Real World Finances, or, Why The Senate HELP Committee Testimony was Ludicrous

As I noted in my last blog post (it's the one immediately below this one, so I'm not going to link to it), the testimony to the Senate Health, Education, Labor, and Pensions Committee on retirement savings was in need of some people more closely attached to reality. We had two academics, a manager from an investment consulting firm and a reporter from the Today Show.

I listened to the whole two hours, and while there were some thoughtful comments (and some far less thoughtful ones as well), both the 'experts' and the Senators need to stop to think about real life. Each of these experts thinks that auto-enrollment (the process by which a new employee is defaulted into a 401(k) plan with a specified rate of deferral, often 3% of pay) and auto-escalation (the process by which that 3% of pay increases periodically, sometimes annually, until it reaches a limit) are good things. Further, they think that default percentages should be higher than 3% of pay and that auto-escalation should go up to about 15% of pay (10% is the current auto-escalation limit).

Reality check time ... wait just a minute, Bozo!

Let's consider a new employee of a company, perhaps in their second job. I am going to make this person married, 27 years old, with no children. I am going to give this person a salary of $60,000 and I am going to assume that their spouse also has a salary of $60,000. That's pretty good for a pair of 27-year olds. I am also going to assume that of these two spouses that exactly one of them is of child-bearing gender. I am going to call this couple Jack and Jill, and I am going to make Jill the one in the new job.

With combined income of $120,000 ($10,000 per month), Jack and Jill are able to purchase a $500,000 house with a 20% ($100,000 down payment). Here's the math on that: I gave them a 30-year loan on $400,000 at 5% with no PMI and annual property taxes of $6,250. Including their homeowner's insurance, that gives them monthly payments of about $2,750, less than the old 28% qualifying threshold. Thus far, other than being able to make the down payment, I don't think this is an extraordinary scenario.

Let's do a little budgeting. My illustration here may not be perfect, but I bet it isn't too far off:

Monthly Salary                               10,000
Taxes (Federal, State, and FICA)   (3,100)
Subtotal                                           6,900
House Payments                             (2,750)
Subtotal                                           4,150
Employee cost for health ins              (450)
Subtotal                                           3,700
Utilities                                             (400)
Subtotal                                           3,300
Food and household supplies           (1,000)
Subtotal                                            2,300
Auto Insurance                                   (100)
Subtotal                                            2,200

OK, enough, you get the picture. While they're at it, Jack and Jill each are in 401(k) plans that are going to auto-escalate them to 10% of pay deferrals. Ignoring inflation, that's another $1,000 per month, leaving them at $1,200 per month, for vacations, gifts, clothing, savings, etc. Some day, they will both need new cars. And, I did mention that Jill is of the child-bearing gender. Jack and Jill would like to have two children some day. Tell me again, how does this math work?

I realize that Jack and Jill could have made a more prudent home-buying decision, but that's not reality. They saw this wonderful home in a great school district. They got pre-qualified for a mortgage and with their excellent credit, the lender wanted to lend them as much as possible. Having been pre-qualified for a $400,000 loan, of course, their real estate agent wanted to find them a $500,000 house. This is reality.

When Jack and Jill have to cut back, are they going to cut back on taxes, insurance, food, clothing, etc, or are they going to cut back on their savings in their 401(k) plans? Only one of those has much discretion in it, so I'm betting on the 401(k). When Jill takes maternity leave for their children, it only gets worse. And, then there is day care. And, you know, the job market isn't all that stable these days. There are lots of layoffs of highly qualified workers. Maybe Jack will get laid off.

I know. They should have thought of all this when they bought their house. But, they didn't. They were buying into the American dream. And, now, they are stuck with the American dream. Their parents had it ... and they had pension plans. But, Jack and Jill don't. Maybe Congress shouldn't either.