The recession will end, the economy will recover, and the aftershocks will subside. But it may take longer to repair fractures in some long-held assumptions about investing and planning for retirement.
Not long ago, employers were lamenting the drain on workplace knowledge that could result from the Baby Boomers’ approaching departure. In fact, many employers were looking for ways to keep older workers in their jobs.
Consider American Electric Power (AEP), a Columbus, Ohio-based utility. "We have a large demographic that is eligible to retire, so our concern has been how we are going to maintain the bench strength to replace those people," says Curt Cooper, director of employee benefits.
But as a result of economic realities, the company’s concerns about losing experienced employees are far less pressing. The company offers a traditional defined benefit pension plan, with payments based on either an average pay formula or a hybrid cash balance formula—whichever provides the retiree a richer benefit. Despite that secure prospect, at least some older AEP employees are postponing retirement for the immediate future, Cooper says. And it’s easy to see why: In the recession, many workers have seen their retirement assets shrink by 30 percent to 40 percent or more.
Even workers who were not heavily invested in equities when the stock market began to sink may want to continue working. "They may decide that giving up a paycheck right now is not desirable," says Dallas Salisbury, president and chief executive officer of the Employee Benefit Research Institute (EBRI), in Washington, D.C.
In survey results released during March, 60 percent of workers over 60 said they’re postponing retirement because of the recession’s impact on their savings. The online survey of more than 8,000 workers was conducted late last year by Harris Interactive for the recruiting company CareerBuilder. Eleven percent of the over-60 workers whose retirement plans are on hold said they may never be able to afford to retire. About 20 percent said it will take them an extra five or six years on the job to rebuild retirement savings, and about
24 percent said it will take a year or two.
Moreover, as employees see prospects dimming for affordable retirement, more may request—and more employers may approve—retirement in stepped-down phases over several years.
Phased retirement is just one possible retirement system change that experts say could emerge from the current financial crisis. Others include greater use of so-called hybrid or cash balance retirement plans; they could provide insulation from stock market swings that can whipsaw 401(k) accounts. In fact, some critics contend that 401(k) accounts’ vulnerability to turbulence in the markets is a fundamental flaw in their design.
To help employees avoid the effects of volatility in investment markets, employers are expected to increase their ongoing efforts to adopt more automatic management features for their plans and offer employees more financial management education, including education on how to preserve 401(k)s’ value as retirement approaches.
Some critics contend that the 401(k) approach to saving for retirement exerts pressure on participants to maximize funds by opting for riskier equities—even during periods when the wiser course would be to move to more-conservative investments.
In addition, some say, employees’ confidence in the reliability of 401(k)s for funding retirement is not shorn up when employers, looking for ways to trim expenses, reduce their matches of employees’ contributions.
Whether employers may be unintentionally adding to employees’ concerns is debatable, but it’s widely agreed that employers, through their benefits specialists, must help employees make the most of their 401(k)s and other tools for funding retirement. It is, in short, part of HR professionals’ fiduciary responsibilities to help employees be knowledgeable about making retirement planning decisions.
The nation’s retirement system faces an uncertain future. The proverbial three-legged stool of retirement savings has never looked so wobbly. Individual debt-to-savings ratios are among the often-cited reasons for the current economic turmoil. Consumers have maxed out their credit and have little or no savings—one leg of the stool—for retirement or anything else.
Meanwhile, the leg representing employer-provided retirement plans has been undergoing a metamorphosis for years as traditional defined benefit pension plans continue to exit the stage and 401(k) plans take the spotlight. The trend of freezing defined benefit plans or closing them to new employees continues apace.
Gary Correia, 52, did everything right. He participated in his company’s 401(k) plan and contributed to get the maximum matching contribution. He saved and invested outside of the plan. And he planned to retire in about 10 years, expecting he could live off his 401(k) account, Social Security, and personal savings and investments.
"The economic morass has completely changed my outlook and plans for retirement," says Correia, vice president of finance for Taylor Guitars, a manufacturer with more than 600 employees, in El Cajon, Calif. "I can no longer accurately predict a retirement date."
Correia is not alone. Several friends and colleagues who had planned to retire next year have lost considerable amounts in their 401(k)s. As a result, their futures will be different from what they had planned. "Recovering or replacing these funds will not happen in the next few years, and they now must continue to work for several more years," he says.
In Correia’s view, there is definitely room for improvement in the system of saving for retirement. The system, he says, "is generally not adequate for most retirees. A more simplistic, open-ended retirement plan would be preferable."
The coming months and years may prove to be a referendum on whether the 401(k) plan has proved its worth as the nation’s primary retirement savings vehicle. These plans were easy to love when the rates of return on their investments were in double digits. Will they remain popular in a prolonged bear market?
Finally, the long-awaited reckoning for Social Security—the third leg—is still to come. Of course, the extent and nature of changes to Social Security—and who will be affected—remain to be seen. Says Adam Meyers, vice president with the Hay Group in Jersey City, N.J.: "There are likely to be some minor changes to Social Security, but it is not going anywhere. Nevertheless, people will still worry about it."
Still, any change to Social Security, no matter how small, will profoundly affect how people think about retirement. After all, 65 became embedded in the culture as the normal age for retirement simply because that was the normal retirement age designated by Social Security when it began in 1935.
The length and depth of this recession will have a profound impact on the retirement stool’s strength and on workers’ confidence in their ability to retire.
If the recession is relatively short-lived and followed by robust economic growth, the downturn could actually be a long-term boon for middle-aged and younger employees if they continue to accumulate assets in their 401(k) plans while stock prices are low, thereby reaping the gains when stocks recover.
But a severe and prolonged downturn could create negativity that feeds on itself and further hurts the retirement prospects of many workers. Laid-off employees could start using retirement assets to meet living expenses instead of rolling them into new retirement accounts. Even employees who don’t lose their jobs can make hardship withdrawals from their 401(k) plan assets under certain circumstances at considerable cost in taxes. Such actions leave workers with depleted retirement accounts to fuel asset growth in a turnaround.
In response to economic pressures, employers’ growing practice of suspending their matching contributions to employees’ 401(k) accounts adds to the uncertainties. Using an on-off switch for matching contributions—or even just considering its use—comes at a bad time for participants. "It’s one thing if the company is about to go under, but many organizations are not in that type of dire situation," says Alan Glickstein, a senior consultant with Watson Wyatt Worldwide in Dallas. "Employees will not be able to plan their retirement effectively if they don’t know if they will get a match or if they think that match could be readily turned on and off in the future."
Thus, when deciding whether to suspend matching contributions, experts suggest, employers should first consider the effect. It’s in their interest to do so because they have a great deal at stake in a healthy retirement system: If older workers—who tend to be expensive workers—decide they can’t afford to retire and don’t leave the workforce voluntarily, thus creating openings and opportunities for younger workers, employers face difficult and uncomfortable workforce management decisions.
Talent acquisition constitutes another factor, even in a recession. Suspending or reducing retirement plan contributions could have a long-term negative impact on the employer-employee relationship and repercussions for future talent acquisition and retention. Even if alienated key employees are unwilling to leave the company now, they could quickly do so when conditions improve.
"Cutbacks in retirement benefits aren’t a good idea unless the company has serious financial problems," says Meyers. "You need the match to encourage employees to save." A company that simply cannot afford to continue matching contributions, he says, should consider making discretionary contributions tied to the organization’s financial success.
Before suspending 401(k) matching contributions, an employer should look for savings in other areas, agrees Barb Marder, a Baltimore-based global defined contribution plan consultant at Mercer, an HR services consultancy. For example, now is a good time to benchmark plan fees, including recordkeeping and investment fees, to seek potential savings.
Although a growing number of employers have instituted automatic enrollment and default investment choices for their 401(k) plans—two of the features of the so-called autopilot structure for
401(k)s—employees will continue to play a vital role in their own retirement planning, barring major changes to the retirement landscape. Therefore, one of the best steps that employers can take is to help retirement plan participants maintain or rebuild confidence in their ability to plan and invest for their own retirement. The sharp reductions in 401(k) account balances notwithstanding, employees should be encouraged to be diligent in overseeing retirement assets. Ultimately, they are responsible for the financial outcomes of their 401(k)s.
"Our employees are the cornerstone of the company," says Jennifer Mann, vice president of human resources at SAS Institute Inc., a software company in Cary, N.C. "We need to help them feel secure and well-prepared for their future."
For most companies, helping employees feel prepared for the future means continuing and enhancing financial education efforts to help them through times of uncertainty and to enable them to figure out how current conditions will affect their retirement plans.
If there is a lesson to be learned from the decline in the financial markets—and the hit that many plan participants took—it will be about the need to avoid inertia and maintain an age-appropriate level of risk in retirement investing.
According to the 401(k) database maintained jointly by EBRI and the Investment Company Institute, nearly 25 percent of retirement plan participants ages 56 to 65 had more than 90 percent of their account balances invested in equities at the end of 2007, before the sharp stock market declines that began last year.
In addition, two-fifths of those participants had more than 70 percent of their assets invested in equities. The resulting equity losses have been particularly devastating for the retirement expectations of these older individuals who simply may not have enough time to wait for assets to recover.
The number of companies announcing plans to suspend 401(k) matching contributions began to increase significantly last December and more than tripled in February, according to the Pension Rights Center, a consumer organization in Washington, D.C., that tracks news reports of such actions. Separately, in a survey of 245 large employers conducted by Watson Wyatt Worldwide in February, 12 percent of the companies that responded said they expect to reduce contributions to 401(k) or 403(b) plans. This is up from the 4 percent that said they expected to make such reductions when the same survey questions were asked in October 2008.
During the years of strong stock market performance, it seemed to make sense to have some exposure to equities to drive asset growth. That strategy clearly backfired on many older workers. "The Baby Boomers got caught up in it and underestimated the risks" of large equity exposure, says Olivia Mitchell, executive director of the Pension Research Council and director of the Boettner Center for Pensions and Retirement Research in Philadelphia.
There is now evidence that plan participants are moving their assets to more conservative investment options, including money market funds and stable value funds—low-risk funds usually containing high-quality bonds as well as contracts whose net asset values are guaranteed to remain stable for a given period. AEP’s Cooper notes that although most employees are staying the course with 401(k) plans, there has been a 3 percent to 5 percent increase in investments in stable value options within AEP’s 401(k) plan.
Alan R. May, vice president in charge of HR strategy, compensation and benefits for the Boeing Co. in Chicago, has also noticed a sharp increase in contributions to money market funds and bond funds among defined contribution plan participants. "Although that is understandable in the short term, people still need to be diversified for the long term," he says.
Losses experienced by employees enrolled in 401(k) and other defined contribution plans, especially older employees on the verge of retirement, have highlighted what some regard as a key weakness in many 401(k) plans: the pressure on participants to make sure their assets last throughout retirement. In fact, such pressure may be the reason for the high exposure to equities among many workers nearing retirement.
Much of the retirement education and communication occurring in the workplace rightly focuses on asset accumulation. But it can be argued that employers and their plan service providers have not done enough to give participants the tools to make sure their assets last through retirement.
Traditional defined benefit pension plans provide retirees with annuities that generate set monthly benefits for the life of the individual and of the employee’s spouse, if that option is chosen. However, in a 401(k) plan, it is up to participants to manage their assets in retirement. "You have to do everything yourself," says Glickstein.
Offering participants the option of taking 401(k) benefits through annuities represents one solution. Relatively few 401(k) or other defined contribution plans currently offer annuities, but Glickstein says more plan sponsors will soon begin allowing participants to transfer parts of their 401(k) balances to annuities over time.
Some employers, like AEP, are already taking steps to add annuity purchase options to their 401(k) plans. "Even before this financial storm hit, some companies were looking at it," Cooper says. "We help employees accumulate substantial retirement assets, but participants are on their own when it comes to making sure the money lasts." If participants purchase annuities as they approach retirement age, they can have guaranteed retirement incomes. "That will be the next big thing in 401(k) plans," Cooper predicts.
Other Changes Possible
As employers work through issues associated with the recession, they may take another look at two not-so-new innovations: hybrid pension plans and phased retirement programs.
Hybrid pension plans, such as cash balance plans, can provide some guaranteed retirement assets for employees without the funding volatility associated with traditional defined benefit pension plans. In defined benefit plans, employers’ annual funding obligations can range from very little to a lot—often in years when they can least afford to make contributions.
Under a cash balance plan, employers annually credit each participant’s account with a percentage of salary or a flat dollar amount and provide an annual interest credit that is either a flat rate or tied to an index.
These hybrid pension plans had been sitting on the back burner for several years as employers hesitated to adopt them, largely out of fear of being sued for age discrimination.
Why such fear? Critics of cash balance plans argued that switching from a defined benefit pension plan to a cash balance plan placed older workers at a disadvantage because cash balance plans allow participants to earn salary-based benefits throughout their careers, while many traditional defined benefit plans base a large portion of benefits on salaries earned at the end of participants’ careers. However, the Pension Protection Act of 2006 settled the issues, making these plans a viable option for employers who might otherwise simply freeze defined benefit pension plans without providing an alternative.
Several companies, including Coca-Cola and Dow Chemical, recently have implemented cash balance plans. "Some companies that have never had a defined benefit pension plan, such as technology companies, have also begun exploring hybrid plans," Glickstein says. "Their workforces have matured, and these companies are looking for new benefits now that stock options are not as attractive as they used to be."
Another possible answer for some emerging retirement questions could be adoption of phased retirement programs. Even if the financial markets fully recover, there are circumstances that will impact many employees’ retirement prospects: Assets in 401(k) plans are down dramatically. Most companies don’t have defined benefit pension plans to serve as a backup. Even within 401(k) plans, companies are cutting back on matching contributions. "Phased retirement programs could be part of a solution to help employees cope," says Steve Vernon, president of Rest-of-Life Communications, a retirement consultancy based in Oxnard, Calif.
A few years ago, there was significant interest in phased retirement to get people to delay retirement, but now many companies are downsizing. "Phased retirement could be a way to get a bunch of people to work half time to avoid more layoffs," Vernon says.
As the current situation plays out, HR executives will have an important role in helping employers and plan participants deal with the aftermath. Boeing’s benefits chief May suggests that
HR executives keep an eye on the situation by conducting surveys to see if the economy is affecting retirement decisions. Surveys of aerospace industry retirees have revealed that when employees are deciding whether to retire, their work and their ability to have a positive impact are more influential than finances. However, May says he will be looking closely at future surveys to see if those influences still apply.
Changes in retirement plan laws and regulations will also have implications for employers. For example, President Barack Obama has proposed a requirement that employers without retirement plans enroll their employees in direct deposit individual retirement accounts—IRAs—and automatically defer a portion of salaries into these accounts unless employees opt out.
Indeed, keeping tabs on this dynamic situation will be key for HR executives. "As recently as August, most employers wouldn’t have dreamed of making changes to their retirement programs," says Salisbury. "Now, many are making radical changes like suspending 401(k) plan contributions."
As the economic situation continues to change, companies may need to rethink their ways of communicating with employees about issues, including retirement savings. After all, if companies stick with retirement education and communication efforts that emphasize staying the course and investing in equities as economic conditions continue to worsen, that could land them in hot water from a fiduciary liability perspective.
"HR executives may not have adjusted to the fact that we could be facing a very different situation this time, and it may require a much longer recovery," says Salisbury. "This could turn out to be unlike anything anyone has had to deal with before."
The author is a New Jersey-based business and financial writer.