Thursday, August 26, 2010

Fidelity data on 401(k)s, news or not?

Sound and thunder without content

Most of the time the news makes some sense even if it just seems to confirm that the world can be entertaining. But, the coverage of some data from Fidelity just didn’t make sense to me. It got more play than it deserved, and every report seemed to focus on the irrelevant. So, hoping to make some sense of it, two versions of it were sent to some friends whose opinions and comments always make sense. This posting is built around their comments. They’re reported in the order received, which, with this introduction, actually makes a coherent posting.

The data concerned Fidelity 401(k) participants. The two versions sent are:
Fidelity: 401(k) hardship withdrawals, loans up
As 401(k) Levels Rise, So Do Withdrawals
Despite extensive coverage, none of the reports I saw or heard addressed the seriousness of the behavior being reported. They all missed an opportunity to educate as well as inform.


“It might also have been a news conference and a press release....

Interesting interpretations, for sure.....

I was struck, even in hearing the radio version of the AP story, (I never heard the WSJ version on the radio, but am sure WSJ radio did their version), with the relative small number of people doing the redemptions....

I don't think either side is wrong or out of line. The AP story is aimed at getting page one play....that's why it's written that way. The WSJ interpretation leans the other way, in trying to take a positive swing at the increase in contribs......

In my opinion, both are really non stories in relation to the overall economy. The hardship redemptions could be for many reasons other than reductions in take home pay and hours, and the increase in the average account is simply explained by the 18 month run up in the stock market.....

One man's trash is another's treasure.....

PS.....I'm wondering if the AP might have done several stories linked to the same news conference or news release....that is often done where there is just too much in the way of percentage comparisons and number crunching involved......”

The Hedged Economist would add:

We are in agreement that the entire story doesn't say a lot about the economy. It's only relevant to the extent it conveys any information about how people are behaving. That's limited.

Regarding the media, you're right about the WSJ story not being played for page one. It was on an inside page of a Saturday edition. Your suggestion that it is not just a press release is probably right. It may not have been a press release at all. If it is, it isn't easy to find on the Fidelity website. Since different people are quoted in the two stories, any difference in "spin" could be the interviewee.

What seems curious is that it got as much play as it has. It has been mentioned on TV, radio, and in the press. It may be that the coverage is just an indication of how desperate media has become in their effort to support a 24/7 new cycle. It might also indicate how dependent on AP the media has become. This is the sort of thing one use to have to dig to get.

Regarding the stories themselves, you’re right that the increase in balances being partially due to improved markets. But, 15% doesn't say much. Stocks (e.g., S&P) aren't up that much year over year and who knows about foreign stocks and bond funds. The impact of markets depends on what has what weighting in the 401(k)s. As you imply, one has to remember that people made contributions during the year. That would increase the average balance, and is probably more important.

It would be interesting to know the impact of the turnover in who is in their programs. That would seem to have a negative impact on average balances since people leaving would by definition have been in the 401(k) and have made contributions. By contrast, new participants have no initial balance.

It also occurred to me that as baby boomers retire they will have had a longer time to have built balances than other groups (even though 401(k)s have only existed since 1981 and were rare initially). That should lower the average balance. It also occurred to me that this year, older people with large 401(k)s can roll them into Roth IRAs. That would tend to reduce the average balance.

Despite all the cross currents, one thing the higher average balance seems to indicate is that there has been growth in the asset side of the balance sheets of 401(k) participants. That’s especially important given the issues discussed with DOC below. It will be a while before we know whether the number of participants grew and whether overall 401(k) assets grew.

The hardship redemptions as well as the maintenance of contributions just sound like how one would manage savings. It is interesting that more people increased elective contributions than decreased. Perhaps it’s a bit more of the savings trend often noted in the press.


“Isn't this normal for the first recession where 401(k)s have been really important stores of household wealth. If you have your retirement money in the 401(k) and home equity, and college funds, etc., how much "savings" do you need? Isn't that entire savings"? These people have tapped their emergency funds, and this is their lowest cost source of capital, especially since credit cards may be full up. All of this sounds normal to me. What is truly troubling is that the average account balance is $61k. (And its up 15% !!! from the year prior!) We're going to see stories again about retirees eating cat food.”

The Hedged Economist

The $61k average balance is probably the most important pieces of data in the release. It is a disturbing number since 401(k)s are probably the mainstay of many people’s provisions for retirement. IRAs, home equity, etc. definitely also have to be taken into considerations as well as the age of the people involved. There are probably some people with other 401(k)s held by other institutions (although one would expect that most would be rolled into IRAs). It is also scary to think that $61k is an average. The median is probably lower since it doesn’t take a lot of big balances to raise the average.

The Federal Reserve Survey of Consumer Finance is probably the best source, but it is only updated every three years. The last one was 2007. In the mean time, snippets like this are what we have.

The other curious figure is the average elective contribution rate of 8%. Granted people can, and should, save in forms other than a 401(k) (e.g., home equity and other capital goods, collectables, cash, IRAs, and financial assets), but 8% for retirement seems low.

It seems incompatible with two rules of thumb for personal finance, although it isn’t definitive. But, save 20% is often thrown out as a target. One would think that would put a cushion that would be used before tapping a 401(k) as the lowest cost source of cash in hard times.

A greater concern is the point you make about retirement and cat food. The old rule of thumb was retirement should be like a three-legged stool. The legs were supposed to be SS, pension, and savings. With pension coverage falling, one would expect to see 401(k) contribution rates growing. It would be an error to substitute a 401(k) for both the pension and other savings. Granted, the 8% figure and $61k reflect the impact of people with pensions and 401(k)s rather than just people totally dependent on 401(k)s.


“I read one of these two last week, too. Frankly, I’m not surprised about the need to withdraw.

While withdrawing from my 401k has never entered my mind (yet), …” The economist, like DOC, then went on to discus when withdrawals would represent rational economic behavior.

The Hedged Economist would add:

A pension or annuity introduces an important consideration. One of the risks that a 401(k) balance can hedge against is longevity (i.e., outliving one’s money). A pension or annuity is an excellent hedge against that risk. But, pensions aren’t that common, and many people who have pensions figure they don’t need to participate in their 401(k). Some don’t because they save elsewhere, but others just don’t want to save.

The caveat is that pensions, annuities, or 401(k)s only protect the participant from that risk to the extent they are funded. One can argue about whether it is easier to assess the adequacy of the funding of a 401(k), a pension, or an annuity. Personally, pensions have always seemed particularly difficult to analyze. They also can introduce concentration risk (i.e., having all one’s eggs in one basket as in having one’s job and retirement dependent on one organization’s management).

Individuals face risks other than longevity. The 401(k) withdrawals make it apparent 401(k)s are being used to hedge other risks besides longevity. Specifically, they are providing liquidity. They’re being used as a rainy day fund, educational fund, home purchase fund, etc.. One can argue about whether that is a good or bad trend, but there isn’t any doubt it is something a 401(k) can do that most pensions’ rules don’t facilitate. Annuities seem to fall somewhere in between, but annuities include such a broad spectrum of products that generalizations don’t apply.

Since there was a time when withdrawals weren’t commonly allowed, 401(k)s haven’t always filled these multiple needs. Nor, was it assumed they should. It seems appropriate to discuss some reason they should only be used for retirement funding.

Withdrawals are often a very expensive way to gain liquidity, (i.e., get your hands on cash). They are designed to encourage participants to give up liquidity. Both positive incentives and penalties are employed. Further, as The Hedged Economist often points out, it is dangerous to use one tool to hedge multiple risks. It is overworking a single hedge.

Two of the major risks arising from the practice of over reliance on a single hedge are illustrated in the articles. First, the right level of hedge isn’t the same for all risks. To illustrate, a rainy day fund of 61k would leave many people feeling quite comfortable. By contrast, 61k won’t produce much income in retirement.

Second, an overworked hedge is usually a very inefficient hedge. Again an illustration, the average withdrawal is about 8k. That 8k can be reduced by a 10% penalty and taxes at let’s say a 15% marginal rate. (It is a rainy day after all). So, 8k becomes 6k. If the marginal tax rate is 25%, 8k becomes 5.2k.

But, that’s just the start of this inefficiency. To hedge for retirement, the 401(k) should be in investments with a decent return. That means they have some volatility. The 8k current value could have had any historical cost.

Yet, the real cost is the discounted present value of the tax deferral being sacrificed. Given ages of from 35 to 55 for the people making withdrawals and the likelihood taxes will go up, that’s probably the biggest cost.

But, cost is only one dimension of the inefficiency. There is analytical cost as in the time an effort that should go into figuring out whether a withdrawal makes financial sense. The illustration above could be reversed by employer matches, exceptional investment performance, changes in the participant’s tax rate over time, etc.. They would all have to be considered. Compare that to the efficiency of having a separate rainy day fund, in this example a 5.2k to 6k rainy day fund.


The pensioner started with a fictitious, tongue-in-cheek “everyman” rant. Entertaining, yes, but to clarify the pensioner’s point I paraphrase: People are overly focused on today, overly influenced by banks (financial service industry ads), overly influenced by favorable tax treatment as a short run fix but insensitive to them when a longer run consequence is involved, feel entitled without feeling personally responsible, and put a lot of faith in other people fixing their problems. But, the pensioner’s comments are below since paraphrasing always undermines the tone of a statement:

“I have to have a flat screen, cable, several cars, vacations, and more... So I used my house as a credit card and why not? Home equity loans gave me a tax deduction and why not? My "double wide" was growing in value at 10 to 25 percent a year. And my favorite banks would encourage a re-finance to free up even more cash. True, they made a lot on fees, but I got free money. There were years I made more money just sleeping at home than going to work.

Well, the house is now under water. I am no longer going to work. The cable bill is due, the kids want a nice private college in New England, and the wife wants a newer BMW.

This is no problem. Those wonderful laws and bankers that got me home ownership benefits also put me into some great tax avoidance savings accounts. And those accounts were all mine and perhaps the secretary in accounts payable. No equal property here. But now out of work, I no longer take her to lunch. And with the market downturn, the 401(k) was perhaps not all great an idea. Just get me some money. I am planning a come back.

So why not take your money out. Pay the 10% penalty. Get whacked on the taxes. Who really does care about retirement when your BMW is due for service now? Surely, all the days of my life, Obama will protect me. He knows this is all the work of Bush, and not the weakness of the American consumer or government’s failed economic policy. And now more than ever we need to be creative to support our personal entitlement to spend, spend, spend. I told that little tramp in Accounts' payable I wanted the $3,500 I loaned her for a boob job. Time to call in your chips. I have another 8 years to rebuild my retirement savings.

(And with social security and a 401(k) of about $61,000 my retirement would have me drinking hooch and eating wet cat food only on Sunday)

Brother can you spare a dime, Obama days are here again......”

The Hedged Economist would add:

The focus on short-run consumption isn’t just an everyman issue. It seems to be a national obsession. As baby boomers age, it will get worse.

Interestingly, all the other people who commented above, at one time or another, have alluded to people being overly influenced by the financial service industry. Especially as it relates to the structure of cash-out refi’s during the housing boom. Yet, at the time, cash-out refi’s were viewed by many as just rational strategies for credit management. Very few people will second guess the public’s consumption verses savings decisions.


“What both of the stories fail to discuss is that these withdrawals are for ‘hardship.’ I wonder how much due diligence the bankers do before releasing the money.”

The Hedged Economist would add:

Disappointment with the abbreviated discussion of how a hardship loan or withdrawal is defined was my initial reaction. Mainly because of where it leads as explained in comments in response to another comment from the pensioner. But first, because of where it leads, a discussion of the relevant IRS definition of hardship follows:

Like loans, hardship withdrawals are allowed by law, but your employer is not required to provide for them in your plan. Like loans, most companies do, but some don't. The cost of administering such a program can be prohibitive for many small companies. Like loans, your employer must adhere to some very strict and detailed guidelines. My guess is that plan administrators have a set of forms one has to fill out in order to make a withdrawal.

The IRS code that governs 401(k) plans provides for hardship withdrawals only if: (1) the withdrawal is due to an immediate and heavy financial need; (2) the withdrawal must be necessary to satisfy that need (i.e. you have no other funds or way to meet the need); (3) the withdrawal must not exceed the amount needed by you; (4) you must have first obtained all distribution or nontaxable loans available under the 401(k) plan; and (5) you can't contribute to the 401(k) plan for six months following the withdrawal. Under the provisions of the Pension Protection Act of 2006, the need of the employee also may include the need of the employee's non-spouse, non-dependent beneficiary.
The following items are considered by the IRS as acceptable reasons for a hardship withdrawal:
1. Un-reimbursed medical expenses for you, your spouse, or dependents.
2. Purchase of an employee's principal residence.
3. Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
4. Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
5. For funeral expenses.
6. Certain expenses for the repair of damage to the employee's principal residence.
Hardship withdrawals are subject to income tax and, if you are not at least 59½ years of age, the 10% withdrawal penalty. You do not have to pay the withdrawal amount back.
A hardship distribution may not exceed the amount of the need. However, the amount required to satisfy the financial need may include amounts necessary to pay any taxes or penalties that may result from the distribution.


“My employer has a deferred comp plan for employees, which works like a 401(k) (i.e., the money goes in and is not taxed). The plan had to agree to follow hardship rule in order to keep the IRS tax exemption. The Treasury department reviewed requests for money to insure that it was within the guidelines. If Treasury rejected the request, the employee could appeal to the deferred comp board, which I sat on for about four years. Most of the time the people came in and we granted their request. However we did the due diligence to protect others who use the plan and want the IRS tax break. Most all requests were made by people who were working for the State, and had a regular pension.

It was a very eye-opening experience about how people had very poor money management skills."

The Hedged Economist would add:

The data provided the media with an excellent opportunity to delve into a discussion of personal money management. Other than abbreviated references to how hardship is defined in the relevant IRS regulation and some potential tax implications, the articles seem to focus on things with supposed global implications. They passed up a potential opportunity to contribute to public understanding of an issue we all have to address. What a shame!

DOC has commented that 401(k)s gave people a ton of responsibility without any relevant education. But, that doesn’t say whether it’s education on asset management (i.e., investing) or personal money management that is missing, or both. Nor does it say which is more important. What this closing comment by the pensioner points out is that personal financial management plays an important role.

The Hedged Economist would close with the comments: this blog often takes an unorthodox approach to investing viewing every investment as a hedge against some risk. Combined with a good grounding in personal financial management, it works. My opinion is that money management is probably the more important than investment prowess, and it definitely makes asset management easier.

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