A better model for retirement savings?


A journalist asked me today whether I thought that the 401(k) system was going to be trusted for retirement planning now that so many people have lost such huge chunks of their investments in the market downturn. Would people still use 401(k)s, she wanted to know, and what might save them or make them better? How about mandatory financial education?

I was a little taken aback at the idea that 401(k) programs might be viewed this way. While certainly market investments of all kinds have taken a beating, the tax advantages of 401(k)s and the possibility of employer matching contributions make them very attractive structurally, even if not attractive at the moment. I wouldn’t want to throw out a system that largely serves to help people simply because of a bad year, or even a few bad years, in the market.

But her question made me think: what could we be doing better? I don’t agree with mandatory financial education as a real curative — I’d certainly be happy enough to have real, actual home economics (not just cake-baking, but money management skills) taught in high schools. I don’t think, though, that would suddenly cure retirement woes, any more than mandatory physical education has cured obesity.

I did have an idea that I blurted out and then warmed to after the call had ended. I believe that one of the big things people forget in their retirement planning is asset allocation — having a 401(k) fully invested in the stock market when you’re 60, say, is a very poor match of your risk profile and your asset distribution. I’ve always liked John Bogle’s advice that your bond holdings be roughly equal, in percentage terms, to your age. 60% or more bond holdings would protect a 60-year-old’s retirement funds to a much better degree than any allocation of stock mutual funds would.

So what in the tax code gives people incentive to properly allocate their assets as they get closer to retirement age? I’m a big believer that if you want people to act a certain way, don’t tell them to act that way in a high school class; instead, make it worth their while in the tax code. Is there a retirement plan model that would present a simple tax incentive for proper asset allocation? As a strawman: you can earn double tax credits for 401(k) or IRA contributions to bond holdings, up to a percentage of your overall retirement savings equal to your current age. (Not ideal, since what you really want is to distribute all holdings, not just current year contributions. Anyone have a better, simpler model?)

I do think that the effects this downturn has had on those in and near retirement have been brutal, in many cases devastating. The 401(k) and IRA programs have taught many Americans the value of retirement savings by giving them a tax incentive to learn. We certainly shouldn’t throw away those ideas, but maybe it’s worth improving them with a program — and incentive — for secure asset allocation.

4 Responses to “A better model for retirement savings?”

  1. jolly Says:

    I don’t think the government should be biasing people’s asset allocation decisions. It’s true that many people would benefit from better balancing of their retirement portfolios, but if they aren’t motivated enough by trying to preserve their retirement wealth, tax code nudges are not going to help. They will only blame others for steering them into a balanced portfolio when they should be have more in cash, gold, foreign stocks, or whatever else looks better in hindsight. Many 401K plan administrators already take great pains to explain the different investment options and benefits of asset allocations, often to apathetic employees who don’t even bother to attend the presentation.

    In the current environment where many people’s retirement funds have been decimated, I would like to see an idea where people could “catch up” on their retirement contributions. Instead of the annual contribution limits, there should be a aggregate contribution limit based on your age (e.g. (AGE-20) * $3000 for IRAs) In any year, you can contribute as much as you want until your total retirement account cost basis hits your aggregate limit. In addition, if your retirement account’s value has fallen BELOW your basis, you can contribute funds to bring it up to your basis limit.

  2. Pev Says:

    I’m with you, I don’t think mandatory financial education is something for everyone, especially if people don’t really care to take those classes. Maybe having cartoons on finance subjects on tv would be better. At least you’re teaching people while they’re growing up. I remembered when warner bros had the Historia or Histaria cartoons about history – that really helped me to do well in my history class. Now there is an idea for ya! 🙂

  3. Jalene Says:

    As a fee-only Certified Financial Planner practitoner, I have a great interest in this topic. I am always concerned when people use generic rules of thumb to advise people on how to allocate funds. Using the percentage of age in bonds theory discounts the real concern of outliving our purchasing power as we age. Age is only one of the factors that needs to be taken into acount when allocating an individual’s protfolio. Is the individual in great physical shape and still working? Have they accumulated substantial savings and are very uncomfortable with the market voaltility? Will they sleep better at night with a more conservative portfolio and still meet their goals?

    The other major issue I have with most 401k/403b plans is the hidden fees and poor choice of investment options. I think this issue is starting to be addressed, but it is still difficult for small employers to find cost effective options.

    I think one of the key issues in Financial Education and Literacy is the financial industry itself. Individuals become disillusioned with “advisors” because they go in seeking unbiased financial advice and end up getting a sales pitch disguised as financial advice. Or they find a fee-only advisor that only accepts clients with assets over $500,000. Using the internet for decision making means wadding through often conflicting information and hoping that you make the best choice. I agree that a sefcure financial future is not complicated: start early, spend less than you make, and keep your assets diversified.

  4. incrediblemsv Says:

    I don’t have any good opinion regarding 401(k)’s – or, in my current case, 200.5(f); however, I have a strong opinion regarding another topic in your article: home economics. I was surprised and a little ashamed when I graduated high school and realized that I didn’t have the first clue how to reconcile a checkbook. While my parents are financially successful in their own right, they never took the time (or maybe didn’t know how) to show me how to budget or plan for the future. As a former 4-Her and home-ec student, I found I still did not have all the tools I needed to survive on my own. I have tried to instill the missing parts of my education into my children’s lives as a result.

    One way was giving each child a week in the kitchen & a limited budget for groceries. I insisted that they plan meals, go shopping, and cook for the family for their week. If there was money left over, there was the reward of doing something with it as a family (movie, rental, etc.) The neatest part was, we found some very tasty recipes that I never would have tried and the kids learned to make choices based on cost vs. value.

    Another thing that was prompted by their grandpa was opening a checking account while still in high school. He fronted each with $100 if they would turn their meager savings accounts into checking accounts. They found out quickly that when their money was in a more easily accessible checking account, it disappeared quickly. The younger of my daughters saw how quickly the well dried up and emptied her checking account back into savings!

    I talked to the banker when they moved away to college about the possibility of getting together with our school board and teaching a hands on segment of budgeting to our local high school home-ec classes. I think this really needs to be taught much earlier than to the standard high school aged classes, though. Middle school math classes would be prime targets. Our local credit union is sponsoring savings bees that challenge children from kindergarten to Seniors in high school to save with a prize for the top savers. It has always floored me that we teach our children to use a sewing machine, but ignore something as important as their financial future and security.

    My oldest kids are now in college, but I think they are making great strides at living within their means. I may have the only kids in college who don’t call me weekly, or even monthly, needing a cash infusion. 😀

    That being said, I *still* would like to see someone address my needs in regards to investment and planning. Last time I changed my investment accounts, I must have used a dartboard. And I am far from the previous poster’s ideal client with at least $500k worth of assets. :S

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