, actively managed mutual funds that, depending on your viewpoint, either (a) logically cannot beat the market on an expected, risk-adjusted basis or (b) overwhelmingly fail to beat the market on a risk-adjusted basis.

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Bad Advice

By James Kwak

I’m starting teaching at the UConn law school this fall, so I got a folder of information in the mail about my retirement plan. UConn professors have a choice between a defined benefit plan (SERS, in which I would be a Tier III member) and a defined contribution plan called the Alternate Retirement Program, or ARP. (There’s also a Hybrid Plan that seems to be the defined benefit plan plus a cash-out option at retirement.)

I chose the Alternate Retirement Program for reasons that are complicated (I used a spreadsheet) and that I may get into another time. The main benefit of defined benefit plans is that they do a pretty good job of protecting you from investment risk and inflation risk, since the state bears most of it. The main downside is that if you will work either for a short time or a very long time at your employer, they have a lower expected value, even given conservative return assumptions. The other downside is counterparty risk.

Anyway, the ARP is a pretty good plan. The administrative costs are a flat 10 basis points.  It includes a reasonable number of index funds (although there are also actively-managed funds—more on that later). And the plan had the sense to ask for institutional share classes with low fees. For example, the S&P 500 index fund is the Vanguard Institutional Index Fund – Institutional Plus Shares, which has an expense ratio of 2 basis points. Adding the 10 bp of administrative fees, that’s still only 12 bp.* (Contrast this with Wal-Mart, for example, which, despite being the largest private-sector employer in the country, stuck its employees with retail fees in its 401(k) plan.)

But despite that, the plan then goes and encourages people to put money into expensive, actively-managed funds. I got a brochure subtitled “A Guide to Helping You Choose an Investment Portfolio” that was almost certainly written by ING, the plan administrator. It has the usual stuff about the importance of asset allocation and your tolerance for risk, and then provides “model portfolios” for various investor types.

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Lump Sum or Annuity?

By James Kwak

Usually the New York Times gives reasonably good financial advice—or, at least it avoids giving really bad advice. Today, however, Paul Sullivan’s column borders on the latter. The question is whether to take a pension payout as a lump sum or as an annuity (a guaranteed, fixed amount per year until you die).

Sullivan’s column isn’t all bad. He talks about the importance of being able to manage your money and the need to be comfortable with risk if you take the lump sum. He also points out the annuity (in this case, based on what GM workers are being offered) isn’t indexed to inflation, which is an important consideration. And he doesn’t come down on one side or the other, although he says he would take the lump sum because, he says, “I would rather control the money myself.”

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Social Security Matters

By James Kwak

Catherine Rampell wrote a post last week about how Americans expect to retire later and how more elderly Americans are working. Her last chart also showed that a growing proportion of nonretirees expect Social Security to be a major source of their income in retirement.

That shows that Americans are becoming more realistic. But still, just 33 percent?

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Magical Investment Thinking

By James Kwak

From a Times article on pension fund investing:

Mr. Dear cautioned that there were big differences in how various alternative investments performed during the financial crisis.

He said that Calpers’s investments in real estate had been “a disaster” and that its hedge fund investments had not met their benchmarks and were under review. But he said that its private equity holdings had easily beaten public stock returns over the last decade.

“Over the longer term, that kind of outperformance represents real skill, not luck, and it’s worth paying for,” he said.

Holy confirmation bias, Batman! When one asset class beats the stock market that’s skill. But when your other asset classes do badly—that’s random variation? If high returns on private equity are evidence that you should continue investing in private equity, then low returns in hedge funds and real estate are evidence that you should pull your money out of them.

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Why Is Wal-Mart Paying Retail Prices?

By James Kwak

Ted K. points out (and comments on) Stephanie Fitch’s article in Forbes on Wal-Mart’s 401(k) plan. The crux of the matter is that Wal-Mart seems to have done a lousy job creating a good 401(k) plan for its employees. Until recently, it had ten funds, only two of which were index funds; the other, actively managed funds all had high expense ratios (the ones Fitch quotes are above 1 percent).* More shockingly, the expense ratios paid by plan participants were the same as the expense ratios paid by individual investors in those mutual funds. It didn’t even pool its employees’ money together to get institutional investor rates. The irony, of course, is that Wal-Mart is the world’s best, most powerful negotiator when it comes to getting low prices for the stuff it sells, yet it exercised no negotiating power in getting low prices for its employees — even though it had $10 billion in assets to swing like a club.

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How Well Prepared Are Americans for Retirement?

The following guest post was contributed by Andrew Biggs. He has studied the issue of retirement savings for a couple of orders of magnitude longer than I, so I wanted to give him the opportunity to outline his perspective on the topic. He regularly blogs on his own blog and, along with about four dozen other people, over here.

After our exchange regarding Tuesday’s blog on The Retirement Problem in the Washington Post (which started over at AEI’s Enterprise blog and continued here),  James generously offered to let me guest-post my thoughts on Americans’ level of preparation for retirement. Overall I’m not so pessimistic, although there are surely problems that must be addressed. But most of the detailed research out there points to problems, but not a crisis.

Both James’s analysis and my own response were built on relatively simple projections using stylized workers who pay into Social Security and participate in 401(k) plans. These illustrations are useful for fleshing out basic issues – plus, in this case, finding how the SSA’s online benefit calculator may have skewed some of the results.

But the best research on retirement preparedness is more involved than this. Most analysis of current retirees uses survey data, such as from the Health and Retirement Study (HRS), the Survey of Income and Program Participation (SIPP), the Fed’s Survey of Consumer Finances (SCF) and the Current Population Survey (CPS). Each survey has strengths and weaknesses.

In addition, broader models of the population are built using this survey data. These models allow for simulations of how policy changes affect current retirees, as well as projecting the population into the future. Such comprehensive models include the Social Security Administration/Urban Institute MINT (Modeling Income in the Near Term) model, the Congressional Budget Office’s CBOLT (CBO Long Term) and the Policy Simulation Group’s PSG suite of models, used by the Government Accountability Office and the Department of Labor for Social Security and private pension projections. While these models, like any others, rely on assumptions regarding a large number of factors, they are also the most closely scrutinized to ensure these assumptions are consistent with current trends.

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Low Savings, Bad Investments

The article below first appeared in our Washington Post column yesterday. I’m reproducing it in full here because there is an important correction, thanks to a response by Andrew Biggs. I’ve fixed the mistake and added notes in brackets to show what was fixed. Also, I want to append some additional notes about the data and some issues that didn’t fit into the column.

Recent volatility in the stock market (the S&P 500 Index losing almost 50% of its value between September and March) has led some to question the wisdom of relying on 401(k) and other defined-contribution plans, invested largely in the stock market, for our nation’s retirement security. For example, Time recently ran a cover story by Stephen Gandel entitled “Why It’s Time to Retire the 401(k).”

However, the shortcomings of our current retirement “system” predate the recent fall in the markets, will not be solved by another stock market boom. The problems are more basic: we don’t save enough, and we don’t invest very well.

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The Biggest Story of the Week

Or the year. Frightening.

I’ve been wondering why the impact of the financial crisis on the overall retirement “system” hasn’t gotten more attention in the media. We already knew the system was in bad shape before September 2008. According to the Fed’s Survey of Consumer Finances, in 2007, only 60.9% of households where the head of household was age 55-64 had retirement accounts . . . and their median retirement balance was $98,000. Given that the stock market has fallen by over 50% from its October 2007 peak – and that, for decades, the standard investment advice has been that stocks do better than any other asset class in the long term – we would be lucky if that median balance were more than $70,000 today.

The Bloomberg article linked to above describes the fragile state of state and local pension systems. These systems suffer from two major problems today. One is that even if they had been managed in a reasonable way, the fall in asset prices over the last year would have blown a huge hole in their long-term solvency.

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