Suffice it to say that with the legislation in place—Bush is promising a quick signature—the future of retirement savings looks a lot different than the past.
Pension reform, in this case, has several major components, all designed to complete the long process that has made individuals responsible for funding their own retirement security. What’s interesting, however, is how these changes add up to create a system that will act a lot like the old days, when corporations funded retirement savings. Here are the key issues:
|
|
Employers can boost participation in their retirement plans by automatically enrolling workers. Individuals could decline to participate but must formally decide to opt out. In addition, employers can boost worker contributions over time so that the savings grows along with the employee’s salary.
This tackles the rampant apathy Americans have about saving and turns inertia into a positive. There is a wide range of statistics available on the subject, but most boil down to this: About half of all eligible workers sign up for their retirement plan; in automatic-enrollment situations, participation rises to more than 85 percent because few workers stop the saving process.
- Investment advice
The act encourages plan sponsors to hire outside financial advisers who can give personal guidance to workers. This tries to solve the problem that many individuals who make their own plans aren’t very good at managing money.
The act also allows for suitable “default” investment choices for workers who don’t pick specific investments. You can expect these defaults to be target-maturity and lifestyle funds, rather than stable-value and money-market choices, the investments many employers currently favor because they are too concerned about liability issues to offer any real planning help.
“The appeal of the advice component is that most people need it, but few are willing to pay for it,” says Steve Patterson, vice president of Charles Schwab’s defined contribution plan business. “Having help available will go a long way towards helping people make better decisions on how to save and invest.”
- Pension solvency
A key focus in the reforms, the health of pension programs, is addressed in several ways. Specifically, employers generally have seven years to pony up enough cash to fully fund their obligations, and employers and unions can’t promise higher benefits when a pension is underfunded. Top executives of firms that have failed to properly fund their plans can kiss off any special golden parachutes.
While the act gives peace of mind to workers and retirees looking at underfunded pension plans, it also gives corporations a reason to freeze or eliminate plans, making future generations more reliant on their own savings.
In the more-distant past, retirement security was predicated on a combination of pension plans plus Social Security and personal savings. When 401(k) and other defined-contribution plans came into being, the assumption changed so that this kind of retirement savings would be for do-it-yourselfers, folks who would not only enroll in the plans but manage the money actively themselves.
The difference was crucial: When pension plans ruled the day, the thought was that people wanted someone to have the responsibility for setting them up for the future. With the advent of the 401(k), the idea was that people wanted to take care of themselves.
That’s where those statistics about participation come in.
What the Pension Protection Act does, effectively, is turn around the basic underpinnings of the system. The idea, now, is that even in the world of 401(k) plans employees want someone to do this retirement stuff on their behalf. That’s why the employer is empowered to save—even if the worker doesn’t actively seek it out—to increase the contributions, to manage the money appropriately and to provide financial help.
“There are three things people need to do to make a 401(k) plan work,” says Jeff Maggioncalda, president of Financial Engines, a Palo Alto, Calif.-based investment advisory firm. “They must enroll, save and invest. And if you don’t do those three things well —and most people don’t seem do be doing them all that well—you won’t get the benefit needed for retirement. This law tries to solve those problems.”
Consider the future landscape, as laid out by the new law.
Someone joins a company, and is enrolled automatically in the retirement plan. The worker doesn’t bother to take an active role and, yet, the longer they work, the more money they pile up.
Says Maggioncalda: “It’s going to feel a lot like the old pension plans, because 20 years from now, you’ll wind up with a lot of money to use in retirement.”
It will feel even more like a pension if consumers follow up with one other big change in the reforms. Among the many provisions of the pension-reform act is clarification of the “safest available annuity” standard. This is expected to encourage employers to offer an annuity distribution option from 401(k) and other retirement plans.
That means that when someone reaches retirement, they’ll have a choice to put the money they’ve accumulated to work buying an annuity, which would make them regular payments for life.
That’s the primary benefit that previous generations sought from their pensions.
“More people, as they retire, need -- or want -- some form of guaranteed income stream, so having that choice in a plan will be very important in the future,” says Mark Thresher, president of Nationwide Financial, the largest 401(k) provider in the U.S.
“Rather than saying ‘I have 200 grand in my 401(k) account, now what do I do?’ people will be able to choose an income stream that could help make sure they are set up better for the rest of their life. ... Consumers will have a lot of choices, but even if they don’t make any choice—other than to stay in the plan—chances are they will wind up looking at a better retirement.”
Chuck Jaffe is a senior MarketWatch columnist. His work appears in dozens of U.S. newspapers.
© 2006 Inside Tucson Business. All Rights Reserved
Comments