(Bloomberg Businessweek) – Retirement security is ending the year on an all-time low. The $1.1 trillion last-minute spending bill will allow trustees to cut benefits in multi-employer defined benefit pension plans. And while it affects a relatively small population, 10 million people at most, it opens the door for other employers to make similar cuts.
Maybe that’s a long way off; maybe not. But the provision is a rude awakening: we may romanticize guaranteed retirement benefits and lament our 401(k) world, but pensions aren’t safe these days either.
Until recently, a pension benefit seemed as good as money in the bank. Companies or governments set aside money for employees’ retirements; they were on the hook for funding the promised benefits appropriately.
In recent years, it has become clear that most pension plans are falling short, but accrued benefits normally aren’t cut unless the plan, or employer, is on the verge of bankruptcy — high-profile examples include airline and steel companies. Public pension benefits appear even safer, because they are guaranteed by state constitutions.
By comparison, 401(k) and other defined contribution plans seem much less reliable. They require employees to decide, individually, to set aside money for retirement and then to invest it appropriately over the course of 30 or so years.
Research suggests that people are remarkably bad at both:about 20 percent of eligible employees don’t participate in their 401(k) plan. Those who do save too little and many choose investments that under-perform the market, charge high investment fees, or both.
It turns out pension plan sponsors, and the politicians who oversee them, are just as fallible as workaday employees. We all prefer to spend more today and deal with the future when it comes.
Pension plans have done this for years by promising generous benefits without a clear plan to pay for them. When pressed, they may simply raise their performance expectations or choose more risky investments in search of higher returns.
Neither is a legitimate solution. In theory, regulators should keep pension plan sponsors in check. In practice, the rules regulators must enforce tend to indulge, or even encourage, risky behavior.
Because pension plans seem so dependable, workers do in fact depend on them and save less outside of their plans. According to the 2013 Survey of Consumer Finances, people between 55 and 65 with pensions have, on average, $60,000 in financial assets. Households with other kinds of retirement savings accounts have $160,000. It’s true that defined benefit pensions are worth more than the difference, but not if the benefit is cut.
As the new legislation makes clear, pension plans can only kick the can down the road for so long. Defined contribution plans have their problems, but there has been a tremendous effort made to educate workers about the importance of participating.
(Even if the education campaign has been the product of asset managers who make money when more people participate, it’s still valuable.) Almost half of 401(k) plans now automatically enroll employees, which has increased participation and encouraged investment in low-cost index funds. And now it looks like a generous 401(k) plan with sensible, low-cost investment options may turn out to be less risky than a poorly managed pension plan, not least of all because workers know exactly what the risks are.