The end result of the shift to 401(k) plans is that employees have considerably less money to retire on today than they had 20 years ago, according to research conducted by Edward N. Wolff, an economics professor at New York University, and the Economic Policy Institute, a Washington, D.C.-based think tank. A recent study by Wolff shows that retirement wealth (defined benefit and defined contribution benefits plus Social Security benefits) for the median (or most typical) household headed by a person aged 47 to 64 declined by 11 percent from 1983 to 1998 — despite an increase in the Dow Jones Industrial Average of more than 730 percent. Only households in that age group with more than $1 million in preretirement income saw an increase in total retirement wealth.
In addition, the percentage of households approaching retirement that would be unable to replace half of their preretirement income rose from 29.9 percent in 1989 to 42.5 percent in 1998, according to Wolff. (Studies indicate that in order to maintain their preretirement standard of living, retirees need to replace 75 percent of their preretirement income.)
Bang for the Buck
Given the new information about 401(k) plan effectiveness, or lack thereof, as a retirement vehicle, some corporations are reevaluating the best way to get the most bang for their retirement-plan buck while meeting the needs of a mobile workforce.
"The question that employers should be asking is, 'What do I want to accomplish with these plans?' " says Steve Kerstein, managing director of the global retirement practice at Towers Perrin, a management consulting firm. "To whom do you want to provide the benefits? Is your goal to maximize the amount of money to people who retire, in which case you'd choose a DB plan, or is your goal a more equitable distribution of profits, which would mean a DC plan?"
The variety of defined benefit and defined contribution plans has increased in the past few years. Cash balance plans — a hybrid mix of defined contribution and defined benefit that allows employees to take their balances with them if they switch jobs before age 65 — represent a good choice for companies looking to adopt their first defined benefit plan. But it's unlikely that companies will flock to these plans. Regulatory agencies and the courts are still trying to determine which method will be used to calculate payouts. (Meanwhile, many companies that converted to cash balance from traditional pensions face accusations that the new plans shortchanged older workers.)
Another option on the drawing board is the DB(k) plan, created by Principal Financial Group, which would allow employers to consolidate a defined benefit plan with a 401(k) plan. The plan would allow companies to file only one set of related documents with the government, and would consolidate other reporting requirements as well. But absent necessary legislative changes, the DB(k) plan won't fly.
Even with the renewed interest in defined benefit plans, there are roadblocks keeping employers from adopting them — most notably, cost. The stock market reversal means many companies have to pony up contributions to underfunded plans, which represent a long-term, fixed financial obligation. And internal plan administration is expensive; companies must fill out a Form 5500 for every benefit plan they sponsor. (Just one Form 5500 at a major insurance company was 16 inches thick, says a spokesman for the Employee Benefits Research Institute.)
All this means that just as employees start to demand defined benefits, employers are less likely to want them. As a result, some groups are pressuring Congress to ease up on defined benefit plan administration rules and craft new rules that would build more flexibility into funding requirements. But these battles are just beginning. In the meantime, a nation of aging baby boomers marches inexorably closer to a "very severe retirement crisis," says economist William Wolman, co-author of the recently published book The Great 401(k) Hoax. "And we're going to need a real crisis before something gets done about this."
Sadly, by the time something does get done, it will be far too late for many retirees.
Kris Frieswick is a staff writer at CFO.
Heartland Change of Heart
There has already been one very large plan migration from a 401(k)-style plan to a hybrid plan with guaranteed payouts, but it wasn't employee pressure that inspired the change. It was the disturbing results of a "benefit adequacy review" that prompted the Nebraska state legislature to call for a better retirement vehicle for the 25,000 state and county employees who are part of the state's defined contribution plan.
The review compared performance of the mandatory defined contribution plan with the state's defined benefit plan (for state troopers, teachers, and judges). "The DC plan fell short of the DB plan in replacing worker wages at retirement," says Anna Sullivan, director of public employee retirement systems for the state of Nebraska. "The conclusion was that people were not as well equipped as a professional to make allocation decisions." Fully 90 percent of defined contribution plan assets were in just 3 of the 11 investment options provided, one of which was the default stable-value fund.
The result was especially surprising, says Sullivan, because the state goes to extensive lengths to educate employees about investing, offering an all-day seminar taught by investment professionals and a toll-free help number. In addition, the state is very generous with its contributions: employees put in an average of 4.5 percent of their wages, and the state matches those contributions 150 percent. Still, says Sullivan, "people don't understand the intricacies [of investing], nor are they removed enough to make good investing decisions and stick with them. They respond out of emotion and try to time the market."
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