Magazine article The American Prospect

We've Already Tried Private Accounts! the 401(k) Experience Shows That Individual Account Holders Often Make Unwise Decisions and Are at the Mercy of Financial Markets

Magazine article The American Prospect

We've Already Tried Private Accounts! the 401(k) Experience Shows That Individual Account Holders Often Make Unwise Decisions and Are at the Mercy of Financial Markets

Article excerpt

PRESIDENT BUSH WANTS TO "PRIVATIZE" a portion of the Social Security program. As part of that debate, we should remember that our experience with 401(k) plans provides some evidence about how well such a program might work. The results to date are not encouraging and should serve as a blinking yellow light.

401(k) plans, which are tax-favored savings accounts, emerged in the 1980s as supplements to traditional employer-defined benefit pensions, where benefits are based on years of service and final salary. Individual 401(k) accounts, funded with employer and employee contributions, end employer liability for pension payments. Not surprisingly, 401(k)s have emerged as the dominant pension arrangement. And in the private sector, most of the responsibility for retirement security has moved from employer to employee.

The supposed advantages of 401(k) plans for employees are twofold. First, workers with 401(k)s can take their full accumulations with them as they change jobs. This arrangement is much better for mobile workers than traditional defined-benefit plans, where, even among firms with identical plans and immediate vesting, workers receive significantly lower benefits than they would have with continuous coverage under a single plan. The portability argument, however, is irrelevant to the Social Security debate because Social Security is a universal defined-benefit plan, and, as such, its benefits are fully portable as people move throughout the labor force.

The second argument offered for 401(k) plans is that they allow people to control their investments and match their investments with their tolerance for risk. Presumably this responsibility is something workers welcome. In fact, the evidence suggests that 401(k) account holders generally make terrible investment decisions, and when offered the opportunity to turn over the decision making to someone else, they grab it.

In theory, workers could do very well under a 401(k) plan. Simple simulations suggest that a worker with a history of average earnings could, through steady contributions, accumulate roughly $300,000 in a 401(k) plan by age 62. In fact, the typical older worker covered by a 401(k) has less than $50,000. Enthusiasts could counter that 401(k) plans emerged only in the early 1980s, so that today's older workers haven't had time to accumulate substantial balances. True. But even those in mid-career appear to be falling considerably short of the amounts needed for secure retirement.

Why the low balances? …

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