The shift is on

By Don Kuehn

In August, the so-called Pension Protection Act (PPA) was enacted to strengthen funding of traditional private sector defined-benefit plans (the kind our parents and grandparents earned after years of hard work for the same company), to shore up the deficit-riddled federal pension insurance system and to improve participation in defined-contribution plans.

Well, welcome to the land of unintended consequences.

The law sets up so many new rules, reporting requirements and funding demands that experts expect many companies—which kept faith with their employees through tough, competitive times—may now find the new demands so daunting that they shuck it all and drop their pension plans altogether.

The number of workers covered by nongovernmental pension plans has declined by 73 percent over the past 20 years, to about 40 million, according to the Pension Benefit Guaranty Corp. (PBGC).

In recent years, large corporations (particularly airlines) have frozen their plans—halting further contributions, tried to buy employees out of plans, or totally abdicated their commitment to workers, leaving the PBGC to pick up the pieces.

Additional premium payments to the PBGC by companies with healthy traditional plans are included in the new law. But if more plans go out of business, fewer are left to pay premiums to the fund, which further reduces the percentage of earned benefits that can be paid to workers. Checks from the PBGC already are less than half of what workers expected.

The prospect of company (and some government-sponsored) pension plans biting the dust should sound alarms for every person who works for a living. If you intend to retire someday—and I mean if you have any dream of retiring—you’ve got to quit procrastinating.

The responsibility for accumulating enough money to fund workers’ retirement has shifted from employers to employees. You must catch the wave or your retirement dreams may crash.

One provision of the Pension Protection Act tweaks the rules for 401(k) and 403(b) defined-contribution (DC) plans. Here’s the shift: The employer’s responsibility in DC plans is limited to administering the plan and funding, or matching, employee contributions. The employee has the burden of investing the money in one or more options, from a menu of choices, to fund his or her own future retirement needs.

There are an estimated 53 million 25- to 64-year-old workers whose bosses offer some kind of retirement plan. But, sadly, only 52 percent of these workers participate in those plans. According to the Employee Benefit Research Institute, almost 40 percent of eligible workers over age 40 do not participate in 401(k) and 403(b) programs where they are available, they don’t contribute enough or they invest their proceeds too conservatively to fund a comfortable retirement.

At the end of 2005, the average 401(k) account balance of all participants, including highly paid executives, was just $58,328. The median account (half more, half less) was a paltry $19,398.

The PPA includes provisions that encourage employers to automatically enroll new employees into 401(k) and 403(b) plans (unless they opt out), increase their contribution rates when employees get raises and create default mechanisms into diversified investment portfolios. It also eases the rules that prohibited plan providers from offering investment advice to participants.

Some experts project that automatic sign-ups will boost the participation rate in DC plans to 90 percent. I am all for the idea of making enrollment as close to mandatory as possible, knowing all too well from my tenure as an AFT pension trustee that many people are paralyzed by the notion of stock market investing. They waste the opportunity to build their retirement future a little at a time. They seem stuck on the notion that if they don’t pick the exactly right investment vehicle, they stand to lose money.

Experts in the world of investing have, for years, advocated the notion that "slow and steady" wins the race to retirement and other financial goals. It’s not so much selecting the "just right" places to sock away your money, as it is to be a regular saver and investor.

Truth be told, we all run the risk of a stock market downturn. Geopolitical issues, macro economic trends and domestic bad news can all turn the markets for short periods of time. However, it’s more important to get in the market and stay in, through good times and bad, and take advantage of the concept of "dollar cost averaging" to build a portfolio of no-load mutual funds or individual stock securities.

I happen to agree with Peter Lynch, the former manager of the Fidelity Magellan mutual fund, who said he doesn’t know where the market will be tomorrow or next week, or even next year. But it’s a pretty sure bet that five or 10 years from now the markets will be higher—probably a lot higher than they are today.

So, your boss can now drag you (kicking and screaming) into participating in a company-sponsored retirement plan, but is that going to be enough? Probably not. Just as a traditional defined-benefit plan coupled with Social Security will not be enough to maintain a decent standard of living for most of us, just having a 401(k) or 403(b) and Social Security won’t cut it either.

With more and more of the burden for making retirement funding decisions shifting to employees, we all have to be prepared to take the additional step of setting up individual retirement accounts (IRAs), Roth IRAs and the like.

The PPA has made permanent the higher contribution rates for IRAs and employer-sponsored DC plans, which were set to expire after 2010. The limit for IRAs is currently $4,000 and is set to rise to $5,000 in 2008 (you can add another $1,000 if you are older than 50), but would have reverted to the original $2,000 in 2011 if no action had been taken.

For 401(k)-style plans, the limit is $15,000 ($16,000 in 2007) with special catch-up provisions allowing most workers over age 50 to contribute another $5,000 per year.

Critics note that higher contribution levels won’t help most low- to middle-income workers who, rightly or not, believe they can barely afford any contribution at all. But the new law also makes permanent special low- and middle-income tax credits on all or part of the first $2,000 of qualified retirement contributions. If not for the PPA, this provision would have expired in 2006.

One additional feature of the PPA makes permanent a new "hybrid" kind of retirement plan called a Roth 401(k) or Roth 403(b), which combines two features: the contribution of after-tax dollars and tax-free withdrawal after retirement (like a Roth IRA), and the security of a company-sponsored matching plan like a 401(k). The money in these accounts can be rolled over directly (and tax-free) into a Roth IRA at retirement, which means no mandatory withdrawals after age 70 ½.

So, while the new law might put more company pension plans out of business because of its "tough love" approach to funding traditional pension plans, it stabilizes several components of individual retirement investing that should lead to more workers taking responsibility for their own future.

It’s your money, and you want your retirement to last a very long time. But if you haven’t made adequate financial preparations it’s going to seem like an eternity.