January 11, 2006
401K Becoming Widespread; Replacing Pension Plans
For more companies, 401(k) becomes automatic
IBM isn’t alone: Large employers are increasingly freezing their traditional pension plans and automating 401(k) features to nudge workers to save in these do-it-yourself accounts, new research shows.
In 2005, 67% of large employers offered a traditional pension - a payout in retirement based on years of service and final pay - down from 91% two decades earlier, Hewitt Associates says.
IBM last week became the latest big U.S. employer to say it would freeze its traditional pension plan. At the same time, IBM said it would sweeten its 401(k) plan for 125,000 U.S. workers.
IBM’s sweeteners include an automatic company contribution of 1% to 4% of pay - even if workers don’t save anything themselves. And for those who do save in a 401(k), IBM will also match 100%, up from 50%, of the employee’s contribution up to 6% of pay.
The pension system is outmoded and unable to handle modern worker-employer relationships. As with all changes, change causes some pain, especially as companies learn they can default on their pensions and let the government pick up the slack. But the pension system is based on a lifestyle where workers stay with a company for long periods of time, and that is simply not the case in the modern world.
In addition, a pension system has a few serious problems. Pensions defer costs for companies, and when faced with immediate compensation increases demanded by unions and pension benefit increases by unions, companies choose the pension increase. This backloads the cost of employment until workers start to retire, at which time a company pension plan starts to collapse under its own weight. At the same time, pension plans create an added level of dependency of an employee on his employer, as an employee two or three years shy of the maturation of his pension will lose an enormous financial windfall by leaving the company. No matter how badly that employee may want to leave, he’s nearly forced to endure whatever conditions the company offers, as losing his pension would be far too costly to move.
The 401k system is a great solution. It is a defined-contribution plan which the individual employee owns. It is based upon appreciating assets (stocks), it is portable, and it is the epitome of a free transaction. The employee is completely free to set his own level of contribution, based on the amount of money he expects he will need to retire.
But therein also lies the problem. Despite the incentives employers offer to participate in 401k programs, nearly a third of eligible employees don’t participate. This is one of those natural features of most people, because when you’re 23 years old, you’re probably not thinking very hard about retirement. You’re usually stressing about how you’re going to pay rent & bills, buy groceries, and have money to entertain yourself in the standard to which you are accustomed; all on an entry-level salary. In too many cases, that lifestyle is subsidized by credit card debt, building debt which must be paid off (with interest) out of future earnings. It’s very easy to get yourself into a pattern of contributing nothing or far too little into your 401k, planning later in life to make up for it. Due to the wonders of compounding interest, however, those workers are making it harder and harder for themselves to recover, because the funds saved early in life will appreciate much more than anything saved later.
Oddly, I see most financial-planning commercials aimed at people in their 40s and 50s, and I’m constantly worried. If you’ve reached that age and you don’t already have a nice nest egg built, you’re probably in very bad shape when it comes to planning for your retirement. And if you’ve got the nest egg built, you probably already understand finances well enough to get yourself where you are that you don’t need a financial planner to “fix” your situation.
I’m not one to advocate government-mandated forced employee contributions, or Congress getting involved in the form of their “privatized” Social Security. As I’ve pointed out in the past, the last thing I want to see is Congress getting even more involved in the stock market, because I’m quite certain it will result in countless negative unintended consequences, including but not limited to lower returns for everybody.
But I applaud companies like IBM. 100% matching up to 6% of income, combined with an automatic company contribution of 1-4% of income is definitely a pretty sweet deal. I always tell friends that you should always put in as much of your income as your employer will match (after all, that’s just free money). But a company like IBM is really pushing to make the transition from a pension-based system to a 401k-based system a positive change for their workers. It is a very good move, and IBM and any other companies which choose to adopt similar policies deserve to be lauded for their actions.
Below The Beltway linked with The Changing Retirement Landscape
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The Changing Retirement Landscape
Last week, IBM added its name to the list of American corporations abandoning traditional defined benefit pension plans in favor of 401(k) plans. As this story reveals, however, IBM is not alone.
Warbucks, you tool bag!
Sechen