Posted on 01/10/2006 7:15:22 AM PST by SirLinksalot
Good Riddance to Traditional Pensions Print Mail
By James K. Glassman
IBM announced last week that it would freeze the old-style pension plans it provides to more than 100,000 employees and instead offer an improved version of its 401(k) plan. This is no run-of-the-mill accounting change or cut-costing measure. It is a major philosophical and economic shift for a bellwether corporation.
IIt means, in short, that International Business Machines is moving away from paternalism and giving workers more control over their own retirements. The U.S. government should do the same in reforming Social Security.
The IBM decision is good news as well for taxpayers, who ultimately could be left holding the bag if the Pension Benefit Guaranty Corp., a federal institution that insures pensions, can't meet the obligations of overextended companies.
Of course, IBM is in no danger of becoming the next Delphi. At last report, it had revenues of about $100 billion, after-tax profits of $8 billion and loads of cash. IBM's pension plan, with $48 billion in assets, is robust. But 40 years can pass between the time someone joins a company and the time he retires. Things change, as GM employees now know. It makes far more sense for workers to carry their retirement assets on their own backs, rather than counting on the company to ante up decades later.
There are two kinds of pensions. Defined benefit (DB) plans, or traditional pensions, involve a promise from a company to provide monthly checks to retirees at a specific rate, depending on how long they worked and at what salary. DBs are headed for the dustbin of history--and good riddance. There were 112,000 of them in 1985 and just 29,000 today.
Second is the defined contribution (DC) plan. Its paradigm is the 401(k), named for an IRS provision. A quarter-century ago, 401(k) plans began sprouting. Some 43 million U.S. workers now have them.
A 401(k) allows workers and employers to put pre-tax income into an account that's mainly composed of mutual funds (IBM offers more than 200 choices). Dividends, interest and capital gains pile up tax-deferred, and the account is owned by the worker. IBM's 401(k), with $26 billion in assets, is the nation's largest. IBM says that, starting Jan. 1, 2008, it will freeze the DB benefits of current workers and instead enhance the DC plan. New hires go straight to the DC.
Under the new 401(k), IBM will match, dollar for dollar, employee contributions of 6 percent of pay (the match is now 3 percent)--and, in some cases, up to four points more.
This is not altruism. IBM figures it will save about $500 million a year through the changes. Probably more important, however, the company gains certainty (the funding requirements of DBs fluctuate), and it provides workers with a stronger sense of responsibility and more confidence in a comfortable retirement.
Some disagree. Lee Conrad, a labor organizer, said after the IBM news: "Employees are going to be losing out on all kinds of benefits. You've got to wonder what's going to happen to the next generation of workers."
No, you don't. A study released last September by the Employee Benefit Research Institute and the Investment Company Institute found that Americans do a fine job with their 401(k) plans. Even with the rotten stock-market conditions of the early 2000s, the average account balances of 401(k) participants rose about 40 percent, to $91,000. And remember, these workers still have two decades to retirement.
Employees have, on average, two-thirds of their 401 (k) money in stocks--an appropriate share--and they are investing more in "life-cycle" funds, which shift to bonds as retirement nears. Loans from the plans are modest and declining.
More financial education wouldn't hurt, but DC plans are working exceptionally well, and complaints that people are too stupid to manage their own money are dead wrong. After all, a record 69 percent of Americans own their own homes--a far more difficult and risky purchase than the slow accumulation of mutual fund assets over 40 years.
IBM's decision offers a good model for reforming Social Security. Let new workers waive Social Security taxes and benefits and choose a 401(k); let current workers freeze their benefits and pay lower payroll taxes while boosting their 401(k) as a substitute. The U.S. government will have a sounder fiscal future when, like IBM, it stops treating adult American workers like children.
James K. Glassman is a resident fellow at AEI.
Dear Realism,
Well, I don't know precisely how many more than 20 years you're talking about, and I don't really know how you've invested your money.
As well, if your income has risen significantly since you began putting money aside in your 401(K), then because the initial contributions of 6% were comparatively much smaller to your current income, it'll seem as if you haven't gotten far in the first 20 years.
Remember that the second 20 years, if invested properly, will likely quadruple what you already have.
Workers should save like mad in the first part of their career, because whatever gets saved early will get much more of the benefit from compounding.
I'd also note that my own statement referred to saving 12% total per year, not 6%.
sitetest
There's a lot of truth to that. By the time 'everybody' is doing something financially the big guys have already taken their profits and moved on, e.g., tech stocks, real estate.
For most of history, you worked till you died. You didn't get 30+ years to goof off first. Retirement is great and a real privilege, but not a right. Most in my generation know that by the time we get to "retirement" age, it will match the average life expectancy age.
As for you second question, we are almost there already. The real question is what will happen when the government can no longer provide bread and circuses?
I dumped those vampires about 3 yrs. ago. I doing it on my own now.
Dear Looper,
"Now we just need to get all governments to do this."
Oh, I couldn't agree with you more! Privatizing Social Security, and eventually turning most all defined benefits plans into defined contribution plans would help workers, help the economy, help business.
"This article is a little too rosy, IMO."
Mr. Glassman is the eternal optimist, and the original purveyor of the Rosy Scenario. ;-) I agree, median would be better than average.
However, we're still only less than 30 years into the defined contribution revolution, and remember that even 20 years ago, participation in tax-deferred retirement accounts and defined contribution plans was less than half of what it is today. The thing that excites me is that over half of households now own equities, either through mutual funds or individual stocks. And 20 years from now, even the MEDIAN account will be much larger than it is today.
I believe that increasingly, regular folks will think like capitalists.
As well, it seems to satisfy an element of economic justice that those who work for a living, if they're a little frugal, wind up owning a modest but real share of the means of production of the American economy.
sitetest
Dear Maneesh,
I agree with your every point.
Another benefit is that people will come to understand that their own future well-being is tied to the economic well-being of the entire country. After all, if the economy stops growing, it is likely that they won't get the returns on their tax-deferred investments that they need to retire comfortably.
Thus, individuals will need to think about how political and economic actions affect the ENTIRE country and economy, not just their own immediate circumstances.
sitetest
So, paying into social security is just a scam? Hmm.
Yeah, it's a scam, but it's our scam.
My son in law just went through this and despire my advice, he's only investing a very minimal percentage. He's not even investing to the match, so he's leaving money on the table. But he is at the lower end of earning, and despite living fairly frugally, doesn't have much more wiggle room in his budget.
But it will also be worth less.
Most Ponzi schemes are that by definition.
Dear Realism,
"But it will also be worth less."
I disagree.
sitetest
Dear joesbucks,
Those are interesting points, but I'm not sure I entirely agree with them. I think that as time goes on, the knowledge of how to invest at least adequately will become more "built-in," just as the knowledge of how to drive a car at least marginally well, once a rather exotic skill, is now considered nearly a basic life-skill. Or how PC skills were once considered exotic, and now they're vital.
For folks with poor mutual fund choices, a nice S&P 500 Index fund might be the way to go. Heck, even for folks with great choices, a nice S&P 500 Index fund might be the way to go. At least until the later years of one's working career.
Interestingly, I don't see much connection between the ability to balance a checkbook, and other "household finance" types of skills, and the ability to invest well. I own three small businesses, and I don't balance a single checkbook, nor the one at home. I'm just rather inept at it. I have a wife and an executive assistant. ;-)
But my businesses are moderately successful, and I'm pretty decent at managing my financial investments.
Conversely, my father, who is 80, is still sharp as a tack at managing his household finances. Yet, when my mother died, she left a modest fortune from defined contribution plans, and I was appalled to see how poorly they were invested. In talking with my father over the course of the last two years, I'm shocked at how this man, who is very competent at managing his regular finances, just cannot wrap his head around the "high finance" stuff.
In my view, it's because he wasn't exposed to this kind of thing when he was younger, and now, well, I guess you can't teach an old dog new tricks.
As well, I disagree that the professional money management expert is automatically at an advantage over the competent small investor. Folks who have to invest billions of dollars find it a lot more difficult to even achieve market-rate returns, because of a combination of their fiduciary limitations and the size of their funds. The smaller investor has advantages that the larger investor doesn't have.
As for guaranteeing defined benefit plans, one problem is that those actuarial tables look at current returns and extrapolate out. So, when the economy is in the doldrums, just when a company needs to be at its leanest and meanest, lackluster stock market returns may require higher-than-typical contributions to the defined benefit plan. Ouch!
sitetest
No one yet is brave enough to admit many of the other "sure" investments are Ponzi's or eventually will be.
<<<<
However, if the US and world population start to decline, bonds may pay better than stocks.
>>>>
That is assuming that foreigners ( e.g. China, Japan and South Korea ) continue to buy our treasuries with the surplus money they have from exporting to our country. Remember, we have a record TRADE DEFICIT with these countries which has been GROWING EVERY YEAR.
We are very fortunate in that they use the surplus dollars we pay them to consume their goods to BUY US TREASURIES, thus ensuring bond market stability.
CAN YOU ASSUME THIS TO GO ON FOREVER ? Why are EURO or YEN or Aussie or Canadian denominated bonds not going to be even more attractive than USD denominated bonds ?
Because the US economy will alsways be the most stable place to park your money.. It is the closets thing to a guarantee there is. Our financial system has too much structural integrity and our economy has too much going for it for the Chinese or the Europeans to ever attract a huge amt of money long term.
Dear Maneesh,
Thanks!
In my view, a well-educated and disciplined small investor will in the long run usually run rings around the professional money manager who must invest hundreds of millions or even billions of dollars.
If you have a million dollars to invest, all you need is 20 good ideas in which to put $50,000 each.
If you have a billion dollars to invest, either you need a much larger number of ideas, or your average investment is going to be $50 million. To get that average investment down to $5 million requires TWO HUNDRED good ideas!
The more good ideas you have to have, the more likely it is that some of them won't be quite as good as the rest. Putting together a good portfolio of 20 stocks that will outperform the market is a darned sight easier than having to put one together with 200 stocks. Yikes!
As well, the fellow with a million bucks just about never has to worry whether his purchase or sale of an issue will "move the market." He just won't be liable to the SEC rules that affect folks who are buying and selling million and millions of dollars of stocks & bonds on a regular basis.
Another critical advantage is that the fellow who is managing a defined benefit plan's assets is forbidden from buying certain types of investments. Thus, he is locked out of the superior returns often provided by these admittedly riskier investments. But the wise investor can carefully buy and sell small (in relation to his portfolio) amounts of these sorts of investments and do very well. When interest rates were higher, I bought a small amount of a junk bond fund (less than 5% of my portfolio). As interest rates came down, not only did I receive the roughly 10% dividend on my original investment, but my investment appreciated significantly over the course of the couple of years that I owned it. By definition, this fund bought bonds that were not "investment grade," and thus, many money managers would have had a tough time buying them.
"I also agree that managing personal finances can be done by a very live in the present detail oriented person. However investing takes a forward looking, entrepreneurial mindset which are usually not found in the same person because it almost creates an inner personality struggle."
I never thought of it this way. You may be right. Maybe all of us entrepreneurial types should be obligated to marry folks who can balance a checkbook readily. ;-)
sitetest
I think that as time goes on, the knowledge of how to invest at least adequately will become more "built-in," just as the knowledge of how to drive a car at least marginally well, once a rather exotic skill, is now considered nearly a basic life-skill. Or how PC skills were once considered exotic, and now they're vital.
You would think. But there's something weird about money. First, in many cases, it's a taboo subject growing up. Secondly, we've created a culture that believes it's no ones business if your spending yourself blind, I'm a big boy so I can handle money and so forth. Look at talk radio. Financial shows overall do poorly in ratings. Politics talk does well. We'd rather hash whether DeLay is being railroaded rather than discussing upcoming investment trends, taxes and the like.
For folks with poor mutual fund choices, a nice S&P 500 Index fund might be the way to go. Heck, even for folks with great choices, a nice S&P 500 Index fund might be the way to go.
Agreed, except, my wife's provider has an index fund that is Morningstar ranked two stars. How can an index fund be ranked two stars?
Interestingly, I don't see much connection between the ability to balance a checkbook, and other "household finance" types of skills, and the ability to invest well. I own three small businesses, and I don't balance a single checkbook, nor the one at home. I'm just rather inept at it. I have a wife and an executive assistant. ;-)
The checkbook example is nothing more than an illustration. Most people who can't seem to balance a checkbook also don't know the first thing about money. As in your case, you've obviously have enough savvy to conduct business affairs. How many people don't have that same "savvy" blessing?
Conversely, my father, who is 80, is still sharp as a tack at managing his household finances. Yet, when my mother died, she left a modest fortune from defined contribution plans, and I was appalled to see how poorly they were invested. In talking with my father over the course of the last two years, I'm shocked at how this man, who is very competent at managing his regular finances, just cannot wrap his head around the "high finance" stuff.
I suffer the same thing, only in different areas. I'm pretty computer savvy. But I cannot for the life of me learn Microsoft Access. Your father probably suffers the same thing. In addition, because he wasn't exposed to the finer things regarding finances, he's likely scared and confused. Plus, everyday you hear of supposedly good financial folks being led away in handcuffs for financial misdeeds. He's probably a bit fearful of having to do a perp walk.
Also, all of us at some level reach our level of ignorance on a subject or an entire subject. Money seems to be that for many.
As well, I disagree that the professional money management expert is automatically at an advantage over the competent small investor. Folks who have to invest billions of dollars find it a lot more difficult to even achieve market-rate returns, because of a combination of their fiduciary limitations and the size of their funds. The smaller investor has advantages that the larger investor doesn't have.
Especially with mutual funds, folks who have to invest billions of dollars find it a lot more difficult to even achieve market-rate returns, because of a combination of their fiduciary limitations and the size of their funds have the same limitations. The only difference is they aren't guaranteeing a return.
Also let me say that I know that as an employee I'm "owed" nothing except what was promised. In many cases, pension plans were promises. I promise to perform my duties everyday. My employer made certain promised to me that if I did my job, they would give me x and y rewards. If it was a defined pension plan, then they should live up to their promise.
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