Friday, October 24, 2008

Saving Retirement in the Face of America’s Credit Crises?

An idea currently being pitched is to nationalize everyone’s 401(k) account. The logic goes something like this: Financial Markets are volatile, if you measure from the high water mark to the low point of the markets it appears the world is coming to an end, therefore the government must intervene. (Sarcasm mine)

The government intervention comes in the form of having people to trade in their existing 401(k) for a Guaranteed Retirement Account (GRA). The GRA would pay a guaranteed return of 3%. So people would trade an investment vehicle that has averaged returns of around 10% since 1978 for a guaranteed return of 3%.

The examples used indicate someone with $50,000 in a 401(k) could trade that in for an additional $500 per month from Social Security upon retiring. One problem with this is that if a retiree passes away within 8 years 4 months of retirement the government keeps the excess in its own coffers whereas in a 401(k) account the retiree’s heirs receive the money.

Historically speaking, an investor that contributed $1,667 per year since 1978 would see his 401(k) grow to over $182,000. (I used 1978 because the author claims the 30 year experiment with 401(k) accounts has been a failure. $1,667 is used because the author uses a principal of $50,000 in the example.) This includes losing almost 40% of the overall value in the current year. To be sure the GRA is the name implies would gave a guaranteed return. Instead of losing 40%, retirees would have gained 3%. However, the increase of 3% would only bring the value to $81,000. In this scenario, a retiree would have traded over $100,000 for stability. That would be a terrible trade. A disciplined approach to 401(k) contributions doesn’t seem to be a failure.

Another issue I take with the author is her disregard of 401(k) history. She makes the assertion that 401(k) accounts are cheaper for employers but earn subpar returns. Obviously, the returns from well diversified 401(k) accounts are better than 3%, but she makes this statement as if 401(k)s were designed by employers who no longer wanted to fund defined benefit plans. However, 401(k)s were actually the result of demands by employees who didn’t want to spend 40 years of their lives with one company in order to receive a retirement even if the employee didn’t have to fund it.

My guess is that instead of trying to save retirement in the midst of a crises, these advocates are just using the fear of uncertainty to move the financial markets closer to socialism.