Posted on 01/13/2006 9:46:13 AM PST by .cnI redruM
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.
It 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.
It all sounds good. My company offered an enhanced 401K plan when it froze our pension plan and then gradually scaled back their 401K match.
Unions still insist on the old style plans, insisting that they are "more secure". In many cases, they are completely wrong and their members, as in the airline industry, pay dearly for it.
"Traditionally" we died at 56 years old when pension were in vogue...
Not to mention, who works at the same place for 30 years anymore? Even 10 years.
exactly, that is the trend. this isn't going to stop, companies don't want to be involved in your retirement savings at all. first the defined benefit pension goes, they move to cash balance and then eliminate that, that leaves only 401Ks and then they slowly qualify how they contribute the company match - until that's gone too.
basically, if you have a private sector job - you'll be saving for your own retirement with your own money, and that's it.
In 2003, the median (a more realistic measure than the average quoted above) 401k account balance for Vanguard 401k participants 55 and over (presumably, those who had the longest period to invest and the highest balances) was about $46,000. One rule of thumb is that a retiree in their late 60s should withdraw no more than 4% of principle a year, so the median 401k will provide an income of around $150 a month.
http://www.retirement-solutions.org/article_401k_reform_campaign_agenda.html\
Meanwhile the hope that average investors, left to their own devices, will do better - or even remotely as well - as pension funds is strongly contradicted by actual experience.
For example DALBAR’s Quantitative Analysis of Investor Behavior (QAIB) has been tracking such returns since 1984, and as of 2003 the average equity investor had earned 2.57% annually; compared to inflation of 3.14% and the 12.22% the S & P 500 index earned annually for the last 19 years. So relative to inflation, such investory lost money during one of the best market decades in history, a time when simply putting their money in an in an S&P 500 index fund and waking away would have returned better than 10% annually net of expenses (!)
And it wasn’t just that they were incompetent stock pickers, their timing in the purchase and sale of fixed income investments was highly inppoertune as well, the average fixed income investor earned 4.24% annually; compared to the long-term government bond index of 11.70%.
http://www.dalbarinc.com/content/showpage.asp?page=2003071601
In any case, even given market returns for median income families the disposable income just isn’t there to save for sustainable retirement income while maintaining anything like current consumption patterns– do the numbers and you will discover that the median middle class American family, were they were saving at a level which could fund retirement entirely out of SS and private investment and savings, would be moving into a trailer, eating rice and beans and driving their 12 year old Toyota Corolla to vacations at a local park bench – which would, for starters, crater the ecconomy.
How we get out of this mess without 25% of the elderly eating cat food for the last few decades of their lives I don’t know – but the usual panaceas from conservatives are IMO no more realistic than their counterparts from the left.
***...complaints that people are too stupid to manage their own money are dead wrong...***
And just who advises the workers which stocks to buy for their 401Ks? If the companies are pushing their own stock, the worker could lose it all if the company goes under. Yes, I realize that if the insurer covering the old retirement plans goes under, the worker is stiffed. But this seems like double jeopardy to me.
And just what happens to the retiree when there's another market bust? Most people are NOT smart enough to play the stock market without advice. So who pays the trader?
Well, the problem is that ever component of a viable solution is unattractive:
1) You need to force people to save, and to start saving young.
2) You need to enforce some parameters on the sort of investment allowed.
3) You need to enforce some controls on the administrative costs allowed.
4) Beyond that, a lot of the realistic investment choices are going to be politically and socially unappetizing to a lot of the participants, for example overseas investment.
All this stuff is anathema to conservative sensibilities, but unless we are willing (and more to the point, it’s politically viable) to allow large numbers of people to spend the last few decades of their lives in abject poverty, we don’t have much choice.
Otherwise, one way or another, the rest of us are going to end up paying for the poor choices made by people who don’t start saving until late in life, invest in anti-gravity, moon-cheese and Enrons, are hornswaggled into paying 5% management fees, and insist on investing only in the US economy.
Than most people should invest their retirement in bonds or annuities.
Well, with allowance for a bit of purple prose, that's exactly what those Dalbar numbers say they have been doing, and for example in the mid to late 1990's I watched a lot of them - some of them my friends, and often intelligent people and “sophisticated” investors - do it.
Successful inventing is hard for average humans - studies of actual returns shows this is so, and behavioral economics shows why it’s so, and why such behavior is so hard to change.
People, on the average, don’t want to believe this because it's counterintuitive to their actual experience in most other human activates, where even a modicum of effort, intelligence and study confers considerable advantage.
Conservatives are supposed to be the boys and girls who put emotion aside and let the chips fall where they many, but in this regards they seem to be no better or worse than anyone else - many of my liberal and conservative acquaintance alike left a lot of skin on the road during the last bubble, and it bids fair to be a dead heat as regards retirement planning as well.
Well, like I said, all the choices are unattractive.
The difference from your example is that if enough people make bad choices, the have the political ability to make the everyone else pay the bill - it's IMO under appreciated, for example, that SS is a part a way to force the stupid, unwise, and unlucky pay at least a portion of the bill that would otherwise be presented entirely to the wise, lucky and smart.
Well, this is in fact exactly how all those investors in Dalbar's numbers have been underperforming the market by around 75% a year: thay have been attempting to “time the market” or “pick winning funds” – and while there may be some room for argument about the ability of handful of exceptional individuals to do so, at the level of retail investment the record of average investors (and for that matter, fund managers) is just awful.
And many people – even people who ought to understand this - have a hard time accepting it; for example in the article under discussion, this really jumped out at me:
“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.”
In fact, just the opposite is true, in the case of a personal residence you are guaranteed a monthly return (the value of living in the property), the requirements of success (pay the mortgage ever month, fix the roof if it leaks, etc.) are clear and straightforward, and the difficulty and cost of selling a principle residence guarantees that people won’t be doing it in response to every twist and turn in the housing market - some people do manage to lose money on such “investments”, but in the last 40 years it’s the exceptional individual and situation in which a homeowner manages to live in a house for a decade and then sells it for only what they paid for it, or less.
But as those Dalbar numbers demonstrate, equities are an entirely different sort of investment; in the current period of depressed dividends most yield little ongoing return, the “rules” of successful investment are complicated problematic, and often counterintuitive, and the liquidity of such investments in combination with innate human behavioral biases tempts average investors to “buy at the top and sell at the bottom” while incurring transaction costs at every point along the way. And in fact, lots of people do manage to lose substantial amounts of money due to such behavior, so much so that during what should have been a “can’t miss” decade average investors couldn’t even keep up with inflation.
The smart move, OTOH, woud have just been, month after month, to have purchased a balanced mix of asset classes via low cost index funds, and month after month, from January to November, to have burned the statements unopened, pausing only to pass Decembers YTD results along to you accountant unread to do your taxes. Such an investor (assuming they were a robot) would have slept better – and more important, done much better – than their neighbor who attempted to “outsmart” the market.
It’s a rare human who can do it, thought; Richard Bernstein, who has a wealth management shop:
http://efficientfrontier.com/
which invests along these lines for clients estimates that only around one person in twenty is actually able to excerpt the self-discipline to stick to such a program, which over the last decade would (for example) continued to invest in Japan every year according to allocation plan, and which during the late 90’s would have steadily sold red-hot US large cap growth (AKA: “The New Ecconomy”) to maintain allocation.
But that’s what it takes.
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