The Bad News Is, You Have a 401(k) Plan

This article is intended by the author to comprise Part Three of Four in a series on lawyer retirement planning. Parts One and Two, 'What In the World Is Going On With Lawyer Retirement Planning?', were published in the Nov. and Dec. 2005 issues of LFP&B.

The good news is your firm has a contributory retirement plan and you are a participant. The bad news is that to manage your money, control much of your retirement destiny and thus the future financial welfare of you and your family, your firm has placed this responsibility in the hands of someone who is almost certainly clueless about such matters.

That person is you.

Contributory retirement plans include 401(k) plans and similar tax-deferred contributory 'retirement' vehicles ' profit sharing plans, IRAs, SEP IRAs, HR 10 plans and the like. Because the birth of 401(k) plans instigated the issues discussed, this article will refer to those plans.

Rather than at age 65, now many are expecting to retire earlier than they would have in the past, and expect to live 30 to 40 years in retirement. 401(k) plans never were intended to be the sole source of retirement funding. But that's what many have come to think. The very name 'retirement plan,' like the equally appallingly named 'social security' plan, reflects our very basic gullibility. The names belie the actual result of both.

The 401(k) in fact represents a looming disaster for America's retirement policies. While such a tax deferred 'retirement plan' may sound good intentioned, 401(k) legislation and other retirement plan 'fixes' had less to do with good intentions than with relieving big business of the financial burden of retirement plans, relieving fiduciaries from potential liability for investment decisions and shifting the burden and decision-making responsibility for retirement to 'workers.' Plus, the birth of self-managed retirement plans created a feeding frenzy among the providers of retirement investments.

The real world problem with 401(k) plans is that too many people are relying on them for their sole source of retirement, and their accounts are grossly under-funded. Accompanying this article is a list of online financial/retirement calculators you can use to scare yourself to death by learning how bad your prospects are for a comfortable retirement. The more realistic question may be: Can you retire? You may think you are the exception. Unless you are the 'millionaire next door' type, odds are you are in a jam.

History of the 401(k)

Before the 401(k), companies, including many law firms, provided some type of retirement plan or pension. Some companies had cash and deferred profit-sharing plans, offering a choice of cash now or deferred profit sharing trusts. The favorable tax treatment of such plans inadvertently was left out when the Employee Retirement Income Security Act (ERISA) was passed in 1974. So, in the Technical Corrections Act of 1979 (to the Internal Revenue Code), in (amazingly enough) Section 401(k), a provision was added allowing the 'roll over' of these cash and deferred plans. In 1981, the Internal Revenue Service said Section 401(k) could apply to almost any kind of employee contribution from 'W-2' earnings, entitling such contributions to tax-deferred treatment.

Companies, including law firms, meanwhile decided conventional pension and retirement plans were way too expensive. In the case of law firms, rapidly escalating salaries made 'traditional' unfunded retirement payments based on historical compensation impossible to continue without triggering a revolt by the remaining lawyers. Companies and law firms wanted to freeze or terminate such plans.

Using Section 401(k), the cost of retirement funding and investment responsibility was turned over to the participants. Senior management was often in an excellent position to make sophisticated investment choices. The regular folks wanted in on these choices. Anti-discrimination rules were in turn used to require that the same choices be made available to all participants. However, participants were simply unqualified to make such investment decisions. So, companies began to offer three or so 'safe' choices ' a stock-based mutual fund, a bond fund and a money market fund. In the early- to mid-1980s, there was a fraction of the number of mutual and other funds we see today. It has been said that in 1980, there was no mutual fund industry, with only between 100 and 200 such funds on the market. There were only a handful of 'index' funds. According to Brooks Hamilton, of Brooks Hamilton & Partners, a 401(k) 'advisory' firm, in 1990 only 5% of 401(k) money was in mutual funds. By 2000, it was half.

Mutual fund companies saw the opportunity to get their hands on your money, and practically overnight, a new industry was invented ' mutual funds for the masses. Jack VanDerhei, a Senior Research Fellow at the Employee Benefit Research Institute, has called the expansion of the mutual fund industry a 'wildfire.' Given the result, the analogy is apt.

Participants began to demand more than the usual limited choices, and plans began to offer many other options. Meanwhile, plan administrators began to worry about fiduciary responsibility for choices offered to, and made by, participants. So, after a bit of lobbying, the laws and regulations were further modified to relieve employers and fiduciaries from any such responsibility.

Companies then thought they would try to 'educate' participants, but began to worry that such 'education' could be construed to be investment advice, generally considered a very bad thing. You may have noticed that even people openly giving 'investment advice' almost always say they are not giving 'investment advice.' (By the way, nothing in this article should in any way be considered investment advice. OK?) Once again, however, the Department of Labor acted to protect plan administrators and fiduciaries by permitting certain types of 'investment advice.'

Therefore, the self-serving 401(k) 'industry' finally achieved what we have today ' total responsibility for the cost of, and decisions regarding, retirement planning in the hands of the one segment of the population least qualified to do so. You. This has created a financial disaster in the making. The 401(k) concept itself is sound. It is how we have treated it that is the problem.

Problems with the 401(k)

According to Jack Calhoun, Jr., Managing Principal of Capital Directions Investment Advisors, LLC, in Atlanta, a fee-only independent Registered Investment Advisor: 'It seemed like a great idea to give Americans total control over their retirement plan assets, but it was in fact a terrible idea. Most people do a lousy job managing their own investments, and most participants would be happy to return management responsibility back to their employers. There is an urgent need for plan providers to give participants professionally managed investment strategies.'

Calhoun's assessment is echoed (if that is the right metaphor for total silence) by the absence of anyone defending the current structure, not even those who make their living selling investments to those unqualified to make such decisions.

This points to a major problem: There is virtually no way to determine the likely results of investment decisions because the actual costs ' fees, commissions, you name it ' are carefully hidden and therefore unknowable to the average participant.

Part 4, coming next month, analyzes the result of these events and discusses ways to make things better, including what you can do to plan for your own retirement.

This article is intended by the author to comprise Part Three of Four in a series on lawyer retirement planning. Parts One and Two, 'What In the World Is Going On With Lawyer Retirement Planning?', were published in the Nov. and Dec. 2005 issues of LFP&B.

The good news is your firm has a contributory retirement plan and you are a participant. The bad news is that to manage your money, control much of your retirement destiny and thus the future financial welfare of you and your family, your firm has placed this responsibility in the hands of someone who is almost certainly clueless about such matters.

That person is you.

Contributory retirement plans include 401(k) plans and similar tax-deferred contributory 'retirement' vehicles ' profit sharing plans, IRAs, SEP IRAs, HR 10 plans and the like. Because the birth of 401(k) plans instigated the issues discussed, this article will refer to those plans.

Rather than at age 65, now many are expecting to retire earlier than they would have in the past, and expect to live 30 to 40 years in retirement. 401(k) plans never were intended to be the sole source of retirement funding. But that's what many have come to think. The very name 'retirement plan,' like the equally appallingly named 'social security' plan, reflects our very basic gullibility. The names belie the actual result of both.

The 401(k) in fact represents a looming disaster for America's retirement policies. While such a tax deferred 'retirement plan' may sound good intentioned, 401(k) legislation and other retirement plan 'fixes' had less to do with good intentions than with relieving big business of the financial burden of retirement plans, relieving fiduciaries from potential liability for investment decisions and shifting the burden and decision-making responsibility for retirement to 'workers.' Plus, the birth of self-managed retirement plans created a feeding frenzy among the providers of retirement investments.

The real world problem with 401(k) plans is that too many people are relying on them for their sole source of retirement, and their accounts are grossly under-funded. Accompanying this article is a list of online financial/retirement calculators you can use to scare yourself to death by learning how bad your prospects are for a comfortable retirement. The more realistic question may be: Can you retire? You may think you are the exception. Unless you are the 'millionaire next door' type, odds are you are in a jam.

History of the 401(k)

Before the 401(k), companies, including many law firms, provided some type of retirement plan or pension. Some companies had cash and deferred profit-sharing plans, offering a choice of cash now or deferred profit sharing trusts. The favorable tax treatment of such plans inadvertently was left out when the Employee Retirement Income Security Act (ERISA) was passed in 1974. So, in the Technical Corrections Act of 1979 (to the Internal Revenue Code), in (amazingly enough) Section 401(k), a provision was added allowing the 'roll over' of these cash and deferred plans. In 1981, the Internal Revenue Service said Section 401(k) could apply to almost any kind of employee contribution from 'W-2' earnings, entitling such contributions to tax-deferred treatment.

Companies, including law firms, meanwhile decided conventional pension and retirement plans were way too expensive. In the case of law firms, rapidly escalating salaries made 'traditional' unfunded retirement payments based on historical compensation impossible to continue without triggering a revolt by the remaining lawyers. Companies and law firms wanted to freeze or terminate such plans.

Using Section 401(k), the cost of retirement funding and investment responsibility was turned over to the participants. Senior management was often in an excellent position to make sophisticated investment choices. The regular folks wanted in on these choices. Anti-discrimination rules were in turn used to require that the same choices be made available to all participants. However, participants were simply unqualified to make such investment decisions. So, companies began to offer three or so 'safe' choices ' a stock-based mutual fund, a bond fund and a money market fund. In the early- to mid-1980s, there was a fraction of the number of mutual and other funds we see today. It has been said that in 1980, there was no mutual fund industry, with only between 100 and 200 such funds on the market. There were only a handful of 'index' funds. According to Brooks Hamilton, of Brooks Hamilton & Partners, a 401(k) 'advisory' firm, in 1990 only 5% of 401(k) money was in mutual funds. By 2000, it was half.

Mutual fund companies saw the opportunity to get their hands on your money, and practically overnight, a new industry was invented ' mutual funds for the masses. Jack VanDerhei, a Senior Research Fellow at the Employee Benefit Research Institute, has called the expansion of the mutual fund industry a 'wildfire.' Given the result, the analogy is apt.

Participants began to demand more than the usual limited choices, and plans began to offer many other options. Meanwhile, plan administrators began to worry about fiduciary responsibility for choices offered to, and made by, participants. So, after a bit of lobbying, the laws and regulations were further modified to relieve employers and fiduciaries from any such responsibility.

Companies then thought they would try to 'educate' participants, but began to worry that such 'education' could be construed to be investment advice, generally considered a very bad thing. You may have noticed that even people openly giving 'investment advice' almost always say they are not giving 'investment advice.' (By the way, nothing in this article should in any way be considered investment advice. OK?) Once again, however, the Department of Labor acted to protect plan administrators and fiduciaries by permitting certain types of 'investment advice.'

Therefore, the self-serving 401(k) 'industry' finally achieved what we have today ' total responsibility for the cost of, and decisions regarding, retirement planning in the hands of the one segment of the population least qualified to do so. You. This has created a financial disaster in the making. The 401(k) concept itself is sound. It is how we have treated it that is the problem.

Problems with the 401(k)

According to Jack Calhoun, Jr., Managing Principal of Capital Directions Investment Advisors, LLC, in Atlanta, a fee-only independent Registered Investment Advisor: 'It seemed like a great idea to give Americans total control over their retirement plan assets, but it was in fact a terrible idea. Most people do a lousy job managing their own investments, and most participants would be happy to return management responsibility back to their employers. There is an urgent need for plan providers to give participants professionally managed investment strategies.'

Calhoun's assessment is echoed (if that is the right metaphor for total silence) by the absence of anyone defending the current structure, not even those who make their living selling investments to those unqualified to make such decisions.

This points to a major problem: There is virtually no way to determine the likely results of investment decisions because the actual costs ' fees, commissions, you name it ' are carefully hidden and therefore unknowable to the average participant.

Part 4, coming next month, analyzes the result of these events and discusses ways to make things better, including what you can do to plan for your own retirement.