Honey, I Shrunk the 401(k)

The bear market has clobbered 401(k) accounts, and it could spark a revival of defined benefit plans.

This reduction in total retirement contributions, say some observers, is not just an outcome of moving to 401(k)s, but also a consequence of soaring health-care costs. “[A chief] factor was that the price of health care was using up dollars that were allocated for benefits,” says Daniel Houston, senior vice president at Principal Financial Group. In smaller companies in competitive industries, cuts have to come from somewhere, and cutting health care can incite even more worker ire than cutting retirement benefits.

Meanwhile, experts claim that employees have generally placed a low value on defined benefit plans. Unlike the user-friendly 401(k), defined benefit plans don’t usually come with personalized quarterly account statements displaying a “personal rate of return” on page one. Employees can’t watch their nest egg grow online, in near-real time. Defined benefit plans have traditionally existed out of sight, somewhere in the corporate finance department.

Underperformers

No longer. With the end of the bull market and the implosion of Enron, employees have realized that their hard-earned savings can dwindle, if not disappear, in a 401(k). New studies have shown that 401(k) plans are underperforming the market and coming nowhere near to replacing preretirement income for most employees.

The problem is exacerbated by employees’ general lack of investment knowledge. A recent survey of defined contribution plan participants by John Hancock Financial Services found that 40 percent of respondents say they have little or no investment knowledge. Fifty percent say they don’t have time to manage their investments. “Human nature may be the Achilles’ heel of the 401(k) system,” says survey author Wayne Gates, general director of market research and development at John Hancock.

The end result of the shift to 401(k) plans is that employees have considerably less money to retire on today than they had 20 years ago, according to research conducted by Edward N. Wolff, an economics professor at New York University, and the Economic Policy Institute, a Washington, D.C.-based think tank. A recent study by Wolff shows that retirement wealth (defined benefit and defined contribution benefits plus Social Security benefits) for the median (or most typical) household headed by a person aged 47 to 64 declined by 11 percent from 1983 to 1998 — despite an increase in the Dow Jones Industrial Average of more than 730 percent. Only households in that age group with more than $1 million in preretirement income saw an increase in total retirement wealth.

In addition, the percentage of households approaching retirement that would be unable to replace half of their preretirement income rose from 29.9 percent in 1989 to 42.5 percent in 1998, according to Wolff. (Studies indicate that in order to maintain their preretirement standard of living, retirees need to replace 75 percent of their preretirement income.)

Bang for the Buck

Given the new information about 401(k) plan effectiveness, or lack thereof, as a retirement vehicle, some corporations are reevaluating the best way to get the most bang for their retirement-plan buck while meeting the needs of a mobile workforce.

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