Beware the 401(k) Gamble

Until recently, the flood of millions of working people into the stock market, principally through their retirement accounts, was hailed as evidence that Americans at all economic levels can make it on their own.

Then Enron Corp. collapsed, throwing thousands out of work and destroying the retirement nest eggs of thousands more. While investigators search for clues of foul play, Washington is rushing in with legislative fixes--including proposals to limit how much company stock can go into retirement accounts.

For many, it is too late. The collapse of Enron’s retirement arrangements is only the latest in a series of similar financial fiascoes during the last decade. But hundreds of thousands, perhaps millions, of Americans continue to shoulder the same kinds of risk borne by Enron workers before their savings evaporated.

“We’re fooling ourselves if we think Enron is a scandal that doesn’t have anything to do with the rest of us,” said Norman P. Stein, a member of the Labor Department’s employee retirement advisory council and a University of Alabama law professor. “What happened to Enron workers could happen to you.”

The reason is a sea change in how Americans make financial provisions for their old age. Working people have turned the stock market into their retirement system, and themselves, rather than their corporate employers, into retirement money managers.

Individuals are now responsible for making the basic investment decisions for half the nation’s non-Social Security retirement savings, rather than having those decisions made the old-fashioned way--by employers who promise benefits no matter what.

That is up from a little more than one-third in the early 1990s. Individuals, together with big institutions, have pumped more than two-thirds of the nation’s $10 trillion-plus in public and private retirement savings into stocks.

So when the stock market takes off, as it did in the late 1990s, so does America’s retirement system. And when it tumbles, as it has in the last two years, so do retirement savings.

“We have a system that has succeeded in amassing a formidable pool of capital and providing retirement benefits to millions of people,” said J. Mark Iwry, who as benefits tax counsel for the Treasury Department until last year was one of the most powerful regulators of the retirement system in Washington.

“On the other hand, the self-direction of investments has shifted the risk of retirement investment from employers to employees, and many workers have ended up assuming imprudent amounts of it.”

They often have done so without even knowing what they did.

Retirees Look Back at Costly Errors

Bill Quinlin certainly didn’t.

The 65-year-old Robstown, Texas, resident retired from Enron several years ago, after nearly three decades as a gas pipeline operator, to care for his dying mother. He had nearly all his retirement savings, save a small pension and Social Security, in 25,000 shares of Enron stock.

When the stock was at its height at better than $80 a share and Quinlin was a paper millionaire, a friend suggested he sell some of his holdings.

But Quinlin said he could not bring himself to do it, largely because the place was being run by Kenneth L. Lay, Enron’s longtime chairman, who resigned late Wednesday.

Lay had saved a utility where Quinlin once worked. And the executive had come down every year or so while Quinlin was at the Corpus Christi pump station to take the men out for barbecue.

“I thought that guy walked on water,” Quinlin said recently of Lay. “Why, if he walked in here this minute, I’d probably sit right down and talk to him.” Quinlin’s shares have gone from being worth about $2 million to a couple of thousand.

Roger Boyce said he didn’t understand the risks he was shouldering either, even though he is sophisticated in financial matters.

The 67-year-old Minneapolis-area resident retired from Enron in March 2000 after almost two decades as a benefits executive and another decade as a safety and security manager.

Boyce said he was well aware that the world of retirement savings was changing when Enron stopped offering old-fashioned pensions in the late 1980s and replaced them with plans such as 401(k) accounts, to which it contributed fixed amounts of stock, but made no promise of what benefits employees could expect when they retired.

“I knew I had to manage these accounts, and I was aware the best protection was diversification” out of Enron stock and into other stocks and mutual funds, he said.

But Boyce ended up pumping about two-thirds of his retirement savings into Enron because of the company’s rapidly rising stock. In any case, he reasoned, with the company in so many lines of business it represented a diversified investment all on its own. Even if one business line failed, another would take its place.

“I know a normal person’s question is: ‘How stupid could you be?’ ” But it was difficult to resist, he said.

Like Quinlin, Boyce saw his Enron stock tumble almost $2 million in value. He and his wife, Marilyn, have been forced to scrap the idea of setting up trusts for their six grandchildren.

“It’s very tough to swallow,” he said.

It used to be that employees relied for retirement income on pensions in which employers managed the funds, promised retirees a “defined benefit” and kept excess profits or losses to themselves. The shift to 401(k)s, IRAs and employee stock ownership plans--in which employee contributions are defined but benefits are left to market forces--is usually portrayed as part of a titanic struggle between an old, dying, paternalistic, industrial order and a new, freedom-filled, entrepreneurial economy. And, in part, it has been just that.

“When we first tried to sell the idea of the 401(k) to Bethlehem Steel in 1981, they said, ‘You don’t understand; it’s part of our culture to take care of our people,’ ” recounted Ted Benna, a Bellefonte, Pa., consultant who is widely considered the “father of the 401(k).”

“That paternalistic attitude has been blown away” by new technology, globalization and Reaganite politics, he said.

The only problem with the old-versus-new portrayal is that it overlooks two crucial facts. The first, as even Benna will concede, is that 401(k)s and similar accounts were not originally intended to replace traditional pensions and grew in a piecemeal fashion. The second is that it was government tax subsidies, as much as market forces and individual choice, that produced the new accounts. According to a variety of regulators and lawmakers, that gives Washington a big responsibility for making sure they are run well.

“Society has a lot riding on people’s retirement savings,” said Sen. Barbara Boxer (D-Calif.), who co-sponsored legislation to restrict the proportion of company stock such as Enron’s in retirement accounts. “We’re paying for them with big tax breaks.”

Indeed, the tax break for pensions and retirement savings is the very biggest that Washington offers, topping such giants as the mortgage interest deduction and the employer tax exclusion for employee health insurance, and amounting to about $100 billion a year.

“Uncle Sam is the largest single investor in the retirement system and has a legitimate interest in how it works,” said Iwry, the former Treasury official.

Only it didn’t work in the case of Enron. And, according to critics, it could fail in the same way at some of the nation’s other big companies.

In the investment world and at the casino, putting most of your chips on one color--or most of your money in one stock--is a gamble.

Before the fall, fully 60% of the money in Enron’s 401(k) plan was in Enron stock. But that hardly qualified the company for the top slot when it comes to packing retirement plans with company stock.

At consumer goods giant Procter & Gamble, the portion of P&G; stock in the unusually generous retirement plans exceeds 90%, according to D.C. Plan Investing, a financial newsletter. At Coca-Cola and General Electric, it is about 80%. At McDonald’s and Home Depot, it is just below 75%.

“The single-largest source of excessive risk for employees in retirement plans is undue concentration in employer stock,” Iwry said.

Investment Industry Balks at Reform Efforts

Most congressional proposals for what to do about the problem run along one of two lines: imposing limits on the amount of company stock allowed in plans or encouraging more investor education. Key critics, including 401(k) inventor Benna, say that neither will work. In the case of stock limits, even some of the authors concede the measure falls far short of what is needed.

Boxer and Sen. Jon Corzine (D-N.J.) want to impose a 20% cap on company stock and reduce the tax break that companies would get when they contributed stock instead of cash. A similar House bill would reduce the cap to 10%.

Both proposals have met with howls of protest from the investment industry, which argues that individuals should have the right to invest their money as they see fit.

Boxer is well acquainted with the argument; many of the same objections were raised when the California Democrat tried to win similar restrictions after floor retailer ColorTile Inc. went bankrupt five years ago, wiping out employees’ 401(k) savings. Her measure was eventually so watered down it made almost no difference.

By contrast, the investment industry enthusiastically supports a bill by Rep. John A. Boehner (R-Ohio) that would encourage companies and 401(k) providers such as mutual fund groups to offer education and financial advice by limiting their liability if their advice turns out to be bad.

Boehner acknowledged that his measure could pave the way for conflicts of interest such as mutual funds advising employees to buy the fund’s products. But he said the danger could be limited by requiring that the conflicts be disclosed. He asserted that there were no parallels with Enron and others encouraging workers to invest in the companies’ own stock.

“The lesson of Enron is diversify, diversify, diversify,” Boehner said. “What we’ve got to do is get that across to people by giving them broader knowledge and access to advice.” Critics say the Boehner bill is an invitation for trouble.

Old-fashioned “defined benefit” plans follow diversification rules that go beyond company stock and a requirement that retirement savings be converted to an annuity, or fixed annual payment, when people retire to ensure that they don’t outlive their own finances and end up in poverty.

To date, no lawmakers, even sharp critics, have publicly proposed giving the same kind of protections to 401(k)s and the “defined contribution” world.

The reason is clear: Such restrictions would fly in the face of the individual choice that has made 401(k)s so popular.

But there are signs that some people are beginning to move in that direction.

Corzine, for example, said last week that the cap he and Boxer are proposing for company stock should be extended to all assets in 401(k) plans so that individuals could not put more than 20% of their retirement savings in any one investment. Benna is pushing a plan to give companies new protections against employee lawsuits over retirement accounts if firms agree to effectively direct employees’ investment options to a few prearranged diversified portfolios.

“Nobody likes to say it, but people who don’t know the difference between stocks and bonds are being asked to pick particular ones,” said Stein, the Alabama law professor. “People are being given too many decisions to make.”

During the late 1990s when the stock market was climbing 20% and 30% a year, such views would have been dismissed out of hand. But with stocks stumbling, the country under assault and polls showing Americans increasingly concerned about “personal security,” some believe there is a chance for change.