Retirement Heist: how companies plunder and profit from the nest eggs of American workers

Even middle-class workers who diligently save are unlikely to accumulate enough to support them in retirement. The plans may be loaded with employer stock that employees are locked into, and the accounts are collections of investing accidents that are even less likely to survive the inevitable market meltdowns. At the end of the day, 401(k)s have been a boon primarily for high-income employees, who can afford to save, and who simply move existing assets into tax-sheltered retirement plans.

These deficits have been well documented. They aren’t the only ones. Like pensions, 401(k)s have a hidden history, and a darker side. That’s why the “solutions” to improve 401(k)s won’t work.

For one thing, despite the 401(k) plan’s image as a democratic savings plan for the masses, it was never intended to be a savings vehicle for the rank-and-file. Employers first set up 401(k)s in the early 1980s so managers could defer their bonuses. The IRS stepped in, saying that taxpayers shouldn’t be subsidizing a discriminatory system. To keep the tax breaks, the plans had to cover a broad group of the rank-and-file.

If the IRS had said “all employees,” or “all employees whose last names begin with the letters P through Z,” there would be no question about who could or could not participate in the 401(k). But, as we’ve seen, employers took advantage of loopholes in the discrimination rules to exclude millions of low-paid workers, provide them with less generous contributions, and make it hard to join the plan and build benefits. In short, many companies have continued to manage 401(k)s for the benefit of the highly paid.

With this in mind, consider the employers’ proposals to increase participation among the lower-paid. One is “automatic enrollment,” enacted in the 2006 Pension Protection Act, which was sold as a way to include participation among the low-paid, because employees are automatically signed up unless they opt out. As long as employers merely offer automatic enrollment (even if low-paid employees opt out) and contribute 3 percent to their accounts, the plans don’t have to pass discrimination tests.

In the abstract, automatic enrollment sounds great. But plug in some real numbers and the picture isn’t so rosy. For a nurse’s aide making $20,000 a year, the 3 percent contribution will cost the employer just $600. That won’t exactly break the bank. But employers are now lobbying for “relief” from the mandated 3 percent contribution, citing hard times. They still want to have the safe harbor from the discrimination rules, though.

They also continue to lobby for a repeal of the contribution limits, currently $16,500 a year for an employee, saying that this would increase retirement savings. It would—for the highly compensated employees who are already saving. Employers would also benefit, because more of a highly paid employee’s savings would be in the 401(k) rather than the unfunded deferred-comp plan.

But how would allowing the highest-paid employees to save more—including those with far more lucrative deferred-compensation plans—improve savings rates for the low-paid? Employers’ answer: By giving executives more of a stake in the small-fry 401(k), they’re more likely to maintain it, not eliminate it altogether.

Not likely. Employers enjoy too many benefits from 401(k) plans.

ESOPs FABLES

We saw in Chapter 1 how many 401(k)s were created to enable companies to capture surplus money from pensions they terminated: By setting aside 25 percent of the surplus in a replacement plan, like a 401(k), they could pay only a 20 percent tax on the rest of the money, and keep it.

Companies then began using employee stock ownership plan (ESOP) assets to fund their contributions to 401(k)s, an arrangement called a KSOP. Since the early 1990s, more than a thousand companies, including Marriott, McKesson, Bank of America, Verizon, Sears, McDonald’s, Parker Hannifin, Procter & Gamble, Abbott Labs, and Ford, have quietly adopted this new hybrid structure.

One way this works: An employer that wants to build a factory might borrow $100 million from a bank, use it to buy $100 million of its own shares, and contribute the shares to an ESOP. The ESOP repays the bank, and the employer contributes an equal amount to the ESOP. The employer than taps the shares to contribute to employees’ 401(k) accounts.²¹ By funneling loan money through ESOPs, employers can deduct both the principal and interest on their loan repayments, reducing borrowing costs by as much as 40 percent. KSOPs provide employers with an additional tax break: They can deduct the dividends on the company stock they contribute to 401(k)s, a move worth tens of millions of dollars a year to large companies. KSOPs demonstrate the dual purpose retirement plans often have: They enable employers to get low-cost loans while inexpensively funding their retirement plans.