Commentary: K.O.'d by the 401(k)

Many Americans are accumulating far less than they'll need

By Commentary by Aaron Bernstein

If you want to see the future of retirement for many Americans, talk to Thomas Zychowicz. The Milwaukee resident put in 30 years as an industrial engineer at Briggs & Stratton before he was laid off in 1998 at age 58. He had diligently socked away 6% of his pay in a 401(k) ever since B&S set up the plan in the mid-1980s. But with two teens at home and a wife who worked part-time, he couldn't afford to save more. So when his $46,000-a-year job ended, he had just $107,000 in his 401(k), not enough to live on for 30 more years, even with the $1,000-a-month pension B&S owed him. He has been bouncing from job to job ever since and now earns $7 an hour at a Kohl's department store. "My 401(k) isn't enough, so I have to keep working at least until I can start collecting Social Security," says Zychowicz.

Many other Americans may find themselves unable to retire, too. It's not just the 30%-plus decline in the stock market since 2000, although that has slashed the retirement expectations of nearly everyone. (Zychowicz's 401(k) hit $143,000 at the peak but has since shriveled to $91,000.) There's a more fundamental problem: The country's retirement system simply isn't working for most Americans, and the 401(k) is the prime culprit. Although many employees became infatuated with their ever-rising retirement portfolios during the 1990s stock market boom, these personal accounts have left most workers less prepared to retire than they were when companies offered old-style defined-benefit pensions.

While 401(k) advocates often deride traditional pensions as paternalistic, most companies kicked in more under that system than they do with plans that require employees to pony up at least part of the money. Only affluent employees have stepped up their own savings to compensate. Everyone else has less available for old age today than they did before 401(k)s became popular in the 1980s.

Indeed, the retirement assets of the bottom 70% of U.S. households are 13% lower now than in 1983, when the stock market was a tenth of today's levels, according to New York University economics professor Edward Wolff (chart). "I was surprised, because I thought the 401(k) revolution would have been very beneficial for the vast majority of workers," says Wolff, an expert on household wealth.

The result: Many Americans will have to work longer than planned. Already, the retirement age has drifted upward after decades of decline, with a quarter of 60- to 69-year-olds working today, up from a fifth in 1991.

There are ways to improve America's retirement outlook. One would be to automatically enroll employees in 401(k) plans, since they rarely opt out once they get in the habit of saving. Congress also could increase tax breaks for defined-benefit pensions. Doing so would give companies an incentive to reinvigorate an approach that worked better for most Americans. The U.S. could face an old-age crisis if nothing is done. "It's clear that Americans on the bottom lack the discretionary income to save enough for retirement," says Michael Tanner, a researcher at the conservative Cato Institute in Washington.

While many experts and political leaders have been urging Americans to save more, almost no one believed that most families are actually worse off with a 401(k) than a traditional pension. Instead, it has been assumed that the problem was with those who don't or can't set aside enough for retirement, mostly poor and low-income workers.

But Wolff's analysis, the gist of which he published last spring, shows just how far behind a majority of families have fallen. The share of the U.S. workforce covered by a traditional pension has fallen in half since the early '80s, to about 20% today. Wolff calculated the current value of those pensions using the Federal Reserve's triennial Survey of Consumer Finances, the definitive source of information on household assets. Although the data are only available through 1998, the results give a fairly up-to-date picture, since the stock market has sunk back to about where it was that year. His conclusion: Households at all levels have lost ground. However, the pension holdings of the bottom 70% have plunged by nearly 40% since 1983, while those of the top 30% have come down by only 18%.

While 401(k)s have allowed top-tier families to more than make up the difference, everyone else is lagging. The assets the upper 30% hold in all defined-contribution plans, such as 401(k)s and individual retirement accounts, have multiplied tenfold since 1983, to an average of $112,000. As a result, their total retirement assets--including all defined-benefit and defined-contribution wealth--have climbed by a healthy 77%, to $188,000. However, families in the lower 70% have suffered an 11% decline. Their average old-age savings today: $29,000.

Part of the problem is that employers have sliced the amount they kick in. On average, employers who set up 401(k)s have cut their retirement spending by 14%, according to an analysis of corporate tax filings between 1981 and 1996 by University of Notre Dame economist Teresa Ghilarducci and two colleagues. "We found 401(k)s are a cost-savings move for employers," she says.

As a result, workers must foot more of the bill for their own retirement. With companies covering fewer workers, and paying less for those they do cover, employers' overall spending on retirement has plunged by 22% since 1986, to an average of 83 cents an hour, according to the Labor Dept. study.

But most families in the bottom 70% don't put aside enough to make up the difference. Many don't start contributing to a 401(k) until they hit their 30s, and many also don't contribute the maximum allowed.

Worse, much of the money Americans have stuffed away doesn't represent new savings. Instead, most families have simply raided other assets to fund their 401(k)s. The net worth of the top 30%, excluding retirement savings, has climbed 15% since 1983, to an average of $775,000, Wolff found. However, the nonretirement assets of the bottom 70% fell by about 9%, to just $33,000. "Most families funded the switch to 401(k)s by drawing down their net worth," concludes Wolff.

It's clear that most employees need more help planning for their future. Unless they get it, many Americans may need to spend a lot more of their golden years hard at work.

Bernstein watches workplace trends from Washington.

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