Whether you view it as a betrayal of workers or as an economic necessity, the traditional pension plan appears destined for extinction as more companies move to reduce their future financial obligations to retirees.
One can rail against the apparent hypocrisy that these decisions are made by well-paid executives with posh retirement benefits, of course. But digging deeper, some companies are being more responsible than others, sculpting pension alternatives to reduce the risk that future retirees won’t have enough savings.
As of last year, just 37 of the nation’s 100 largest companies were still offering a traditional pension plan for newly hired workers, down from 42 the previous year and 50 in 2002, according to Watson Wyatt Worldwide. Even the government is getting in on this act, as evidenced by the Department of Energy’s decision to tell contractors it will no longer pay for pensions for new hires.
Given that this trend is unlikely to reverse, the most obvious concern is money: Is the loss of pension benefits being offset with increased company contributions to 401(k) plans and other retirement alternatives?
Less apparent, but maybe more important, are some key nuances to how companies structure these pension alternatives: Are they adopting defaults that automatically enroll workers in a 401(k), automatically divert some salary into that account, and automatically allocate those savings to a logical investment?
Some companies are being more generous than others. International Business Machines Corp., for example, closed its traditional pension to new hires starting in 2005 and recently announced that those hired earlier will have their benefits frozen after 2007.
To compensate, the computer maker doubled the 401(k) matching contribution for recent hires, and will do the same for all workers starting in 2008, paying dollar for dollar on up to 6 percent of salary that an employee defers into the account.
More significantly, IBM is adding a lump sum contribution of up to 4 percent of salary regardless of whether an employee defers any pay into the 401(k). That means IBM’s share of a worker’s retirement savings could reach 10 percent of salary — or more than three times the rate typical of many 401(k) plans.
Verizon Communications Inc. also will be offering a guaranteed match of up to 6 percent of salary for 50,500 managers whose pension benefits will be frozen in July, plus an additional “performance-related” contribution of up to 3 percent contingent on the telephone company’s business results.
But despite the apparent similarities between the two companies, IBM has adopted a more progressive approach that addresses some of the inertia that workers exhibit when it comes to 401(k) plans.
For starters, IBM is automatically enrolling new hires in the 401(k) plan with a default contribution rate of 3 percent deducted from their pay. Further, the lump sum contribution for all workers won’t be contingent on IBM’s performance and will be granted even for those who choose not to defer any salary.
Taken together, these policies promise to force more IBM workers past the initial hurdle of merely signing up for a 401(k) plan. Research has shown repeatedly that employees who don’t participate in their 401(k) often intend to sign up, but never get around to it, sacrificing the “free” company match through this inactivity.
Verizon’s plan enhancements will be lost on those who don’t sign up on their own. This creates a vulnerability that some employees may not prepare for the new post-pension reality with greater retirement savings.
In a study of one large industrial company that switched to auto-enrollment, employee participation in the 401(k) jumped substantially under the new policy. Among new hires, just 5 percent opted out of the program, leaving 95 percent enrolled. Before the new policy, only about 75 percent enrolled voluntarily, according to the analysis by John Beshears and David Laibson of Harvard University, James J. Choi of Yale University, and Brigitte C. Madrian from University of Pennsylvania.
Two other differences between the IBM and Verizon plans that deserve attention are the default rate of 401(k) salary deductions and the default choice of investment for contributions.
Though better than nothing, IBM’s default 3 percent deduction is insufficient to maximize the company match of up to 6 percent. Naturally, employees are free to boost their salary deferral to 6 percent, but here again research has shown a human tendency toward inaction. Experts fear that a savings rate of 6 percent — 3 percent from salary and 3 percent from IBM’s match — may not produce a sufficient nest egg.
Likewise, experience suggests some employees may not move their savings away from the “stable value” mutual fund that IBM uses as the default investment for 401(k) contributions. Designed more for safety than growth, a stable value fund could prove far too conservative to provide adequate savings. Madrian says a better starting point would be a “lifestyle” fund geared toward a worker’s age. IBM, like many companies, is waiting to see if a pension reform bill in Congress will provide authorization to be less conservative.
Verizon pays all of its 401(k) match in company stock until age 50, at which point employees can allocate half to other investments. While stock is a common 401(k) option, a default like Verizon’s can put too much money at risk in one vehicle. There may be little danger of the disastrous results this produced for Enron and Worldcom employees, but the shares of both IBM and Verizon have been money-losers in recent years.
Like those who criticize social security, some argue that any default 401(k) enrollment and deduction is a paternalistic intrusion on a person’s privacy. But judging from the long-ago sacrifices in pay that were required to win hearty pensions, it’s fair to say that preference for a secure future persists, as does a company’s duty to help.