Reassess Retirement Plans -- Before It's Too Late
These days, 401(k)s represent the largest pool of money invested in capital markets -- more than $1 trillion by some estimates. Many employees invest only in 401(k)s, and a bad market skid can spin terrifying visions of flamed-out retirement accounts. Prior to mid-August, many Maxsys 401(k) participants had never experienced a market loss; what those who left the line sought from human resources was assurance their money was still safe. And make no mistake -- they wanted assurances.
To these workers and others, a tumbling market seemed about as safe a bet as shooting dice on a craps table, which doesn’t make the job of addressing employees’ concerns easy for human resources professionals. Employees at Maxsys, for example, can choose among 35 mutual funds, with investment strategies ranging from boldly aggressive to stolidly conservative. To encourage employee participation, the company offers a 25 percent match on the first 6 percent invested. “And still,” says Karla Worsdell, director of human resources for Maxsys, “most people have a real lack of understanding as to how the stock market affects their 401(k) funds. The best we can do as a company is make sure they understand their investment choices and the risks associated with those choices.”
The Dow can knock out a lot more than just Ks.
Hewitt Associates, a Lincolnshire, Illinois firm that tracks the daily transfer activity of 1.4 million 401(k)-plan participants, found little evidence during the August Dow dive of widespread panic among 401(k) investors. Although there was “significant movement” in 401(k) trading -- about five times more than usual -- the higher trading volume was still less than 1 percent of total 401(k) assets, says Stacy Schaus, Hewitt’s 401(k) investment consultant. “We don’t want to send the message that it was a panic level, because it wasn’t,” she stresses. “We’re talking about a very small percentage of the population.”
Yet 401(k) participants everywhere unfolded third-quarter statements showing average declines of 15 percent. An employee who in July had $30,000 in his retirement fund was left with $25,500. It was a shocking reminder, for the first time in years, that stocks can go down as well as up.
Of course, 401(k)s weren’t the only investment vehicles affected by the downturn. Across the North American continent, employees with company stock options and employers who offer traditional pension plans were knocked about, as well.
Stock options increasingly qualify as an important perk in the compensation packages of many employees, regardless of where they stand on the corporate ladder. The last 10 years have seen a definite trend toward “employee ownership” wherein employers use company stock options to reward and retain key employees, says Susan H. Marcille, partner in Ernst & Young Human Resources Consulting Group in Atlanta, Georgia. Many companies actually require that a certain percentage of an employee’s retirement assets be invested in company stock. Coca-Cola and BankAmerica are just two examples of companies which seem relatively at ease about stuffing their 401(k)s with their own stock. But even established companies can experience stretches of poor stock performance.
Employees who gamble their retirement on the good fortune of a single company probably risk too much, says Robert Pennington, retirement instructor and pension specialist at the College for Financial Planning, Inc. “It’s risky in any portfolio to depend too heavily on a single asset. In the case of a retirement plan, it’s doubly risky if that asset is company stock because if the company experiences financial difficulties, employees could find both their jobs and their retirement plans wiped out. Employers would be wise to take more precautions on their employees’ behalf.”
Otherwise, guess who they’re going to blame?
According to the Employee Benefit Research Institute in Washington, D.C., companies have an average of 20 percent of their 401(k) plan assets invested in company stock. Employees who had cheerfully rallied behind the company banner when their stock rose steady and high can quickly turn sullen and resentful if the market takes a nose-dive. The fear and paranoia sometimes engendered by sustained stock drops can cause workers to explore other employment opportunities, particularly if stock losses cause the employer to become more cautious in expansion, or even inaugurate layoffs.
And then there are traditional pension plans, also known as defined benefit plans. Although the 401(k) and other defined contribution plans are growing at a rate of 12.5 percent a year, defined benefit plans still account for 65 percent of all employer-based pension and retirement assets, according to the Spectrem Group, a San Francisco, California-based financial-services consulting firm.
Under a defined benefit plan, an employer agrees to pay specific benefits to an employee upon retirement. Benefits are typically determined by a formula based on years of service and pay level at retirement. Employees do not make contributions under these plans, and no individual accounts are maintained. Instead, employers contribute to a trust fund amounts that are necessary to provide the benefits specified. Under these plans, when the Dow drops 740 points in one week like it did this past August, the only one hurt is the employer, who still bears the risk for providing the guaranteed level of benefits.
Yet strangely enough, these particular benefit plans have a reputation for being “complicated and hard to understand by your average employee,” says Andy Stratton, principal with the Atlanta, Georgia-based employee-benefits firm Buck Consultants Inc. “Most plans are funded well, and on an ongoing basis. But when the market drops, employers at the very least need to reassure everyone working for the company that their retirement funds are safe.”
Hope for the best, prepare for the worst.
Since capital management companies and individual investment “wizards” can’t accurately predict the stock market, human resources specialists can hardly be expected to do better. But while some employees will understand that the gains of past years will cushion the impact of a down market, others may blame evaporating investments on their employers, says one senior retirement consultant with a global management firm.
According to a survey released by William M. Mercer, a New York human resources consulting firm, a dramatic market downturn could erode employees’ confidence and leave many employers scrambling to deal with a lot more than just hurt feelings. More than half -- 52 percent -- of the 209 employers surveyed have no plans to communicate with employees in the event of a market crash.
These same employers hadn’t bothered to discover whether plan vendors were prepared to provide employees with information or service. The great majority of the remaining employers have only informal plans to communicate with their employees, or simply expected plan vendors to do the hand-holding. And only 3 percent of all employers surveyed had formal plans in place to counsel their employees in the event of a market meltdown.
Nearly a third of Mercer survey respondents offer their own company stock as an investment option within their 401(k)s. Of those, 2 percent said that more than 50 percent of plan assets were invested in company stock; 7 in 10 of those employers do not address the issue of a sharp downturn or severe share-price volatility. Yet how you deal with these issues and others may well have an impact on your own company, as well as an impact on the golden years of your employees.
“Look, no one’s expecting a company to predict when the Asia stock market will fall, but it’s one of those events that usually triggers finger-pointing within an organization,” says Brian C. Ternoey, principal for William M. Mercer. “No one can predict the market, but you can demonstrate responsible planning by monitoring the prospects for retirement security for your employees.”
HR shoulders the responsibility.
Though the U.S. economy seems strong for now, nobody seems sure what to expect next. The recent stock market losses to employees everywhere could have been huge. It’s certainly possible the ever-climbing market of recent years may not soon return, so now is an appropriate time to reassess your company’s pension offerings and employee educational programs. If stock prices continue to fall, it could take as long as a decade or more to recover; many employees near retirement could be destroyed.
The responsibility for choosing company investments that are offered to employees almost always rests with human resources personnel. So, to begin with, consider meeting with current service providers to review and update original company objectives. Identify and rank these objectives -- increasing employee participation, adding investment options and so on. Determine, too, whether plan vendors are prepared to provide employees with information and services in the event of a market cataclysm.
Revisit -- and if necessary, realign -- company policy with the U.S. Department of Labor ERISA 404(c) guidelines established in 1994: Offer diversified investment options, each with different risk and rewards; allow employees to change their investment allocations at least once each quarter; provide educational material so employees understand their investment options and can make informed decisions.
Also recall that effective January 1, 1999, the Taxpayer Relief Act (of 1977) forbids companies from forcing employees to put more than 10 percent of their 401(k) plan funds in company stock or assets. However, the new law does not apply to the employer’s matching contributions or if plan participants have discretion in how their assets are invested. “Many times, employees aren’t even aware of the need to diversify their own investments,” says Lynn Dudley, vice president for retirement policy at the Association of Private Pension and Welfare Plans in Washington, D.C. “This law helps protect employees against companies who direct all pre-tax money in company stock.”
And don’t forget that traditional pension plans already are required by federal regulations to diversify their investments. Specifically, plans may not invest more than 10 percent of assets in company stock or company-owned real estates.
Of course, being compliant doesn’t “completely resolve you of fiduciary claim,” says Kevin Wagner, senior retirement consultant at Watson Wyatt Worldwide, a global management consulting firm in Southfield, Michigan. “Even if you follow all the requirements of ERISA section 404(c), for example, you must still prudently select and monitor all investments. If you don’t, an employee may turn around and sue you because you gave him inappropriate choices.” So in other words, play it safe.
Employee education should begin with an intensive audit to gauge current communications techniques and to research their needs and concerns. According to the international consulting and actuarial firm Towers Perrin based in New York City, 39 percent of all 401(k) participants say they don’t even know how their savings plan assets are allocated. Even when employees have the choice of other investment options, they tend to go for what they know. Indeed, the findings suggest that many employees are operating in the dark when it comes to investing money. Yet respondents who say they’ve had assistance in retirement planning from employers are more likely to be planning and saving.
This means your job as an HR manager is not an easy one, since the number of options available at today’s companies averages about 10. “People want to be able to diversify more broadly,” explains Hewitt investment consultant Schaus. Just like the investment textbook says, the more your employees diversify, the more they’re protected from market swoons.
Schaus recommends employers advise employees of both the benefits, as well as the unique risks, of their retirement plans. And if you’re the one who makes the investment decisions for your company, carefully monitor your investments selections. If one gets too risky, remove it as an option.
Compaq Computer Corp., working with mutual-fund giant Vanguard Group, developed a 401(k) intranet to make its retirement plan more accessible to employees. Other companies use videos and seminars to educate employees. Roughly 80 percent of the companies researched by the Spectrem Group offer daily valuations of 401(k)s. The paradox, of course, to better communication with employees and better financial planning, is there’s an increase in company pension expenses.
In mid-September, Maxsys human resources director Worsdell brought in Steven Lathrop, a certified financial planner from Newport Beach, California, to address the company’s agitated employees. If nothing else, everyone learned to recognize the types of risks that are “inherent in all investments,” says Lathrop. “All company pension plans should have a wide selection of stock market offerings, each representing a different style of investment. By giving your employees more options, you mitigate any concerns they may have later and you lower your company’s fiduciary liabilities.”
Of course, Maxsys already offered 35 investment choices, including a few European international funds. “Some people are savvy and monitor it all the time,” says Maxsys’ HR director Worsdell. “Others feel they’ll never have enough money. It’s all they can do to pay their bills, let alone save for retirement. Still, others are risk-takers, and they don’t care. I’m comfortable with what I picked for our company, and I’m not too worried about the cycles. It’s something out of most people’s control, anyway.”
To be sure, this may not be a satisfying conclusion for most of you out there, but at least there’s still time to make a few changes before it’s too late.
Workforce, December 1998, Vol. 77, No. 12, pp. 100-104.