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Retirement Roulette

As corporate finance experts hand off more responsibility for retirement to individual employees, the number of big winners and losers among those employees is growing.
Tim Reason, CFO.com | US
October 21, 2009

The decline of defined-benefit plans and the growth of 401(k)-style defined-contribution plans has been widely reported. In 1996, both types of plans held roughly the same total assets, give or take a few billion (see chart, below). By 2007, defined-contribution plans held $3.73 trillion—oustripping defined-benefit plans by more than a trillion, according to a recent study by the Employee Benefit Research Institute.

Despite the shift, those plans at first glance appear to have performed similarly during the current market decline. The EBRI study appears to shows that the market hurt defined-benefit and defined-contribution plans equally in 2008 — both fell by 28%, while individual retirement accounts (IRAs) fell 24%.

But aggregate numbers don't tell the whole story, says EBRI Senior Research Associate Craig Copeland. Defined-benefit and defined-contribution plans are similar in terms of overall asset allocation, he says, so they appear to behave similarly when the market moves.

But in employee-led defined-contribution plans and IRAs, says Copeland, "you get more much more variation in what happens at the individual level." While defined-benefit plans tend to remain within a 10% band across most plans, he says, "variation on the individual plans is very large."

Indeed, when the stock market does well, says Copeland, "DC plans have typically outperformed DB plans." But that, too, he says, is the result of individual outliers — workers whose entire portfolio is invested in equities during boom times tend to skew the average performance of the plans upward.

U.S. Private-Sector Retirement Plan Assets (in $ trillions)

Defined Benefit (Pension)Defined Contribution (401(k)-typeIRA
1996$1.59$1.63$1.47
1998$1.91$2.24$2.15
2000$1.98$2.49 $2.63 
2002$1.64$2.04 $2.53 
2004$2.13$2.79 $3.30 
2005$2.28$3.02 $3.65 
2006$2.53$3.48 $4.22 
2007$2.67$3.73 $4.75 
2008$1.93$2.67 $3.61 
Source: Federal Reserve, Flow of Funds, 1996-2008

As the nation continues to move away from the concept of a regular retirement pension and toward individual management of retirement savings, that means there will be increasingly big winners — and big losers — among retirees. "It is not clear what the percentage is going to be or how many are going to be worse off," says Copeland.  


Some workers, indeed, may be glad they took matters into their own hands. "The average DB payment is not incredibly high" notes Copeland, "it's about $9,800 on a yearly basis." Under a defined-contribution plan, "people have the potential to accumulate more."

But those workers savvy or lucky enough to play the market well face an additional challenge when they reach retirement: figuring out how to make their money last. That's as important as saving for retirement in the first place, says EBRI, "so that retirees do not outlive their assets."

Increasingly, even defined-benefit pensioners face that challenge. More defined-benefit plans now are offering lump-sum distributions, both when workers reach formal retirement age or when they are laid off pre-retirement. And, notes Copeland, more than a third of defined-benefit plans are cash-balance plans, many of which are denominated in a balance-like figure. The result: "People are more likely to take a lump sum," says Copeland.

In either case, workers must rely on their own financial-management skills, rather than the regular payments they once received from employer-sponsored plans. "One option is to annuitize their assets," says Copeland.

EBRI's analysis of assets in different types of retirement plans over the past 12 years shows that assets in all plans — including defined-benefit plans — grew during the period from 2004 to 2007. It also shows substantial losses in 2008.

"Americans have a great deal of work to do after the tremendous loss of wealth in 2008 to ensure financial security in retirement," the EBRI study concludes. "However, some optimism is warranted, as most individuals continue to contribute to their individual account plans and are in a position to accumulate added wealth as the economy recovers."




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