401k follies: Bad timing and bad advice
by digby
Yglesias has a useful post up this morning about the crisis in 401ks:
I like the metaphor in Tom Friedman’s latest column, arguing that we now live in a 401(k) world. But I wish he’d spelled it out in greater detail, because the problem with living in a 401(k) world is that Planet 401(k) is a pretty sucky planet. Here’s the essential shape of 401(k) as a backbone of the retirement system:
— Poor people get absolutely nothing.
— Wealthy people who would have had large savings anyway get a nice tax cut that offers no meaningful incentive effect.
— For people in the middle, the quantity of subsidy you receive is linked to the marginal tax rate you pay—in other words it’s inverse to need.
— A small minority of middle class people manage to file the paperwork to save an adequate amount and then select a prudent low-fee broadly diversified fund as their savings vehicle.
— Most middle class savers end up either undersaving, overtrading, investing in excessively high-fee vehicles or some combination of the three.
— A small number of highly compensated folks now have lucrative careers offering bad investment products to a middle class mass market based on their ability to swindle people.
He’s right. But I have to defend at least some people in the industry (one of my closest friends is a financial planner) who charge on a fee basis and do a good job for middle class workers who have accumulated enough assets that they need professional advice from someone with integrity. But it’s true that most people who have 401ks are not educated enough about their own retirement future to even know they need something like that or, more commonly, have enough assets to make it worthwhile. And there are definitely charlatans everywhere in the financial sector. What else is new?
Still, it’s quite clear that the 401k experiment has turned out to be, for the most part, a bonanza for Wall Street and the wealthy while the people it was designed to help are worse off than ever. For much of the second half of the baby boom, people currently in their 50s, many of whom who were hit hard by the recession, the loss of real estate and 401k value, retirement looks bleak. Some lost their jobs as well, which is devastating at that point in your life, because they’re very hard to replace at the same level. Aging parents and kids in college create even more of a squeeze. Many of these people had no choice but to tap into their retirement savings at a huge loss and they are facing a very ugly financial future as a consequence. (Of course, it’s the same ugly financial future that poor people always face …)
But it turns out that it isn’t just 401ks. It’s hit the guaranteed benefit plans as well. This story in the New York Times last week-end was just hair-raising:
To retirees, the offers can sound like the answer to every money worry: convert tomorrow’s pension checks into today’s hard cash.
But these offers, known as pension advances, are having devastating financial consequences for a growing number of older Americans, threatening their retirement savings and plunging them further into debt. The advances, federal and state authorities say, are not advances at all, but carefully disguised loans that require borrowers to sign over all or part of their monthly pension checks. They carry interest rates that are often many times higher than those on credit cards.
In lean economic times, people with public pensions — military veterans, teachers, firefighters, police officers and others — are being courted particularly aggressively by pension-advance companies, which operate largely outside of state and federal banking regulations, but are now drawing scrutiny from Congress and the Consumer Financial Protection Bureau.
The pitches come mostly via the Web or ads in local circulars.
“Convert your pension into CASH,” LumpSum Pension Advance, of Irvine, Calif., says on its Web site. “Banks are hiding,” says Pension Funding L.L.C., of Huntington Beach, Calif., on its Web site, signaling the paucity of credit. “But you do have your pension benefits.”
Another ad on that Web site is directed at military veterans: “You’ve put your life on the line for Americans to protect our way of life. You deserve to do something important for yourself.”
A review by The New York Times of more than two dozen contracts for pension-based loans found that after factoring in various fees, the effective interest rates ranged from 27 percent to 106 percent — information not disclosed in the ads or in the contracts themselves. Furthermore, to qualify for one of the loans, borrowers are sometimes required to take out a life insurance policy that names the lender as the sole beneficiary.
Obviously, these are predatory operations. But the people who are taking these loans out aren’t morons — they’re desperate. And that’s the real problem here. This crappy economy is destroying people’s lives and they are eating through their savings until they have nothing left. Solve that problem and you’ve solved a big chunk of the retirement savings problem as well.
And if there’s ever been a time to expand Social Security benefits it’s now. Cutting them is insanity.
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