The 401(k) Myth

May 3, 2011 ( - Among the calls for “reform” in pension benefits for governmental employees it is fairly common to hear policy makers say, “We cannot ask taxpayers to continue to foot the bill for public employee benefits that are far more generous than their own.”

The comparisons frequently drawn are between governmental defined benefit plans and private sector 401(k) plans. 

A reasonable question to ask is, were these private sector employees who are complaining about public defined benefit plans forced into 401(k) plans as their primary form of retirement savings or did they actually go along willingly?  There were a couple of key things happening when the private sector began a mass migration from defined benefit to 401(k) individual account plans.  Private sector employers were growing weary of the increasing regulatory complexity associated with maintaining defined benefit plans, not to mention the premiums they had to pay to the Pension Benefit Guarantee Corporation. 

From the employee perspective, a protracted bull market was running that started in 1982 and that had only experienced minor blips along the way.  It was a fairly easy sell to convince employees that defined benefit plans were antiquated and not going to provide anywhere near what would be available from 401(k) plans where they could control their own destiny and reap the benefits of the double digit returns that were there for the taking.  (It’s also worth noting that there were service providers encouraging the transition because it was clear that defined benefit plan managers were much better positioned to keep service provider costs down than would be individual investors.)   The end result was that employees accepted the deal when the deal looked good and rolling the dice did not seem to involve much risk. 

Well, in the last decade, the 401(k) participants rolled snake eyes twice and now resent the governmental employees who plodded along with their stodgy old defined benefit plans, thus avoiding massive losses at two points over the past ten years.  Even though it is probably just human nature, it is unfair to say that the public employees have a much better deal than their private sector counterparts when the fact is that the private sector folks gave up their deal for what they assumed (or were led to believe) was going to be an even better deal. 

The current private sector dilemma was probably predictable, at least to the students of behavioral finance, since individual investors seem to have an uncanny capacity for making the wrong decisions when it comes to investing for the long term.  Between chasing yield and buying high and selling low, performance has been less than stellar, particularly in times when the markets turned against them. While some rode out the storms, many made a flight to safety at market lows and missed the rebound, thus ending up with a fraction of what they had in their accounts at one time.  You might wonder who they were selling to at the lows.  In many instances, I suspect it was the defined benefit plans rebalancing their portfolios into stocks.  More on this later.

Private sector employees who are ill-prepared financially for retirement create the same problems that were mentioned earlier for public sector employees who may find themselves in that position.  Suggesting that the public sector join the private sector in a race to the bottom hardly appears to be a viable solution to the long-term objective of providing an aging population with reasonable levels of retirement income security.

- Gary Findlay, Executive Director, Missouri State Employees’ Retirement System (MOSERS).   

Mr. Findlay is executive director of the Missouri State Employees' Retirement System (MOSERS), a position he has held since 1994. Prior to that, he spent 16 years as an administration and benefit consultant with Gabriel, Roeder, Smith & Company, a national actuarial and benefits consulting firm that specializes in serving the needs of public employee benefit plans. He was CEO of that firm from 1986 until he joined MOSERS.  

Next up:  Where's the Alpha?

Also in this series:  Public Employee Retirement Plans and the Myth of the Risk-Free Rate