John Bogle: The whole retirement system, in fact, in the country is in, I think, very poor shape, and it’s going to be the next big financial crisis in the country, I honestly believe. … The private pension plans are underfunded by an estimated $400 billion, and the state and local government plans are underfunded by an estimated $800 billion. That’s a $1.2 trillion shortfall between the assets the plans have and the liabilities they will have to the pensioners as they pay out their retirement checks over the rest of their lifetimes.

Frontline: How do they get away with that? Don’t they have to fund them?

John Bogle: No, they don’t, because a lot of it is based on assumptions. Our corporations are now assuming that future returns in their pension plan will be about 8.5 percent per year, and that’s not going to happen. The future returns in the bond market will be about 4.5 percent, and maybe if we’re lucky 7.5 percent on stocks. Call it a 6 percent return — before you deduct the cost of investing all that money, the turnover cost, the management fees. So maybe a 5 percent return is going to be possible, in my judgment, and they are estimating 8.5 percent.

Why? Because when they do it that way, corporation earnings become greatly overstated, and all the executives get nice, big bonuses. They are using pension plan assumptions as a way to manage corporate earnings and meet the expectations of Wall Street.

Frontline: So if a company overstates the value of its pension plan assets, it makes the company look better to Wall Street, so there’s an incentive to kind of exaggerate, if not cheat.

John Bogle: That is precisely correct. And let me clear on the cheating: It’s legal cheating; it’s not illegal cheating. In other words, you can change any reasonable set of numbers — and corporations have done this, have raised the pension assumption from 7 percent to 8.5 percent — and all of a sudden that corporation will report an earnings gain for the year rather than an earnings loss that they would otherwise have. Simple, legal.

inadequacy of national savings being directed into retirement plans. “Thrift” has been out in America; “instant gratification” in our consumer-driven economy has been in. As a nation, we are not saving nearly enough to meet our future retirement needs.

I would argue the shift from DB [defined benefit – pensions] plans to DC [defined contributions – IRA, 401(k)] plans is not only an inevitable move, but a move in the right direction in providing worker retirement security.

At the end of 2008, the median 401(k) balance is estimated at just $15,000 per participant. Indeed, even projecting this balance for a middle-aged employee with future growth engendered over the passage of time by assumed higher salaries and real investment returns, that figure might rise to some $300,000 at retirement age (if the assumptions are correct). While that hypothetical accumulation may look substantial, however, it would be adequate to replace less than 30 percent of pre-retirement income, a help but hardly a panacea. (The target suggested by most analysts is around 70 percent, including Social Security.)

Part of the reason for today’s modest accumulations are the inadequate participant and corporate
contributions made to the plans. Typically, the combined contribution comes to less than 10
percent of compensation, while most experts consider 15 percent of compensation as the
appropriate target. Over a working lifetime of, say, 40 years, an average employee, contributing
15 percent of salary, receiving periodic raises, and earning a real market return of 5 percent per
year, would accumulate $630,000. An employee contributing 10 percent would accumulate just
$420,000.
…
Nearly 20 percent of 401(k) investors in their 20s own zero equities in their retirement plan, holding, instead, outsized allocations of money market and stable value funds, options which are unlikely to keep pace with inflation as the years go by. On the other end of the spectrum, more than 30 percent of 401(k) investors in their 60s have more than 80 percent of their assets in equity funds. Such an aggressive allocation likely resulted in a decline of 30 percent or more in their 401(k) balances during the present bear market, imperiling their retirement funds precisely when the members of this age group are preparing to draw upon it.

As noted earlier, excessive investment costs are the principal cause of the inadequate long-term returns earned by both stock funds and bond funds. The average equity fund carries an annual expense ratio of about 1.3 percent per year, or about 0.80 percent when weighted by fund assets. But that is only part of the cost. Mutual funds also incur substantial transaction costs, reflecting the rapid turnover of their investment portfolios. Last year, the average actively managed fund had a turnover rate of an astonishing 96 percent.