American Express began as a delivery company in 1850, pioneering “mailbox money” in more than one way. The upstart U.S. postal system could only handle letter sized envelopes so there was a need to deliver larger parcels and valuable items, and American Express was born. American Express then established the first private pension plan in the United States in 1875.
An Old Fashioned Idea for a $5 Trillion Misunderstanding
Banks came to rely heavily on the secure and reliable delivery service of American Express from the east to new western territories. But, in 1890, William Fargo took a trip to Europe and returned home frustrated. Despite being president of American Express and carrying with him traditional letters of credit, he found it difficult to obtain cash.
Today, more than $5 trillion sits in 401(k) mutual funds as letters of credit for retiree’s travel plans who are finding it equally frustrating to convert that fluctuating currency to income in their hands. The same is true for many more dollars in IRA Rollovers previously in 401(k)’s.
Improvements and breakthroughs in the delivery of - anything, anywhere, and at any time - have been astounding ever since that first American Express stagecoach. The only thing missing for many Americans today, is that pension check in the mailbox.
Changing the entire course to retiring happened unintentionally. A benefits consultant named Ted Benna noticed this little paragraph “k” in IRS code 401, written in 1978. It allowed a tax break for companies to let workers save a little extra cash on the side. This provision allowed employees to shelter a portion of their pre-tax earnings into a savings account to later supplement their defined benefit pension. Never intended to become a retirement plan, and never able to replace a pension’s insured income stream, the 401(k) was ignored at first. It was not until two years later that Ted Benna pitched the idea to a bank client who ignored his advice. So, he set the first 401(k) savings plan up for his own company instead.
The idea took off from there. It has been Christmas morning for Wall Street’s mutual fund industry every day since.
Corporate America has shifted from defined benefit pension plans to defined contribution 401(k)’s and has never looked back. Today, more than 55 million Americans have based their retirement dreams on the misunderstanding that they have a retirement plan. I believe it is worth looking back. The 401(k) was supposed to be an extra savings account and nothing more.
Ted Benna said - about his original idea to use the 401(k) code, but not as a plan - “It has transformed what’s happening with retirement...but it wasn’t intended, it was a fluke.”
Companies knew they could save money, and employees thought they could make more money, all through a 401(k) – a perfect storm of greed washing away the conservative old fashioned pension. Who needed the safe delivery of a monthly check if a hot fund could make more than that in a week? Just 13% of Americans have a defined-benefit pension plan now, down from 76% in the mid-1980s, according to data from the Bureau of Labor Statistics.
How do you convert these modern-day letters of credit into mailbox money to be cashed every month? For all the mind-boggling advancements in delivery services since those early American Express stagecoaches, the technology that now needs disrupting the very most is transforming old 401(K)s or IRAs into mailbox money once again.
Those very first 401(k) accounts are almost four decades old now. The only problem is that retiring workers are now like William Fargo back at that teller’s window in 1890, holding letters of credit in the form of mutual funds on brokerage statements, and asking for cash and getting the same blank stares. I am not a writer, I am sharing the confusion I have witnessed over two decades when any investor that came to our offices for the first time was asked - what is your specific plan to generate income for life now? Even the most sophisticated investors with large nest eggs, all based any withdrawal strategy on projected returns. We believe an income plan must be generated from mailbox money instead.
Don’t take my word for it. Let us listen again to the father of the original 401(k), Ted Benna, who stated, "Hey, if I were starting from scratch today with what we know, I'd blow up the existing structure and start over."
“The great lie is that the 401(K) was capable of replacing the old system of pensions,” says former president of the American Society of Pension Actuaries, Gerald Facciani.
Don’t take their word for it, ask Fidelity the largest provider of 401(K)s. They have been trusted with over $1 trillion in these accounts since Ted Benna first discovered the code. Fidelity has been asked many questions actually…in a class action lawsuit by its own employees over its own 401(k) plan. Not started by a disgruntled low-level employee but rather a director with great access. If its own plan was alleged by 50,000 workers to have enough conflicts of interest and fees for the company to settle, then what must be going on in customers’ accounts?
Fidelity is not an isolated case, just the biggest among many red flags being ignored by too many investors. Ameriprise, Wells Fargo, Insperity, JP Morgan, Edward Jones, Morgan Stanley, Neuburger Berman, Franklin, New York Life, American Century are among other recent class action lawsuits by 401(k) participants. And, that’s during a good market!
The National Association of Retirement Plan Participants’ “Trust and Engagement” survey found that only 30% trust their own retirement plan provider. And, that is a five-year high.
While judges and Congress will be used to right wrongs and re-write rules, I note there is one thing all those folks with radically different opinions on what is best for the 401(k) industry have in common – they each have their own pension instead.
Ted Benna said about confusion in 401(k)’s, “Now this monster is out of control. We went to three options, then to six, then to seven, then to 15. It is far beyond what most participants were able to deal with…I helped open the door for Wall Street to make even more money than they were already making. That is one thing I do regret.”
According to the Investment Company Institute and Brightscope, the average 401(k) plan has 29 fund choices. This explosion in complexity gave rise to an army of consultants needed to create and monitor the growing menu of choices. “That’s when the investment community took over the 401(k) business,” says Benna, who adds that total costs increased from roughly 0.1% for the earliest plans to 1% to 2.5% today. “The bottom line is there was money to be made,” he added. There are stewardship expenses, transactional expenses, legal expenses, trustee expenses, administrative expenses, bookkeeping expenses, communication expenses, and investment expenses.
Make no mistake, anything this big for this long must be a co-conspiracy. Our animal spirits spiked by more choices make American consumers particularly ill-equipped to perform the role of longevity planning. Then, mix in confusion - one survey revealed 92% of Americans “have no clue” what they are paying inside 401(k)s and 72% think they are paying nothing. A bull market that lasted almost two decades starting in 1982 was the perfect accomplice for that greed and apathy.
Nobody knows how this experiment ends. We are just now retiring that first generation of 401(k)s who saved for more than three decades and then are handed the steering wheel to land it.
The longest running survey on the subject of Retirement Confidence is the 28th annual survey by the Employee Benefit Research Institute & Greenwald & Assoc.
Among 401(k) participants:
33% have estimated how much income would be needed in retirement
31% have calculated how much they’d need to have saved prior to retirement
80% are interested in a plan option of guaranteed monthly income for life once retired
Ted Benna agrees. When retirement does come, he says he would cap the percentage of assets that can be taken as a lump sum. The bulk of participants’ savings, he believes, should be annuitized for a steady stream of retirement income.
Unfortunately, I would not expect a big shift in corporate America for many entrenched reasons. Quietly, a devastating blow to corporate pensions was buried inside the Budget Act of 2015 - an increase in payments companies will be forced to make to the Pension Benefit Guaranty Corporation (PBGC). Those costs rose more than 40% over the next few years for companies offering plans. It helped reduce the net price tag of the budget deal because it is counted as revenue for the government. That may be the final nail in the coffin for traditional defined pension plans as we knew them. Companies cannot afford them.
But, you can.
Ted Benna’s idea about what he would do with a large portion of savings is once again catching on. The most impressive academic background and resume I have seen caught my attention on this topic. David Babbel applied for a job at the World Bank. He did not get the job, and was told he needed a postgraduate degree in one of six different categories. Not wanting to take chances, he got one in ALL six. Carrying an MBA and bag full of PhDs, he went on to teach finance at Wharton. He wrote a paper on reducing risk in fixed income portfolios that Goldman Sachs was so impressed with, they hired him to run their risk management along with their pensions and insurance division. He still taught part-time at Wharton. Finally, he went back and got that job at the World Bank and was also hired to consult the U.S. Treasury, the Federal Reserve and the Department of Labor.
What always impresses me more than any resume though is a simple personal story. David Babbel describes in detail ignoring the advice of his Wall Street buddies, who encouraged him to let his investments ride, hoping for more growth. Instead, he decided after all he learned to create a simple lifetime income plan. Despite having more access to more smart money investment ideas, he chose to create his own personal pension instead, using income annuities. He humbly describes that not only is the math better, but it is simpler, and he admits that he did not want to make complex financial decisions throughout retirement as he aged. I think for a family, that legacy of peace of mind that can get passed along – “here is how it all works honey, and it is very simple” – is a key piece of the financial freedom puzzle.
Americans thought we wanted to run our own math for retirement. But, as it turns out, that team of pension actuaries in the back room with the bigger calculators is just better - for a portion of a nest egg - if you want to know exactly how much mailbox money you can receive for the rest of you and your spouse's lives.
If you are nearing, or already are in retirement, you need to ask the same question the original founder of the first money delivery company did when William Fargo returned home unable to get his own cash – how can I build something better?
You deserve some full disclosure, if you are wondering who in the world is delivering an idea from 1875 as cutting edge?! After escaping Wall Street in 2006, our firm was opened to share old fashioned values with families who believe in something even better than retirement – complete financial freedom. The ingredients are simple. Since that very first pension plan 143 years ago, there has not been one product invented on Wall Street that is needed to build multiple income streams to last a lifetime, in our humble opinions.
To be clear, we believe 401(k)s are great for pre-tax savings accounts, exactly as they originated. But, they are not a plan. Our 401(k)s and Rollovers hold dividend paying stocks and individual bonds (no funds), focused exclusively on free cash flow. And, we choose to fund personal pensions. Those three sources of income have stood the test of time. Good old fashioned ideas do not need new codes from the government, or any new products from Wall Street.
On Twitter @RyanKruegerROI