Honey, I Shrunk the 401(k)

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

The review compared performance of the mandatory defined contribution plan with the state’s defined benefit plan (for state troopers, teachers, and judges). “The DC plan fell short of the DB plan in replacing worker wages at retirement,” says Anna Sullivan, director of public employee retirement systems for the state of Nebraska. “The conclusion was that people were not as well equipped as a professional to make allocation decisions.” Fully 90 percent of defined contribution plan assets were in just 3 of the 11 investment options provided, one of which was the default stable-value fund.

The result was especially surprising, says Sullivan, because the state goes to extensive lengths to educate employees about investing, offering an all-day seminar taught by investment professionals and a toll-free help number. In addition, the state is very generous with its contributions: employees put in an average of 4.5 percent of their wages, and the state matches those contributions 150 percent. Still, says Sullivan, “people don’t understand the intricacies [of investing], nor are they removed enough to make good investing decisions and stick with them. They respond out of emotion and try to time the market.”

As a result of the review, Sullivan has added a hybrid plan (effective December 31) in which all contributions are pooled and managed by the same manager that currently handles the state’s defined benefit assets. The contribution rates for both employee and employer will remain the same, so the change will not cost the state any additional funds. However, payouts will be made in an annuity format, and employee accounts will earn a defined rate of return on the assets (based on the federal midterm rate plus 1.5 percent). “We’re obviously hoping to outperform the interest credit rate,” says Sullivan, and there is a possibility that if the fund performs well, “we could improve the benefit to include a percent-of-salary component.” Current employees will have a choice whether to enter the new plan, and new employees will be automatically enrolled.

Sullivan says the move is a “straightforward step” toward an eventual defined benefit plan for all employees. “I think there’s a place for a 401(k) as a supplement, but not as your base benefit,” she says. “The foundation of your benefit needs to have more security to protect you against major downturns.” —K.F.

The Rich Got Richer…

Huge gains by $1 million+ earners drove average wealth higher in preretirement families.
Sources: Edward Wolff; Economic Policy Institute

Households Headed by Person Aged 47 to 64: % Change 1983-1998

  • Average income 20.4%
  • Average net worth less DC pensions 11.7%
  • Average retirement wealth 4.0%
  • Average total wealth 8.4%

…The Middle Class Got Poorer

But wealth declined sharply in median-income preretirement families.

Households Headed by Person Aged 47 to 64: % Change 1983-1998

  • Median income 14.1%
  • Median net worth less DC pensions -16.8%
  • Median retirement wealth -11.0%
  • Median total wealth -16.7%

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