Nearly every day a new report notes that we’re not saving enough for retirement. By examining a few recent events we may understand why.
According to the Pension Benefit Guaranty Corp. (www.PBGC.gov), the number of Defined Benefit (DB) pension plans is steadily shrinking. There were some 114,000 such plans in effect in 1980. Today some 31,000 exist, largely due to the cost to administer them.
DB plans were common among workers from previous generations, such as those who were employed by large companies or had a union or government job. Entering into such a plan was almost automatic once a worker completed the minimum amount of time to become “vested” – usually five years. Members of such plans rarely worried about how their money was invested because it was virtually all but guaranteed – the PBGC, which is backed by the federal government, takes care of that. While companies use a variety of formulas to determine payments, generally the amount one receives at retirement depends on how long she worked for the company and what her salary was at retirement time. In addition to Social Security these plans, plus savings and other income sources (and usually a lower-expense lifestyle) helped generations to comfortably retire by furnishing 10-50% of one’s retirement income.
Massive layoffs in aviation and manufacturing dumped $18.9 billion in pension claims on the PBGC. This has raised fears that a taxpayer bailout might be required. So far, the PBGC has held steady. In 2006 it paid $4.1 billion in benefits to 1.3 million workers and retirees as the Pension Protection Act of 2006 provided a new framework for funding DB plans and increased requirements to communicate this to participants. It offers greater tax incentives for companies increasing pension-plan funding and levies financial and other penalties for those underfunding their pensions.
The question is will the new and costly rules have the unintended effect of persuading some companies to either freeze or terminate their plans or to switch to other types?
Worry-Free No More
While they’re generally perceived as worry-free by plan participants, the $9 billion default by United Airlines in 2005, the largest pension-plan default in US history, proved concern is warranted. In 2004, nearly 1,400 DB plans were terminated. Fully 192 of these plans were “distressed.” With a judge’s approval, a company entering bankruptcy-court protection can default on future payments. The maximum the PBGC provides is $45,614 per year ($3,801 per month) – putting higher-paid workers and retirees in danger of not receiving the full amount they were anticipating.
Enter the widely criticized Defined Contribution (DC) Plan. Largely 401(k) and profit-sharing plans, these allow workers to regularly deposit money from their salary on a tax-deferred basis until retirement into a variety of investments. The employer has no obligation to contribute although many do provide a “match” based on a percentage of the worker’s contribution. The responsibility for these “self-directed” plans is on the worker, who may or may not have the financial know-how to invest for the long term. Recall cases like Enron where employees had inordinate amounts of retirement money stashed into company stock. Many of them woke up one morning to find that their retirement plans had to be indefinitely put on hold.
Stormy Waters Ahead
The Defined Benefit vs. the Defined Contribution plan – while it would take the wisdom of King Solomon to make the right choice, there are many things one can do to monitor their plan, like checking statements and pay stubs to see that the correct amount is being withdrawn and deposited into the right accounts. Periodically meeting with the human resources representative who helps employees understand their pensions can keep one aware of changes that may impact benefits. But none of this will make anyone a better investor or protect one if the company goes bankrupt or unscrupulous or careless administrators mismanage the funds.
Americans are sailing on stormy seas when it comes to their financial futures. Consider that the strength of our Social Security system is questionable and inflation has returned to whittle away at purchasing power. With a defined benefit plan one depends on their employer to wisely invest and administer pension funds. With a defined contribution plan investors are responsible for their own fates.
While the mainstream media (and some politicians) often make investing sound simple, the examples above prove otherwise. The truth is – today’s pre-retirees are vulnerable. We need to take greater responsibility for our retirements and align with an independent financial planner sooner rather than later. Such relationships can help us get the most from our financial futures.
Paul Strebel, CFP, CPA is an independent financial adviser with The Strebel Planning Group in Ithaca (www.strebelcpa.com).
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Paul Strebel My extensive background includes experience working for a “big eight” accounting firm, two large brokerage firms, two large insurance companies, as well as tax manager for a large international manufacturing corporation. Full Profile & Contact Information...
Jeannie Campanelli
Jeannie Campanelli, Ed.D, CPCC, is deeply committed to sparking the hearts of people to experience an inner confidence - that sense of wholeness, aliveness, and serenity that comes from deeply knowing yourself, fully accepting the lightness and darkness of being human, and living freely by standing in your own truth.
