The perils of do-it-yourself pension plans

Planning for retirement is gradually becoming more of a do-it-yourself proposition. As a result, Americans can be less certain of how much they will get when they retire. That does not bode well for those who don't make savvy choices in their retirement plans.

Here's what's happening:

At present, a medium-wage earner who retires at 65 receives Social Security benefits of about $1,000 a month. That replaces about 41 percent of his or her previous earnings.

This so-called "replacement rate" for a medium-earning worker could fall to 30.5 percent for someone retiring in 2030, notes Alicia Munnell, director of Boston College's Center for Retirement Research.

Some of the reasons for this drop: The normal retirement age is being extended gradually to 67; Medicare premiums are being hiked; and, over the years, with inflation and rising wages, more retirees may have more of their Social Security income subject to taxes (but possibly at lower rates). And if Congress cuts benefits to close a perceived financing gap for Social Security, benefits could fall even lower.

The good news is that with gradually rising productivity, Social Security payments could still have more purchasing power than they provide today.

At any one time, half of American workers are covered by a private pension system. That ratio hasn't changed since the 1970s. At retirement, about 60 percent of Americans receive private pension benefits, often modest, in addition to a Social Security check.

Private pensions come in two varieties: Traditional pensions, in which the employer provides a "defined benefit" to the retiring employee. (The number of such plans has been shrinking.) And "defined contribution" pensions, such as 401(k)s for business and 403(b)s for nonprofits. (These have been growing in number.)

Under a defined-benefit plan, the employer takes and manages the investment risk. Because of the weak stock market and low interest rates, that corporate burden worsened in 2002. A study by Wilshire Associates finds that pension assets for firms in the Standard & Poor's 500 index dropped $106 billion to $892 billion in 2002. In the same year, their pension liabilities rose $105 billion to $1.07 trillion. Nearly 9 of 10 plans are underfunded.

Company contributions to their plans almost quadrupled in 2002 to $41 billion from $12 billion in 2001. During the stock-market boom of the 1990s, most plans were overfunded.

Another new study, by FTI Consulting, calculates that of the 354 companies among the S&P 500 with defined-benefit plans, 215 will have to make additional contributions exceeding $36 billion this year to comply with the law. FTI Consulting, of Annapolis, Md., figures these contributions are for most companies "relatively manageable."

Nonetheless, they reduce profits and capital available for company projects.

Business has been pressing Congress to ease the burden by changing the law governing how pension plans calculate their obligations. Instead of reckoning the future return of their assets on the basis of the 30-year Treasury bond rate, companies would be allowed to use the higher rate of long-term corporate bonds.

David Certner, director of federal affairs for AARP, an organization with millions of older people as members, doesn't mind such a change if it is confined to calculating needed contributions to a pension plan. But he terms the change "outrageous" if used to reckon the value of lump-sum pension payments to workers leaving a firm. That's because a 2 percentage point increase shrinks a $100,000 lump sum by $25,000.

The interest-rate change is part of a much broader pension bill proposed by Reps. Rob Portman (R) of Ohio and Ben Cardin (D) of Maryland. Other provisions would cost $100 billion over 10 years in lost federal revenues. It has been taken back for revisions to reduce the cost. A revised bill could pass the House this summer, Mr. Certner says.

To shrink pension costs in this economic slowdown, some companies have suspended their matching contributions to their employees' 401(k) plans. A forthcoming study by Ms. Munnell's think tank lists 15 big firms doing so.

That will diminish the assets available upon retirement and discourage some employees from participating in the plans. As it is, 401(k)-type plans are already much riskier for employees. Employees must choose whether to participate, where and how much to invest, how to reallocate the funds into more stable investments as they age, what to do with the funds in a plan should they change jobs, and how to allocate the funds when they retire.

Munnell says many, if not most, individuals are making mistakes. Some 25 percent of employees on average don't join the plans. Only 10 percent set aside in their 401(k) plan the maximum amount allowed under the law. Many invest too much in their own firm's stock or do not diversify their investments in other ways. Relatively few rebalance their portfolios to include more conservative investments in more senior years.

Just as everyone need not learn carpentry to build their own homes, not everyone should have to learn investing to manage their own retirement plans, Munnel argues. She would like the law changed so companies could automatically carry out key investment decisions for employees - unless they opt out of any of these decisions at any time. For instance, new employees would be automatically enrolled in a 401(k) plan at a level to take full advantage of the employer's matching contribution.

"People should take a close look at what they have" in the way of retirement money, says Christian Heller, a retirement specialist at the Economic Policy Institute in Washington. "If all these trends are combined, it doesn't look good for current workers." A third of working households, he calculates, will have inadequate pension funds for a basic standard of living on retirement.

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