On a recent flight home to Washington, D.C., from a conference in Tucson, Arizona, Dallas Salisbury, president of the Employee Benefit Research Institute, struck up a conversation with his seatmate on the subject of life expectancy. The fellow passenger, a man in his early 60s, had already retired and said he expected to live into his 80s.
Salisbury asked what he would do if he lived into his 90s. The man replied that if his retirement savings dried up he could always move in with his children.
"When I asked him if he had ever talked to his children about moving in with them, he said, ‘Well, no,’ " Salisbury says.
The conversation exemplifies the challenges facing companies that provide retirement plans, Salisbury says. People are living longer, and Social Security and the traditional pension system no longer guarantee that those who retire at 65 will live comfortably.
"Most everyone spends money on the assumption that they don’t have much life left," he says. "Then they end up living much longer than they had thought. My daddy is 91 and lives on Social Security and his defined-benefit plan. But everything else is gone."
Employers that offer 401(k) plans are navigating a minefield of liability issues around how much they can do to help employees save enough for retirement—without being held liable if workers don’t have enough when they retire, Salisbury says. Many 401(k) plan providers worry that if they automatically enroll employees into their plans, participants who claim that they didn’t choose their investments may sue them. On the other hand, employers are concerned that if they don’t do anything, they will be held accountable if employees don’t have enough savings to retire.
The trend of people living longer has created its own set of headaches for companies that still offer traditional defined-benefit plans, Salisbury says. Many of these companies are freezing their pension plans because they can’t afford them anymore or are declaring bankruptcy. "Companies are looking at their domestic and global competition and asking what are the implications of continuing to offer a defined-benefit plan," Salisbury says. "After looking at the cost structure and pricing, they are questioning if they can maintain it."
As 401(k) plans become the retirement savings vehicle of choice for employers, politicians on Capitol Hill are looking to take the best features from defined-benefit plans and 401(k) plans and meld them together.
"With the defined-benefit plan, everyone participates," Salisbury says. "With the defined-contribution plan, the employee chooses to participate and selects the investment options. The question policymakers are looking at now is ‘How can we mimic the best features of the traditional defined-benefit plan while still honoring individual choice?’ "
A few of the proposals would allow 401(k) providers to automatically enroll employees in their plans and automatically increase their contributions on an annual basis without fear of being sued. Another set of proposals being discussed would provide companies that want to continue to offer defined-benefit plans with a new type of hybrid pension plan that would limit an organization’s risk while offering employees the same level of guarantees.
"At a time when there is such division between political parties and ideologies, people have been willing to let their hair down and work toward some common ground," says Karen Friedman, policy director of the Pension Rights Center, a Washington-based consumer advocacy group.
Some good news is welcome. Defined-benefit plan providers are bracing for sweeping pension funding reform to address the $23.3 billion deficit at the Pension Benefit Guaranty Corp. If passed, the reform could result in an increase in premiums and make it harder for companies to keep their plans intact.
Jim Rich, chief investment strategist at IBM Retirement Funds, decided to begin automatically enrolling employees into IBM’s 401(k) plan last year after the company closed its cash-balance plan. Rich knew there was the possibility that employees might view the move as IBM being too much like Big Brother, but he says it was more important that the employees took advantage of IBM’s new 6 percent employer match. Also, he says, employees can always opt out of the automatic enrollment feature.
In a 2005 Hewitt Associates report, 59 percent of plan sponsors said they want to implement automatic enrollment in their defined-contribution plans. But many companies, like IBM, are worried about being viewed as too paternalistic by employees. An even greater concern, however, is which funds companies will choose for the employees’ automatic enrollment, employers say.
On that question, employers tend to fall into two camps. Some, like IBM, have chosen a conservative stable-value fund as the default. These funds are considered a safe choice but won’t outpace inflation in the long run, making it hard for an employee to have enough savings to retire.
"That’s the Catch-22 for employers," says Vanessa Scott, legislative counsel at the ERISA Industry Committee, a trade association representing large employers. Either way, employers run the risk of employees coming back in 30 years and suing them for choosing the wrong investments.
"We need guidance on what would be the most acceptable investments as the default," says Bob Kleckner, manager of savings plan administration at Alcoa. "It makes plan sponsors uncomfortable to go ahead and automatically enroll employees into a 401(k) plan even if they are doing the right thing for employees." For now, Alcoa has decided against offering automatic enrollment.
But a few proposals that have been introduced may address the fears of Kleckner and other 401(k) plan sponsors. Rep. Rahm Emanuel, D-Illinois, Sen. Jeff Bingaman, D-New Mexico, Rep. Benjamin Cardin, D-Maryland, and former Rep. Robert Portman, R-Ohio, have each come out with proposals that would provide safe harbors from fiduciary liability to companies that automatically enroll employees in their 401(k) plans and automatically increase their contribution rates each year.
Each of the proposals asks the Department of Labor to clarify that investments like lifecycle funds and balanced funds are appropriate default options. If such a proposal goes through, many more employers will offer automatic enrollment, says Laurel Cochennet, a retirement consultant at Mercer Human Resource Consulting.
The details of each of the proposals vary, but the goal of allowing employers to offer automatic 401(k)s remains the same. Some lobbyist groups would like safe harbors to include annuity options so that employers could ensure that workers have enough after they leave their jobs.
"I think there are going to be around seven or eight bills ultimately," says David Wray, president of the Profit Sharing/401(k) Council of America, which is working on its own proposal.
"The fact that people are haggling over the details is a sign that that things are moving forward," says Alicia Munnell, director of the Center for Retirement Research at Boston College. "Everyone is for the general idea, and they are just working over the details."
The Conversation on Coverage, a project created by the Pension Rights Center in 2001, has been working on a number of possibilities for a type of hybrid pension plan that would apply some of the elements of a 401(k) plan to a defined-benefit plan. The members of the project, who are employers, lobbyists and executives at financial services companies, have been holding closed-door meetings for the past several months to try to come up with nonpartisan proposals that could gain traction on Capitol Hill, Friedman says.
The Conversation on Coverage wants to revive defined-benefit plans specifically because the group does not believe that 401(k) plans are the panacea that many believe them to be, she says.
"As we have an increasing number of individual 401(k) accounts, the bigger policy question is: Can 401(k) plans alone do the trick in terms of providing adequate income to employees?" Friedman says. "When you look at the average 401(k) account size, the answer is probably not."
Among the proposals that the Conversation on Coverage is developing is the Guaranteed Annuity Plan, an employer-funded defined-contribution plan by which the employer guarantees the rate of return on account balances of workers. The plan would be financed by the employer through regular contributions based on the percentage of compensation of each worker.
There would be a minimum guaranteed rate of return, but the details are still being worked out. At retirement or when employees leave their jobs, they would have the option of receiving a lump sum or rolling their assets over into an annuity.
Another concept, the Plain Old Pension Plan, is a variation on the traditional defined-benefit plan. It would start with a low guaranteed benefit that employers can increase in any year and reduce back to the minimum in future years, making employers’ funding requirements more predictable.
The group hopes to formalize some proposals during the next 12 to 18 months.
As the baby boomers retire, many employers say that traditional defined-benefit plans will come back in vogue as a way of attracting and retaining older workers. Creating a new type of retirement plan that combines defined-contribution and defined-benefit plans is necessary, Friedman says. "There is recognition among our working groups that having a hybrid plan is a good idea," she says.
Just the fact that conversations between both political parties are going on is a good sign for employers, says Sylvester Schieber, vice president and director of U.S. benefits consulting at Watson Wyatt Worldwide. "Ultimately, we will reach some decision that will move us forward," he says. "But first we must find the easiest path to begin with."
Workforce Management, August 2005, pp. 49-51 --Subscribe Now!