The Do-It-Yourself Pension
By: Russell Wild; Source: AARP Bulletin Date Posted: 2005-09-01 08:44:00-04:00
Mel Zischler retired this year from Principal Financial Group of Des Moines, Iowa, one of the American companies that still offer a traditional pension plan to about 20 percent of workers in private industry. Zischler, 63, spent 44 years with the company, ending his career as an operations manager. He now receives monthly checks equal to roughly 43 percent of his final year's salary. And he'll continue to receive those checks—adjusted for inflation—throughout his life, in addition to his Social Security and savings. Zischler says, "I'm not worried about funding my retirement years."
Lynnell Bagby of Philadelphia has worked for more than 30 years. Typical of many Americans, she's had several jobs. None has earned her a pension. And at only three jobs did she put in enough time to qualify for a 401(k), the kind of retirement plan, known as a defined contribution, that has replaced most traditional pensions.
The 401(k) plan may be funded by the employee or the employer, or both, but the defined contribution provides no retirement payoff guarantees. For the past six years, Bagby has been working as a secretary in a nursing home. Her employer currently contributes $25 a month to a 401(k). She doesn't contribute because on her salary of $22,000 a year, she says, there simply isn't anything left after paying the basic bills.
The sum total of her two 401(k) plans—pretty much her entire nest egg—amounts to $700. It would be a bit more, but three years ago she had to withdraw money to pay a plumbing bill, incurring a government penalty of 10 percent. Company contributions were cut off because of a rule: no contributions for a year after an employee makes a withdrawal. "I try not to think about retirement," says Bagby, 52. "I put blinders on. I don't want to know how bad it is."
While the number of companies reneging on their pension promises has made headlines [see "Pension Roulette," in the July-August AARP Bulletin], the loss of traditional defined benefits, like Zischler's, is a larger social issue. "Since the late '80s, there has been a continual decline in the number of employees covered by traditional pension plans," says Steve Blakely of the Employee Benefit Research Institute in Washington.
The traditional pension provided millions of American workers with comfortable retirements for the past two or three generations. Some companies have replaced it with the controversial cash-balance plan, a hybrid of the defined benefit and the 401(k), which in many cases shortchanges older workers. More commonly, the traditional pensions have been replaced by 401(k) plans. Or by nothing at all.
And the assault isn't limited to private employees. Gov. Arnold Schwarzenegger, R, earlier this year announced his intention to terminate all California state employees' traditional pensions and replace them with a new 401(k)-style plan. He may or may not get his wish, but his campaign has come to symbolize pressures on the public sector to follow the lead of private industry.
"With traditional pensions disappearing, many workers will find themselves largely dependent on their 401(k) plans to retire—and 401(k) plans, without question, are simply not as good for the American worker as the traditional pension," says Nelson Lichtenstein, director of the Center for Work, Labor and Democracy at the University of California, Santa Barbara.
Not everyone agrees. The defined benefit plan generally allows for a steady although often modest stream of retirement income. Today's more common 401(k)s and others, like the 403(b), covering government workers and nonprofits, allow employees to sock away money, which employers often match. Wisely invested, these plans can grow and even allow the employee to retire flush. It looks good, at least in theory.
But then there's the reality. Ask Lynnell Bagby, with her grand total of $700 over 30 years.
Or ask John Hotz, deputy director of the Pension Rights Center, a nonprofit advocacy group in Washington. "The official government figures tell us that about half of the private work force is 'covered' by some kind of pension or retirement plan," he says. "That means that half is not covered. That's bad enough. But what's really sad is that coverage doesn't necessarily mean a person will have adequate funds in retirement."
In fact, the nation's largest private employer, Wal-Mart, has 1.3 million employees in America who are technically covered by a retirement plan, but just half of them had account balances in 2003. Of those who do have balances, many may be as small as Bagby's. In fact, a recent study by Hewitt Associates, a human resources firm, reports that nearly one in four Americans with 401(k)s has a balance of less than $5,000.
But what about Americans who make good money and can stash away the maximum ($14,000 a year, $18,000 if over 50) into a 401(k), and also get a fat company match? Surely, 401(k)-style plans are a good deal for them. Yes? No?
Maybe.
Ron Gebhardtsbauer, a senior pension fellow with the American Academy of Actuaries, says that the move from defined benefit (DB) to defined contribution involves a clear transfer of risk from employer to employee.
"In the early 1990s, during the dot-com boom when stocks were flying, employers reduced their DB plans, and people didn't care because their 401(k) plans, largely invested in the stock market, were on a tear. But in 2000, when the market started to tumble, well, a lot of people's 401(k)s suddenly started to look more like 201(k)s—that is, worth only half as much," says Gebhardtsbauer. "And a lot of retirees are going to run out of money."
Jerry Korabik, a vice president with Ibbotson Associates, a Chicago-based investment research firm, points out that the markets always carry risk, and even someone invested in blue chips is vulnerable. "Historically, the S&P 500 [an index of America's largest 500 companies] has seen an average return of 10.4 percent—but that is an average over many years. There have been years in which the market goes down and stays down for a considerable time," he says.
Consider two people approaching retirement, Korabik says, each with a 401(k) of $200,000 invested in a basket of S&P 500 stocks. Retiree A left his job in January 1996. Each of the next three years, he withdrew 5 percent of the money. Retiree B left his job in January 2000 and also withdrew 5 percent each year. After three years, Retiree A, who quit when the going happened to be good, has a balance of $382,092. Retiree B, who quit just when the market headed downhill, finds himself after three years with a nest egg of $100,136.
In fact, many people who retired in 2000 saw their nest eggs shrink far more than Retiree B's. That's because many investors do far worse than the S&P 500. According to the Hewitt study, employees invest, on average, about 27 percent of their total 401(k) balance in their own company's stock, generally a lousy idea. This is why some Enron employees lost nearly everything when the energy giant went bankrupt and its stock, once $90 a share, plummeted to less than $1.
This and dramatic pension defaults by airlines, steel and other industries have Congress scrambling to protect Americans' retirements. Several bills are in the works to shore up the Pension Benefit Guaranty Corp. These bills aim at enforcing corporate pension contributions and protecting older employees who are hurt when traditional pensions are converted into cash-balance plans.
Meanwhile, the do-it-yourself 401(k) is likely to be key to boomers' retirements. Here are a few tips for building and protecting your pension portfolio:
Maximize your contributions. Contribute as much as you can and as early as you can to take advantage of compound interest. Make a Herculean effort to put in at least the minimum to get your full company match. Otherwise you're leaving free money on the table.
Invest wisely. A well-diversified portfolio of stocks, bonds and cash is the best defense against loss—both market loss and inflation loss. As a rule, the closer you are to retirement the more conservative your portfolio should be. For help, check with your plan administrator or consult an investment counselor.
Check your statements. It doesn't happen often, but yes, sometimes employers steal from their employees' retirement funds. Check your statements, and make sure your contributions are being registered in your account.
Plan your rollover. Recent studies indicate that nearly half of all workers leaving their jobs cash out their 401(k) plans. They are not only tapping into their retirement savings, but if they're cashing out before age 59 1/2, they are most likely getting smacked with taxes and a hefty penalty. Don't cash out! If you leave your job, you may have the option of keeping your 401(k) plan right where it is. Or you may be able to move it to the 401(k) plan of another employer. You can always roll it into an individual retirement account (IRA).
Russell Wild is a financial planner and writer based in Allentown, Pa.
Additional Related Links
Interactive Retirement Calculator From AARP Bulletin Online
Pension Roulette—How Secure Is Your Future? (July-August 2005)
7 Costly Pension Pitfalls (AARP The Magazine)
Guide to Important Pension Plan Documents (AARP.org)
Checklist: 27 Questions to Ask About Your Pension Plan (AARP.org)
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