From the November 2008 issue of Investment Advisor • Subscribe!

401(k)s in Crisis

The financial meltdown has taken its toll on Americans' nest eggs

Since the financial meltdown took hold, one thing is certain: investors' 401(k) accounts have dropped. The retirement planning industry, along with Congress, is trying to get a handle on just how significant the crisis has been on defined contribution and defined benefit plans.

Jack VanDerhei, research director for the Employee Benefits Research Institute (EBRI), told the House Education and Labor Committee in testimony October 7 that it's "impossible" to quantify how the financial crisis has affected DB plans, but it is "obvious that a marked reduction in funding ratios and/or increase in volatility may make continued sponsorship of these plans less attractive under some forms of pension accounting modifications." What's more, he said, the Pension Protection Act of 2006 (PPA) "has established specific restrictions with respect to freezing of accruals, plan amendments, and lump-sum distributions as a function of funding ratios." He cited recent estimates from Watson Wyatt, which projected that pension plans would be 84% funded as of September 24, down from 91% in the second quarter.

More is known, however, VanDerhei said, about the impact the financial crisis has had on DC plans, primarily 401(k) participants. While older employees have devoted less of their portfolios to equities than younger employees--which makes people assume that older workers are less vulnerable to downturns in the equity markets--older workers' "average account balances are significantly larger and therefore have more to lose in a significant downturn," he said. VanDerhei also cited recent research from Fidelity, which found that participants did not increase their borrowings from 401(k) accounts in 2007 and the first half of 2008. However, Fidelity found that hardship withdrawals are on the rise in the first half of 2008 compared with the first half of 2007.

Losses From -7% to -11%

VanDerhei said EBRI took the most recent information in the EBRI/ICI 401(k) database (year-end 2006) and used employee-specific information as well as financial market indexes to estimate the percentage change in average account balances among the 2.2 million 401(k) participants present from year-end 1999 through year-end 2006, by age and tenure. For the first nine months of 2008, he said, "the percentage loss in average account balances among 401(k) participants in the consistent sample varies from a low of -7.2% for the oldest cohort (age 56-65 in 2006) with the shortest tenure with the 401(k) sponsor (six to 10 years in 2006), to a high of -11.2% for the youngest cohort with 21-30 years of tenure." The reason that this particular group has the lowest average loss, he said, "is a function of the reduced equity exposure they take (on average), as well as the larger ratio of contributions to account balance given their relatively short tenure."

The group with the largest average loss, he continued, are "those young enough to still have a relatively large equity exposure in their accounts, compared with the others in the long-tenure cohort."

NAVA, the Association of Insured Retirement Solutions, took a poll of 300 insurance professionals in early October on the nation's economy and financial markets. The poll was conducted via instant electronic polling during NAVA's annual meeting and found that when it came to their personal retirement strategies, 77% of respondents said they are "staying the course with their established long-term plans, rather than making significant near-term adjustments." The poll also found that 65% believe that investor confidence is either "flat or falling," while 99% said that most retirement-minded Americans would take action to address the financial crisis by either moving money into "safer" investments, become more risk averse, avoid equity-based financial products, and may even resort to "stashing their savings under the mattresses."

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