Charles Schwab's 401(k) fumble.

Charles Schwab's 401(k) fumble.

Charles Schwab's 401(k) fumble.

Moneybox
Commentary about business and finance.
March 17 2003 6:05 PM

401(ko)

Charles Schwab's self-destructive decision to stop matching employees' retirement contributions.

Last Friday, the New York Times reported that discount brokerage firm Charles Schwab Corp. was joining the ranks of struggling companies that have halted or suspended matching contributions to employee 401(k) plans.

When earnings and growth stall, companies routinely reduce salaries and fringe benefits such as 401(k)s. El Paso Corp., CMS Energy, Goodyear Tire and Rubber, and Great Northern Paper have all done so recently. In 2002, both Ford and DaimlerChrysler suspended matching programs for salaried workers.

But for Schwab, this cost-cutting move seems like a remarkably poor strategy, a great way to undermine one of its essential businesses. After all, the San Francisco-based broker manages 401(k) assets and programs for individuals and companies. Schwab also relies almost entirely on the health of the stock market for the rest of its business. And 401(k) contributions—whether from individuals or corporations—provide a crucial stream of new money for stocks.

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In the '90s, when commentators used to say that the market was "liquidity-driven," they meant that the new money continually sloshing into stocks helped keep prices high. Since the bubble burst, however, more Americans have plowed discretionary investments into real estate or other assets. As a result, retirement funds have emerged as a necessary and consistent source of liquidity. (According to the Profit Sharing/401(k) Council of America, an estimated 42 million 401(k) investors had total assets of $1.6 trillion in 2001.) Even as mutual fund investors withdrew cash from stocks last year, companies, governments, and other institutions continued to buy stocks for their pension plans or to match contributions to employee 401(k)s.

To be sure, individuals have significant tax incentives to max out their own 401(k) contributions. But successful 401(k)s nonetheless rely on a social contract between employers and employees. While a company contributes less than it might under a traditional pension, the match is crucial to making it a two-sided transaction. As Alicia H. Munnell, a former Federal Reserve official who now directs the Center for Retirement Research at Boston College, told the Times, "Eliminating a match has potentially disastrous effects, based on all the empirical evidence."

Until recently, Schwab provided a generous match. For each dollar a Schwab employee put in up to $250, the company would kick in $2. Thereafter, employee contributions were matched on a dollar-for-dollar basis up to 5 percent of total compensation. A Schwab employee who earned $50,000 could thus get up to $2,500 from her employer to augment her own savings.

On the whole, corporate 401(k) contributions have been falling in recent years as profit margins tightened and the labor market loosened. According to the Profit Sharing/401(k) Council of America, the average matching payment fell from 3.3 percent of salary in 1999 to 2.5 percent in 2001.

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For most companies, scaling back paternalistic practices that sprouted in the boom years is a legitimate cost-saving measure. Most workers would probably have jobs, health insurance, and current income rather than 401(k) matches. But Schwab isn't just any company. At the end of 2002, about $88 billion of the assets in Schwab accounts—or about 10 percent of the total—were in employer-sponsored retirement plans. Schwab is also the leading provider of self-directed brokerage accounts, accounts within 401(k)s that let plan participants invest in stocks and bonds. And for years, out of its own economic interest and a sense of public-spiritedness, Schwab has relentlessly argued that 401(k)s will provide a cure for America's chronic propensity to undersave.

It has been a painful few years for Charles Schwab and the company he founded in the 1970s. In the past few years, its stock has fallen nearly 90 percent, and Schwab has reduced its headcount by 35 percent, or 9,000 jobs. Charles Schwab has justly been ridiculed for appearing in advertisements that ran after the bust, in which the chairman faces an auditorium filled with jittery investors. "First of all, relax," a smiling Schwab says. (Hmmm. Millions of customers have just had their faces ripped off, and a billionaire tells them to chill out?)

Still, the 401(k) move is a bit mystifying because—poor ads aside—Schwab has shown a significant amount of public relations savvy in recent months. The company, which didn't offer investment advice during the '90s, recently started an arm to provide independent research. Its stock picks have outperformed the market thus far. And the company routinely lobbies for legislation that would expand contribution limits for … 401(k)s.

Schwab's words carry special weight in part because Charles Schwab holds something of an adjunct position in the Bush administration. At the Waco economic summit last summer, it was Charles Schwab who put the bug in President Bush's ear about the dividend tax cut. (Since Mr. Schwab owns—directly and indirectly—about 70 million shares of Schwab, Bush's proposal would turn the $3 million he gets in dividends annually into tax-free income.) And last July, Schwab and Commerce Secretary Don Evans hosted an investor town hall meeting in Phoenix to discuss the steps the administration had taken to restore investor confidence. (It must have been brief.)

Schwab didn't say how much it would save by stopping the 401(k) match, although it pegged the savings at less than $15 million per quarter. For a giant company like Schwab, that doesn't sound like much—especially when it seems like the potential cost is far greater. After all, what would happen to Schwab's bottom line if corporate America copied its example? Nobody likes a restaurant where the chef refuses to eat his own cooking.