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Illusion401k Worth*

May 26, 2002

Do 401(k)'s Give Workers an Illusion of Wealth?


n the long economic expansions of the 1980's and 90's, the wealth of middle Americans seemed to rise. Their stock portfolios and home ownership gave them the appearance of growing richer. But now it turns out that net worth went down, not up.

That is disheartening, and counter-intuitive. After all, middle Americans did benefit from stock portfolios and homes, increasing their wealth as these assets rose in value. Yet add in all the other forms of household wealth, as Edward N. Wolff, a New York University economist, does, and balance sheets change for the worse.

The main culprit is shrinking pension wealth, although it is not alone. Rising debt, particularly mortgage debt and home equity loans, also took back from wealth what rising home prices had conferred. There is stealth in the damage. People focus on the balances in their 401(k) accounts, for example, and fail to realize that company-paid pensions, now gradually disappearing, would have made them wealthier than saving on their own for retirement.

Not noticing the deterioration in their wealth, they even substitute 401(k) accounts for other forms of savings, putting money in one pot while removing it from another.

"I think the 401(k) is a real scam," Mr. Wolff said. "People get their monthly statements and they say, `Wow, look at how much money is in my 401(k),' and they don't see what has disappeared."

Let's be clear who we mean by middle Americans. They are not the 20 percent of all households whose breadwinners are paid $75,000 a year or more. Those households have increased their total wealth since 1983, the starting point of Mr. Wolff's study. Many have never been richer. That is not the case for the median household, with an annual income of $50,000 or so.

Refine the households even more. Consider those whose breadwinners are 47 to 64, old enough to have accumulated wealth. Add up their wealth from all sources — stocks, bonds, homes, pensions, savings accounts — as Mr. Wolff has done.

He calculates that the median wealth was $162,800 in 1998, the last year for which government wealth data is available. Adjusted for inflation, the same calculation for that age group in 1983 produced $188,100 in wealth at the median. (Half the households had more, half less.) That is a 13.5 percent decline in wealth, and the loss was similar for almost all the households with annual incomes of $35,000 to $75,000, Mr. Wolff found.

The middle class in America is defined by this income range. Nearly 35 percent of households qualify. Their wealth, after falling from 1983 to 1998, has at best leveled off since then, given the stock market sell-off and the recession.

How would Mr. Wolff reverse the loss? "The most desirable thing may be to re-establish the old defined-benefit pension system," he said, referring to the company-funded pensions that guarantee fixed annual benefit payments in retirement.

Among middle-income households, the breadwinners in 42.4 percent had defined-benefit pension plans in 1998, down from 68.9 percent in 1983. But the number of 401(k) accounts, a k a defined-contribution plans, soared. Some 69.2 percent of households had them in 1998, up from 7.4 percent in 1983.

MR. WOLFF, a recognized expert in wealth and income, is not without challengers. Some say that his definition of net worth leaves out the value of a family's cars, or that the survey data of 1983 and 1998 are dissimilar enough to flaw comparisons. Others question his calculation of the present value of future pensions.

Mr. Wolff contends, for example, that a 50-year-old expecting a $20,000 annual company pension at the age of 65, and suddenly forced to fund it himself, would have to have accumulated $200,000 in savings by now. Ergo, a $20,000 future company pension represents $200,000 in present wealth. The 401(k) savings of households in the 47-to-64 age group, in contrast, average only $69,000.

But for Mr. Wolff's $200,000 to make sense, said Eric Engen, a resident scholar at the American Enterprise Institute, "you have to assume that people don't change employers and they collect the promised pension over enough years."

Whatever the caveats, Mr. Wolff's main point is now widely accepted: The swing from company-guaranteed pensions to 401(k)-style plans has definitely lessened wealth — and also relieved employers of billions of dollars in pension obligations.

"You cannot simply dismiss Wolff's findings," Mr. Engen said.

Stagnant wages, the rising cost of education, divorce, layoffs — all these and more help to explain why household wealth is shrinking. The heartbreak, however, lies in the self-delusion that silences protest. Mesmerized by 401(k)'s, too many households fail to notice what's missing.

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