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The weakness of 401(k) plans

Since my essay two weeks ago on “Retirement Security a Silent Disaster” two developments lead me to write this follow-up essay.

First, a week ago “NBC Nightly News with Lester Holt” had a lengthy report on the subject of the future of retirement in America. NBC News reported that 46% of Americans had nothing saved for retirement.

Second, last weekend’s Post-Journal reprinted an article on 401 (k) accounts from the New York Daily News. The article was written by a former Post-Journal reporter, Gerald Scorse. He put a “happy face” on 401 (k) s becoming the most common source of retirement income in America.

In preparing my essay for the June 1 Post-Journal I had not come across the fact that 46% of Americans had saved nothing for retirement.

This failure of almost half of Americans to save anything for their retirement is troubling for two main reasons.

First, significant portions of future generations trying to retire on Social Security alone will be financially strapped and unhappy in their retirement. Social Security was never intended to be the sole source of income in retirement; Social Security was and still is intended to be a financial floor for every American.

Second, no doubt good portions of the 46% who have not saved anything for retirement are workers in their 20s and 30s. Younger Americans tend to view retirement as a distant condition. Money for a new car, purchasing a house, or taking the kids to Disney World seem much more immediate needs than setting aside money for retirement.

Young people who do not save for their retirement in their 20s and 30s are making a huge financial mistake. (Obviously some of the 46% are people on government assistance who do not have spare income to save for their retirement).

The power of compounding savings or investments in your 20s and 30s can put you on a path to a good, financially comfortable retirement..

I had the privilege for eight years of teaching “Business Law” to accounting majors at SUNY Fredonia. Each year I used the following illustration of the power of compounding and, therefore, the importance of saving early for retirement.

“Jane” at age 25 began investing for retirement by putting $2,000 a year for 8 years in a retirement plan, investing a total of $16,000. “Joe” waited until 35 to save for retirement, investing $2,000 a year for 30 years, for a total of $60,000.

But at age 65 Jane’s account, as a result of compounding, is $269,000, while Joe’s account is only $244,000 or $25,000 less! (This example assumes an 8% annual return).

Gerald Scorse’s article made the point that most 401 (k) accounts are invested in the stock market and that the stock market usually grows impressively over time. That is generally true.

Some 401 (k) accounts, however, could have been invested in bank CDs. Since the Great Financial crash of 2008-09 until about a year ago, bank CDs often paid no more than 1% interest. Even with a 2% inflation rate over those years, retirement savings in bank CDs actually lost value.

Gerald Scorse’s article avoids the fact that 401 (k) accounts invested in the stock market can encounter many years in a row where the stock market does not go up or even loses value. Even though a retiree’s 401 (k) may be down 20% in a given year, for example, the retiree still needs to take money out of the depleted account in order to live. The retiree’s account may never grow enough to make up for a retirement withdrawal in a down stock market.

Mr. Scorse does acknowledge that 401 (k) s will never be as good for workers as a defined pension plan; but that the reality is that our country will not see the return of pension plans for most workers.

A huge weakness of our country depending on 401 (k) s for retirement is that Federal law still allows employers to advertise that they offer a 401 (k) benefit to which they contribute nothing. The only retirement savings in those accounts, therefore, is whatever the employee chooses to contribute.

A 401 (k) with no employer contribution is essentially meaningless.

The Congress should at least require large employers (such as those with over 50 employees) to make a minimum employer contribution to their 401 (k) plan in the area of 5% of the employees’ earnings.

Millions of Americans currently in their 20s, 30s and 40s will have a comfortable retirement only if their employers make a meaningful contribution to their 401 (k) plans and if employees contribute to the 401 (k) plan starting as soon as possible.

Fred Larson is a graduate of the Princeton University Woodrow Wilson School of Public and International Affairs Yale Law School, operated a private law practice for 38 years and served as a State University at Fredonia adjunct faculty member from 2006-2014.

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