Friday, March 25, 2005

Pensions vs. 401(k)?

With continuing problems around 401(k), are pensions really dead? Consumers are increasingly aware of problems investing for retirement income. Between employees not having any sophistication or investing savvy, employer HR organizations not wanting to provide investment advice (not that they should), and a lack of broker support, 401(k) investors are in a unique position NOT to maximize their returns. Pensions have shown a much higher efficiency rate for actually providing for retirement than DC plans. Much of this is due to a more concerted effort to the plan sponsor’s fiduciary responsibility to minimize risk while maximizing profits. Studies have shown that contributed dollars to provide a set level of retirement benefits is much lower for DB plans than it is for DC plans. The problem is that employers don’t want to be stuck with the entire burden of funding employee retirements in today’s transient employment environment.

Take the current Social Security debate for example. In reality, the SS actuary reports that there is no real (significant) long term shortfall that impairs the ability of the system to pay plan participants.

“During the past year there has been no important change in the financial outlook for either Social Security or Medicare. Under the intermediate assumptions, the combined OASDI Trust Funds show a 75-year actuarial deficit equal to 1.92 percent of taxable payroll, slightly larger than last year's estimate of 1.89 percent. That change is largely attributable to moving the valuation period forward a year from 2004-78 to 2005-79, which adds a year (2079) with a large projected deficit into the estimate of long-range funding adequacy. The OASDI Trust Funds, separately and combined, are adequately financed over the next 10 years under the intermediate assumptions.”

If this were a private plan, the plan sponsors would have increased their annual contribution to the plan decades ago and the projected shortfall would not exist. However, instead of a guaranteed payout, the feds want to privatize a portion of the funds into personal accounts, putting the money further at risk. The long term projection might be less risk for the SSA, but a smaller average payout for retirees.

What’s the solution? I really have no idea. Clearly DC is not going anywhere. However, I’m not convinced that DB plans are going to disappear in the long term. #1) It’s not quite so easy to terminate a plan. #2) even if you can terminate the plan, you’re probably going to pay into it for a period of time and the plan will exist until the last plan participant dies in 50-60 years (year 2060-ish).