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'Magic Money' Working Magic on 401(k)s

By Gerald E. Scorse
401(k) defined contribution accounts, while regularly maligned, are doing better by workers than the defined benefit plans they swept aside.

A top policy expert isn’t buying reports of a private-sector retirement “crisis.” In an article, Andrew Biggs not only rejected the gloom but offered a striking counter-narrative. He cited figures showing that 401(k) defined contribution accounts, while regularly maligned, are doing better by workers than the defined benefit plans they swept aside.

His numbers speak to the power of 'magic money': savings built up in large part by stock market investments, compounded by decades of tax-sheltered capital gains and dividends. The most fortunate retirees are having their cake and eating it too. They’re taking annual distributions from their accounts, and having the withdrawals more than replaced by new magic money streaming in (full disclosure: the author is among the most fortunate).

Let’s review some of the key figures, and see how 401(k)s and similar defined contribution accounts are making the golden years more golden for millions of retirees.

First, defined contribution plans cover a far greater proportion of workers. “Participation is higher in 401(k)s, with 61 percent of private sector workers participating according to a Social Security Administration analysis, versus a peak of 39 percent for defined benefit plans.” The percentages underscore a truth commonly ignored by defined benefit advocates: the vast majority of non-government workers never had such plans, and likely never would.

Current retirement savings also far exceed the comparable figures for the years when only traditional pensions existed. Federal Reserve data show that total savings in employer-sponsored plans rose from 27 percent of gross domestic product (GDP) in 1947 to a peak of 57 percent in 1975. But, Biggs points out, “in the four decades since 401(k)s were introduced, total retirement savings nearly tripled to 157 percent of GDP.”

Other yardsticks yield equally compelling results (thanks partly, of course, to magic money).

For example, a 2017 study by economists from the IRS and the Investment Company Institute put the income of the median retiree at 103 percent of what they were making prior to retirement, “far exceeding the 70 percent ‘replacement rate’ that most financial advisors recommend.”

Workers appear to be getting a better deal even without any magic. Vesting periods are shorter, and company contributions have soared; according to the Labor Department, employer deposits to private-sector plans “more than tripled as a percentage of salaries since 1975.”

With so many signs flashing positives, why all the negatives for 401(k)s? Why are they disparaged as a backward step?

There’s good reason. Defined contribution plans effectively lift the pension burden from employers and put it on employees instead. They offer little to no security. The stock market, where most 401(k) money heads, is notoriously volatile. Inevitably, unnervingly, Wall Street hits stretches when the averages slide deep into the red.

But there’s an inverse inevitability as well, and it gets little attention: the inevitability of market recoveries, often speedy recoveries.

MarketWatch analyzed selloffs and recoveries from 2010 to September 2015. The declines averaged 26 trading days to bottom out, an equal 26 days to recover; the median did even better, recovering from a 19-day drop in just 15 days. Wealthfront looked at down markets from 1965-2014; over those fifty years, all the declines of less than 10 percent “bounced almost instantly.”

Uber-crashes are inevitable too. In the latest, from June 2008 to March 2009, the financial crisis took all three major indices to 12-year lows. Then began the recovery: the S&P 500 finished 2009 up 64.83 percent from its low, the NASDAQ up 78.87 percent, the Dow-Jones 59.28 percent. As it happens, the rebound was also the start of what’s become the second-longest bull market in the last 85 years.

There are two morals to this retirement story. First, based on the record, defined contribution accounts deserve more cheers than jeers. Second, magic money really is working magic, enriching both current and future retirees.

Over the long run it’ll do lots more enriching. It’s almost, well, inevitable.

Gerald E. Scorse helped pass the bill requiring basis reporting for capital gains. He writes on taxes.

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This story was published on August 13, 2017.

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