Are 401(k)s Contributing to the Growth of the Outsourcing of Jobs?

Hear me out. 401(k)s may well be playing a role in the enthusiasm in executive suites for thinning the ranks of employees by either turning them into contractors or moving activities over to outsourcers.

We’ve regularly pointed out that the economic case for outsourcing is often weak to non-existent, and in practice, outsourcing often merely serves to transfer income from lower-level workers to managers and the top brass. As we discussed long-form last week, in “The End of Employees,” corporate claims that outsourcing made them more agile didn’t hold up to scrutiny.

A reader mentioned a few additional factors he had seen play into decisions to outsource jobs. One, surprisingly is 401(k)s. He didn’t unpack the reasons but a tax maven gave a high level overview, and I hope any experts in the readership will provide further details.

401(k)s were never designed to be a substitute for pensions. They were intended to serve as a supplemental retirement savings plan.

However, now that the gap between top executives and rank and file pay has grown enormously, the members of the C suite can and do sock away huge amounts of money in their 401(k) plans. By contrast, lower level workers may not put away very much, particularly since 63% of Americans don’t have the cash on hand to manage a $1000 unexpected expense.

If a 401(k) plan becomes “top heavy,” as its benefits are unduly skewed towards towards top executives or owners, it will “fail,” meaning no longer be qualified as a 401(k) plan, unless stipulated corrective measures are taken. Details from the IRS website:

The top-heavy rules generally ensure that the lower paid employees receive a minimum benefit if the plan is top-heavy. A plan is top-heavy when, as of the last day of the prior plan year, the total value of the plan accounts of key employees is more than 60% of the total value of the plan assets.

If a 401(k) plan is top-heavy, the employer must contribute up to 3% of compensation for all non-key employees still employed on the last day of the plan year. This contribution is subject to a vesting schedule requiring participants to be 100% vested after three years; or 20% after 2 years, 40% after 3, 60% after 4, 80% after 5 and 100% after 6 years…

It’s common for a 401(k) plan to be top-heavy, especially for smaller plans and plans with high turnover.

The same page defines “key employee”.

As the tax maven explained, “The usual way to deal with this problem is to bribe employees to pay in with employer matches. But that gets expensive.”

So another way is to really thin the ranks of lower level employees, so you have to have somewhat fewer execs, and the remainder of employees on average higher paid (they have to manage all those outsourcers!) so they are more likely to pay into a 401(k). Mind you, the math doesn’t necessarily work (in fact it could easily become worse if the guys at the top pay put the same amount into their 401(k)s as before and the cutting and reworking of lower level positions results in lower 401(k) contributions). But the key issue is that the source and the tax maven both indicated that there is a belief in Corporate America that getting rid of bottom-of-the-food-chain workers can be done in such a way as to ameliorate incipient or actual 401(k) “top heavy” problems.

The reader pointed out two other seldom-mentioned-in-public issues that contributed to more and more temp and outsourced work. One was class, that upper/upper middle class people increasingly see it as beneath them to manage employees from blue collar backgrounds.

Our source had been in a senior role at a small money management firm. Its main outside law firm was Simpson Thatcher. Their partner had Blackstone as his major client.

One day, the Simpson Thatcher partner suggested that the money management firm might want to consider outsourcing its back office, as most of his clients did. The head of the firm was skeptical and said he doubted that it would save any money.

The Simpson Thatcher partner not only agreed, but he said that in most cases that wasn’t what was motivating them. “They find it easier to manage a business where everyone is from the same socio-economic background.”

A final not-officially mentioned contributor is employee stock grants. Unlike 401(k)s, there are no complicated government rules, plus they are a staple only in the tech industry. However, careful students of the Wall Street Journal story that gave rise to our post would have noticed that Google and Amazon were particularly keen about using contract workers and outsourcers. Microsoft has also long used contractors. At least one of the reasons is that public shareholders aren’t terribly keen about their positions being diluted by grants to employees. Or to put it anther way, the capitalists aren’t too keen about sharing with ordinary workers, even when the point is to motivate better results. I’m told that the coders at Microsoft, who are employees, sit in close proximity to the quality assurance types, meaning the staff that checks for bugs, who aren’t. Is it any wonder why Microsoft’s software is so crash prone?

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24 comments

  1. PlutoniumKun

    Two anecdotes relating to class issues in work and outsourcing.

    The British have a justifiable obsession with why their industry has faded away while the Germans continue to dominate in a whole range of sectors where the British once reigned supreme. I recall reading an interview years ago with a mechanical engineer who had worked in Germany and Britain, and was asked the difference. He said the difference was that in Germany he worked all day designing things. In the UK he spent half the day designing things, the other half on the shop floor trying to explain to the technicians what the drawings meant. He attributed this to two things – the deskilling in the UK of metal workers and machine technicians, but also the class system – managers just didn’t respect or want skilled technicians and didn’t want to deal with shop floor issues, so the engineer was seen as a ‘half way’ person who’s job it was to make sure good quality final products left the door. In Germany, they trusted the machine operators do do everything that was necessary. Its hard not to see this as a major contributor to the way the US is losing its reputation for quality manufacture.

    The second one relates to support staff for a very major silicon valley company. I know someone who worked in HR for them as they were expanding very rapidly a few years ago. They had a ‘hire in bulk, fire the surplus before they get any employment rights, keep the good ones’ policy, so there was a huge turnover of mostly very young and ambitious staff. That is unpleasant enough, but the HR person told me the real shock for those let go (or who decided to move on) was when they asked for references. They were then informed they had not actually been working for this major company, they had in fact been working for an agency, and were refused permission to use the company name on their references. They were told, in effect, that if they had asked, the would have been told they were not direct employees, but as it hadn’t occurred to them to ask….

    Reply
    1. FluffytheObeseCat

      Thank you for recognizing the second incident as a class issue. It’s weird and sickening, but out here on the west coast people literally do not have the vocabulary and understanding to define it as such. And it sure as hell is. Native born, college educated employees commonly believe there is no difference between them, and those who control every aspect of their lives. No intrinsic, structural difference. Just “talent”, and maybe a little luck. It’s brainwashing of the most elegant kind.

      Reply
  2. JohnL

    In short, yes. And single payer would do even more as health insurance is the last hold corporations have over workers.

    I’ve been self-employed for more than half my working life working mostly as a contractor for corporations working from home. My job security is much better than the employees I work with. (In the US. Germany is a different story)

    For those who can”t quite handle self-employed, there are unions. My neighbor is retired union commercial electrician. His union gave him job security, unemployment benefits when needed, pension, health insurance, disability insurance… He has done much better than his school mates who went to college.

    Germany has strong unions who participate in running companies. The US & UK had Reagan and Thatcher.

    The USA has shareholder value & this quarter’s results. In much of Europe it’s illegal to fire or layoff workers as long as the company is making a profit. Companies can’t hire & fire as easily so spend more on worker training. Multinationals hire & fire the US workers first. At my customer this his resulted in a loss of institutional memory in the US, which is why I now work with the Germans. 7:00 am conference calls for me here in the PNW!

    Unions are the answer. We will need to build new ones.

    Reply
    1. Procopius

      I think the German tradition goes back to Bismarck. I don’t know enough about him, but he apparently recognized that you would have fewer revolutions if you had well-fed, healthy citizens. Also you would have better soldiers, which became important after the French Revolution made conscript armies necessary. Also you would have more tax revenue if you had prosperous industry with well-trained, productive workers. This last part I’m not so sure about, because German industrialists in the early 20th Century (e.g., Krupp) certainly exploited their workers horribly.

      Reply
  3. amousie

    Didn’t Bartlett and Steele do newspaper articles on something similar to this back in the 80s? It has been about 20 years since I last read America: What Went Wrong but I thought back then part of their investigation was that the retirement financial products of one group of workers were used by takeover artists to decimate / raid companies which had been profitable and their own fully funded employee retirement funds.

    Sounds like the premise of this article is that the executive suite has now joined the game more directly or they just don’t care or rather have to care about employees.

    Honestly, why should the executive suite care? The government sent up the rules as well as the enforcement of said rules, they are only following the incentives. Plus competitive advantage and cooperation within your own class are what you learn growing up. It gets reinforced in college, then reinforced again harshly within the first say 5 years of corporate life as the hierarchy enforces its own tacit rules.

    Now that the wealth at the upper levels has expanded and grown so out-of-whack (over 500 billionaires in the US plus all the wealth “support” families), the only way to maintain your families’ position is to continue to play the game by the “rules” until someone from the outside forces the game to change. Even if some see the danger and want to change, there will be those who will never stop or can’t stop because they are addicted to the game, the success, the power, the adrenaline rush… take your pick. It really is a sickness on a certain level. Even if they wanted to, that class could never police their own. Well, except when someone from their class eats their own or does something so egregious that it can’t be ignored.

    Anyway, Bartlett and Steele did some good work of the initial waves of dismantling as I recall. I’m going to hit the library and see if it stands up to my memory.

    http://www.barlettandsteele.com/books/am_wwr.php

    Reply
    1. pricklyone

      >>Honestly, why should the executive suite care? The government sent up the rules as well as the enforcement of said rules, they are only following the incentives. <<

      I gotta call on this part. This is not the way it works. Have you heard of ALEC? Have you looked at the size of the "lobbying" industry? The rules were set up by the same cohort who, supposedly, are incentivized by them. Who is this Government we hear about? I would submit it consists of those who complain the most about "exessive regulation", and the elected they have purchased. If they have a beef with "Government", they should look in the F'ing mirror.

      Reply
  4. Northeaster

    “If a 401(k) plan is top-heavy, the employer must contribute up to 3% of compensation for all non-key employees still employed on the last day of the plan year.”

    This is important because what one company did, let’s call them HAL, they fire their employees before the years end. This enables them to not have to make contributions to their 401(k) because employees were not employed for the full year as stipulated to received the corporate match. HAL is especially adept at firing thousands of workers, especially older, and replacing them with H-1B’s. Meanwhile, even though HAL’s share price has been flailing over the past few years, HAL has spent billions on buybacks, thereby boosting their EPS, which was a big part of executives compensation, who cashed in millions worth of their shares in same said time period.

    Reply
    1. oho

      hmmm, HAL sounds like IBM. Where the glass ceiling has been broken, a woman can gut a company for short-term myopia just as good as any man.

      Also throw in near zero interest rates, which make it easy to issue debt to finance buybacks.

      Reply
  5. JohnL

    The move to contract workers has been beneficial in some respects such as making it easier for women and minorities to find employment, but has tended to fossilise senior management into risk-averse bottom-line focussed authoritarian types and companies into organizations who spend money on buy backs, buying up competitors, and lobbying rather than innovation or employee development.

    Reply
  6. Katharine

    The Simpson Thatcher partner not only agreed, but he said that in most cases that wasn’t what was motivating them. “They find it easier to manage a business where everyone is from the same socio-economic background.”

    Of course, if lower ranks were better compensated, the difference in socio-economic background would be less stark and the difficulties experienced by management (poor dears) would be less.

    Reply
  7. fred

    Yves,

    “Yet another reason to regard 401(k)s as a failure….”

    What amount of stocks are held by tax exempt organizations and what incentive do they have to continue outsourcing so as to achieve higher rates of return? For example the John D. and Catherine T. MacArthur Foundation, $6 billion in assets and less than 200 staff. They have essentially zero incentive to be concerned about employees in any of the companies they own stock in.

    Reply
    1. pissed younger baby boomer

      Foundations are the ultimate tax dodge keeps giving to their children and future generations of their clan .The rich have no empathy for the middle class much less the poor. If we use our power e.g. peoples movement it might change the country .I can only hope. I few years ago I wanted to go the local democratic party.The meeting( can forget this ) 8:30am Wednesday once a month. ;(

      Reply
  8. curlydan

    I’m not a fan of 401(k)s, and I’m not a tax/accounting person. But I don’t see them as a much of a contributor to outsourcing. As I think about it, say a company has $25M in its 401(k) plan. Of that,

    $15M is from 10 “key employees”
    $8M is from 40 mid-level employees
    $2M is from lower-level employees

    A company could see that soon they are going to exceed the 60% top heavy level. Do they outsource all their lower-level employees?

    Then it becomes $23M under management with $15M and $8M and they’re definitely top heavy at 65% from key employees.

    Also, most 401(k)s limit contributions to $18K (or $24K if you’re over 50 and in catch up mode). I’d say stock grants would be a much better way to enrich executives because you can funnel so much more through stock grants.

    A few times, I’ve had my company strangely write me a letter mid- to late-year and “cut me off” from 401(k) contributions, claiming I was a highly compensated employee. Maybe they were trying to keep under the 60%? Not sure.

    I think the issues you or others have brought up (class, earnings pressures, getting rid of health care) seem like bigger contributors.

    Reply
    1. Tim

      This.

      On a separate note, I wish that the Social Security witholdings/contributions went straight into a USA Sovereign wealth fund with wide discretion for domestic investment in our future. Funding Infrastructure, a general government bank for all from individuals to businesses, investment in corporations that represented strategic interests to the US….

      The benefits would be two fold, it would force allocation of the tax receipts, and would create a legitimate source of revenue to justify investments that would create jobs, thus creating more tax receipts.

      I mean between employees and employers, 12% of income every year, with even the smallest of compounding interest would yield a perfectly good nest egg for everybody, but today the money immediately disappears into congressional appropriations.

      Reply
      1. Procopius

        I’m not really knowledgeable about the long-term returns to stock investment. There are people who extol it, and in any given year there are funds, even low-load mutual funds, who do much better than the market, but aside from Berkshire Hathaway are there examples of long term success? I’m totally risk-averse, and believe the SS Trust Fund has a much better record than 99-44/100% of investors. How about actual Sovereign Wealth funds? Has Singapore actually done so well? How about Qatar? Malaysia? I seem to recall there have been some rumblings in the news lately about 1MDB.

        Reply
      1. DSB

        Correct, the annual $18k contribution limit (2016) doesn’t help a highly compensated executive to replace a significant portion of their compensation in retirement. Catch-up provision doesn’t help.

        That is why a number of companies make use of non-qualified deferred compensation plans for their highly compensated executives. It is not unusual to see a lower limit of $100k for participation, or based on job class. These plans can allow participants to defer up to 100% of their compensation annually, with deferred amounts growing based on various “investment” options.

        I am not trying to make an argument for 401k’s, but I think the vast majority of companies would elect to make use of these non-qualified plans as opposed contorting their business and structure to avoid 401k limits.

        Reply
  9. Octopii

    If a Safe Harbor 401k is set up correctly it allows the plan to be top-heavy. The safe harbor can be used with single-owner companies, not sure about any other situations. But in my case I didn’t want to worry, so I fired everyone and set up a solo 401k, which is only available for single owner-employee companies. So yes, the headline premise is correct, Betteridge’s Law notwithstanding.

    Reply
  10. scraping_by

    One factor given little notice in discussions of outsourcing, offshoring, and the rest is the undoubted rise of mere fad-surfing. Executives are given credit for rational, if vicious, thought processes when they’re often just doing what everybody else is doing. Or doing what the consultants say everyone else doing.

    These days they’re also mindlessly acting out what they were taught in business school. Or seminars, or what they read in magazines. No real appreciation for long term consequences, just the knowledge the safe thing to do is a standard thing to do.

    Once it was cutting edge nastiness for short term gain, it’s now mainstream nastiness for short term gain.

    Reply
  11. lyman alpha bloba

    Odd that simply contributing less for key employees doesn’t seem to be an option. I guess it depends on the total compensation for top execs, but you’d think that those making a few million, which I’m sure is the case for some of these companies, maybe wouldn’t need a 401K in the first place.

    Reply

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