WSJ Journal Report - When 401(k) Investing Goes Bad

Jennifer Levitz reported in the Wall Street Journal's Journal Report [subscription required] last week, "When 401(k) Investing Goes Bad - Teachers in West Virginia offer a valuable lesson for what not to do".

Ms. Levitz chronicles the story of how West Virginia's school districts jumped on the participant-directed defined contribution bandwagon 17 years ago with disastrous consequences for employees.

"It was horrible," says Judy Hale, president of the West Virginia Federation of Teachers union. Most felt poorly informed, and they invested too conservatively, putting the largest sums of money into a fixed-rate annuity, a safe but low-yielding option that typically is inadequate for building a nest egg.

As employees began to retire, most balances were pitifully small."

Of course the solution to their problems was an "old fashioned" pension plan!

So on July 1, after a vote authorized by the state legislature, 14,871 school employees, or 78%, switched to the old-fashioned pension plan.

Trouble with AIG VALIC:

The West Virginia plan initially offered stock and bond mutual funds, a money-market fund, and an annuity, in this case from Variable Annuity Life Insurance Co., or Valic, a unit of American International Group Inc. In addition to the Valic annuity, current offerings include funds from Capital Group Cos.' American Funds unit, Federated Investors Inc., Fidelity Investments and Franklin Resources Inc.From the start, most employees favored the annuity. Some say they were swayed by Valic's sales force, which included former educators and school employees who went into the schools during the workday to talk about the option. "These people came during your lunch or during your planning period basically to sell the program," says Debra Elmore, a third-grade teacher in Ansted, W.Va.

Ms. Elmore acknowledges knowing little about investing. "Oh, Lord no," she says. "I had no idea." She set up her account so that 85% of her contributions would go into the fixed-rate annuity. "I just thought, 'Well, these are safe. Let's stay there.' "

We will come back to Ms. Elmore's comment in a minute...

AIG spokesman John Pluhowski says the insurance company hires former school employees to sell its products to schools "because the education market is important to us; educators know the needs and concerns of educators." He says the representatives were "not authorized or directed to give investment advice; they were only authorized to sell a fixed-annuity contract."

Anne Lambright, executive director of the state's retirement board, says that the board offered "some general education" about investing to employees, but that "not everyone took advantage of it." She acknowledges that advice was limited and that much of the information employees received was probably from the companies selling the products. "I'm not sure how much information they got in terms of comparison between products or stocks and bonds," she says.

At one point, about two-thirds of all assets in the plan were invested in the fixed-rate annuity, according to the board's annual reports. For the first two years, the annuity offered an annual return of 8.5%, but then it dropped to 4.5%, according to a state official. Mr. Pluhowski says the 4.5% is the guaranteed minimum return, while the higher percentage was based on then-market conditions.

By 2005, complaints from employees and the union about low balances in the defined-contribution plan had mounted. State officials closed the plan to new participants and reopened the pension plan to new hires. The following year, school employees voted on whether to end the defined-contribution plan, but a state court later deemed the vote unconstitutional because those satisfied with the plan would have been forced to return to the old-fashioned pension plan. This spring's election was couched differently: Workers voluntarily could elect to transfer their account into the old pension plan, provided that at least 65% of current employees wanted the transfers to be permitted.

The threshold easily was cleared -- in part because as of April 30 the average account balance in the defined-contribution plan was $41,478, and of the 1,767 employees over the age of 60, only 105 had balances of more than $100,000. "Our members were going to run out of money five or six years into retirement," says Ms. Hale of the teachers union.

Some retirement experts say another problem that surfaces in 401(k) plans is the "red-truck syndrome": Plan participants use some of their nest egg at retirement to buy something they always dreamed of having. Teresa Ghilarducci, an economist at the New School for Social Research in New York, says many workers take their 401(k) in a lump sum and have difficulty making it last. She says the West Virginia case "shows the nation what is wrong with everyone's 401(k)," including a lack of investment knowledge and fiscal discipline.

Long-time readers would recognize Ms. Ghilarducci who we noted on July 7th when she appeared on NPR's Fresh Air program promoting her new book, When I'm Sixty-Four: The Plot Against Pensions and the Plan to Save Them."


Back to our main topic today, needless to say, there's a state investigation into whether VALIC made misrepresentations to induce state employees to invest into its annuity...

Now back to Ms. Elmore's comment. In a letter to the editor in the Journal today, Ernest Jordan writes from Florida:

All employers should learn from your article "When 401(k) Investing Goes Bad -- Teachers in West Virginia Offer a Valuable Lesson for What Not to Do" (The Journal Report on Investing in Funds, Aug. 4) the need to focus on employee education and employer fiduciary oversight. There were ways to stave off these issues years ago.

It is shameful that AIG's Variable Annuity Life Insurance Co., or Valic, takes a hit to their reputation for doing exactly what they were contracted to do by West Virginia: provide the conservative investment option in the defined-contribution plan.

This all sounds like sour grapes to me. I only have 401(k) investments for my personal retirement. It is up to me to contribute enough and invest the money in a way to ensure that I have what I need to retire. People today spend more time planning a vacation than they do taking responsibility for planning their retirement. The employees were charged with making prudent investment decisions, and West Virginia was charged with ensuring that there was proper oversight to the plan and that proper education was provided to their employees. At the end of the day, West Virginia was asleep at the wheel and should be embarrassed.

Ernest Jordan

Wellington, Fla.

Not to be outdone, Matthew Mehdi Rafat delivers our acerbic, sarcasm-laced punchline for the day from Cambell, California:

We are entrusting our children to people who can't handle basic investing and, somehow, we wonder why we end up with financially illiterate adults.

Matthew Mehdi Rafat

Campbell, Calif