My mother in law had Parkinson’s. Totally there mentally and yet totally unable to feed herself, get to the bathroom, or even adjust the pillows on her chair for about 10 years. Let me assure you that she resented for every second of it the fact that her retirement plan was “Be perfectly healthy until I drop dead instantly.”
One thing that can be a problem for a 401(k) plan is the expense ratio and the fees associated with the plan. I’ve seen articles such as this one pointing out that a small difference in these fees can add up to a lot of lost money over time.
Absolutely correct. And not just a problem for 401k plans, but for anyone investing in mutual funds.
We all know how compound interest works, right? A small percentage of growth, when fed back into investments results in exponential growth in the long run. Well, expense fees that are a percentage of your investment work exactly the same, except they reduce your growth exponentially.
My rule of the thumb is to avoid any fund that charges more than one half of one percent (0.5%). The best funds charge less than 0.1%. If your employer doesn’t offer any funds with low expense fees, you have to ask for more options or somehow get your investment money into a lower cost.
(Some people will swear by their favorite fund that charges 2-3%; that it makes up for the fee with better performance. Well, good luck with that. I’d rather get the market average than pay someone a cut off the top to gamble with my money.)
If at 90 or 95 I have too much money coming in I can live with that better than too little. But the chances are more for the too little. Inflation. When my Father in Law retired with the teamsters. SS and his retirement check amounted to about the same as his take home pay. He had extra income. 20 years later with COLA increases to SS only he had to watch his pennys.
That kind of thing can get you at any time. I was talking about the idea that normal living and recreation expenses would be constant over retirement, which is the model it appears the retirement planners use.
And medical problems are independent of defined benefits versus defined contributions.
That might be a benefit of a defined contribution plan. The pension I was going to get wouldn’t grow with inflation either. My annuity can.
But was he spending as much 20 years after retirement as he was five years after? Inflation adjusted, I mean.
Hilarious. Most “companies” realized a long time ago that they couldn’t feasibly use defined benefit plans any nore. The main ones left are those forced into it by union and of course governments who are …well, governments.
One big advantage of 401k plans is that they are a lot better for people who switch jobs. Defined benefit plan formulas are designed to reward long term service with the company, and the formulas frequently use some form of service x final average salary. In such cases, a person who works 15 years with one company and then 10 years with another (for example) gets a lower payout than someone who works 35 years with the same company.
These days, long term service with the same company is not as common as it once was, so there’s less demand by employees for DB plans.
Another important ingredient is discount rates. Besides for the assets needed to back the plan, the amount of the liabilities are themselves subject to change, and discount rates are a big factor. The lower the rates, the higher the liability.
Thus, in times of economic downturns, the pension plans get it coming and going. Their investments take losses, while the interest rates go down, which raises their liabilities.
Sorry, that should say:
In such cases, a person who works 15 years with one company and then 20 years with another (for example) gets a lower payout than someone who works 35 years with the same company
Not hilarious - sad.
The same market forces are impacting pensions in Canada. The same result - the vast majority of companies have abandoned Defined-Benefit just as in the USA. The main difference? Canadian rules were not so lax; as a result, the vast majority of pension plans were sufficiently funded that even in the case of bankruptcies, there was no detrimental impact on the company plans. There was sufficient funding to meet the obligations of the plan (up to the point of bankruptcy).
Meanwhile, the airline bankruptcies in the USA basically put a massive load on the pension board; even though it limited pensions (IIRC) to a maximum of somewhere around $50K (so much for the promised pensions for high-paid pilots). It had the added bonus that as the pension guarantee corp raised its premiums, it made DB hat much less attracive for those plans that were still a going concern.
Yes, in general, I assume most plans were like mine - COLA adjustments did not start until you began to collect, so the guy who put in 15 years at A is collecting a pension later based on 20-year-old salary figures. Plus, benefits like early retirement often did not apply unless you had your 30 years, or age+years = 85, or whatever the rule; so you wait until 65 to collect. Plus, those first 15 years were likely entry level, and so the payout is based on a more junior salary on top of everything.
This was another gotcha for employers. The amount of money needed based on actuarial numbers, gets much larger toward the end of the worker’s career, due to accumulated years meaning higher payout, higher wages, less time to go before collecting pension,possible higher obligation with early retirement options, etc.
In a 401k you would contribute relatively evenly - say X% of pay - every year. For the actuarial calculations, the DB pension fund required very little for that employee in the early years, quite a lot more toward the end. This is fine in a steady-state situation, a nice mix of young and older employees so contributions too were even. In around the 90’s and 2000’s it was the third wave of the triple whammy. Bad markets destroyed the value of the fund,low interest reduced the value and yield of bond assets, and in a bad market, employers laid off - often by seniority - and did not hire, so the pension obligation became loaded with aging employees whose contribution obligations were much higher.
Basically, Defined Benefit plans made sense in a steady, reliable(growing) economy like N. America before the oil crisis. In a iregular economy they made no sense.
I should add that the actuarial calculations - what amount of money was needed to make the payments the fund was obliged to pay - depended on anticipated growth of the fund. This in turn was calculated using interest rates; so there’s a fourth Whammy - the future value of the current fund dollars dropped as interest rates dropped and appeared poised to stay low. (I forget exactly which market rate the calculations used, but it was based on the bank rate or long term projections, somehow.)
So not only did the value of the fund drop due to a bad stock market, but the amount of money needed to make up the shortfall was much higher than before too.
The way the current buyout programs work is that if you don’t take your money, your pension gets moved away from the company you used to work for to a management company, which wouldn’t be affected if your former company went under. I admit that not having to worry about the health of Lucent was a minor reason I yanked my cash.
If you read about the influence of big pension plans like CalPers on the companies they invest in, it is clear that they don’t just invest in index funds.
Especially when the company reduced its investment in good times when the value of the pension was above the legally required value, so as to improve the bottom line. When the market goes down the company is often affected, and then complains about having to make up the shortfall as you said.
And people who changed jobs more frequently than in this example had vesting time, when benefits did not accumulate, represent a substantial portion of their earning period.
In a defined contribution plan there is usually no vesting period, and when and if you leave not only do you bring your money with you but you can put it in a wider variety of investments than offered by any company, which can lead to better returns if you are smart (and lucky.)
Don’t assume that all governments and all public employees are on defined benefit plans. It depends on the government.
For instance, back in the 70s, the government of Saskatchewan looked at the issue and ran the projections for the defined benefit pension plan for provincial employees. They realised that long-term, it was a fiscal time-bomb, with the taxpayers potentially on the hook for a huge unfunded liability which would have to be paid out of general revenue.
So, they implemented a long-term, relatively painless solution. They closed entry to the defined benefit plan as of a set date (can’t remember the exact date, but say December 31, 1977 for the purposes of the discussion). Then they created a new defined contribution plan, with matching employer and employee contributions, and independently managed by a pension benefits agency. All new hires in the provincial public service from January 1, 1978, have been on the new defined contribution plan.
Now, the unfunded liability for the old defined benefit plan has continued to grow, as the employees in the old plan have retired and started drawing their pensions. But, the overall pool of those employees is closed, and the pension claims for the new employees since the transition date are not an unfunded liability - the government has contributed the employer contribution to their pensions on a pay-as-you go basis, with each employee’s pay cheque.
It was an elegant solution, as it fixed the long-term problem, without affecting the pension rights of the public employees in the old defined benefit plan.
As another data point, the auto industry did away with defined-benefit pensions for new hires several years ago. The costs associated with these plans were a major component of the forces that drove General Motors and Chrysler into bankruptcy a few years ago. I don’t know what new hires get, but it’s probably a 401(k). It sure as shit ain’t a defined benefit pension. The “legacy” pension funds are run by an entity called a VEBA, which is managed by the United Auto Workers union. The auto companies have offered buyouts to pensioners as a way to get rid of the unfunded liability in their pension funds.
No because inflation adjusted he did not have as much to spend.
Yes, it’s the simplest solution - and the cheapest.
When the company I worked for hit hard times, there was speculation that they would fold their pension plan (at least, for non-union employees). As I pointed out to worried co-workers, no danger of that. They did what Saskatchewan did, and new hires were in a defined contribution plan.
When the fund is severely underfunded is a bad time to convert the plan to “net present value” and give a chunk of cash (locked-in savings plan) to every employee. With the current laws, they had 5 years to spread out to pay the outstanding fund obligations. During that time, the market could recover, too, reducing their liability. If they cashed out the fund, they would have (a) converted the assets at the worst time in the market and (b) have to come up with the equivalent of 5 years’ worth of make-up contributions in a few months.
Closing the plan for new employees is the simplest, cheapest and most effective method of getting out of it. Worst case, they might convert those employees with less than 10 years, where the cost of buyout was minimal.
I recommend Pension Plan proponents read this article.
NYT - Private Pension Plans, Even at Big Companies, May Be Underfunded
Here are a few excerpts.
[QUOTE=NYT]
Of the 500 companies, 338 have defined-benefit pension plans, and only 18 are fully funded. Seven companies reported that their plans were underfunded by more than $10 billion, with the largest negative figure, $21.6 billion, reported by General Electric.
[/QUOTE]
[QUOTE=NYT]
Virtually all pension funds had assumed returns would be better, leaving them underfunded when their investments failed to perform as expected.
[/QUOTE]
[QUOTE=NYT]
Next year, pension funds will appear to be better funded, even if they are not. Congress voted this year to allow funds to discount their obligations using a 15-year average of bond yields, meaning they can use a higher rate and so report lower obligations.
[/QUOTE]
This next part is a paraphrase of a finance professor that I read material from: Sandy Leeds at the University of Texas.
[QUOTE=Paraphrase of Sandy Leeds]
Congress recently passed a transportation bill that is funded by an accounting gimmick. The way they paid for this bill is that they changed the discount rate for corporate pension plans. Instead of using relatively current interest rates to discount the pension liability, companies now can use the average yield from the past 25 years (when rates were higher).
In other words, by using these higher rates, the present value of the companies’ obligations appears to be lower. As a result, companies can contribute less. This smaller contribution means that companies will have a smaller deduction (from earnings) and that they will pay higher taxes.
The result is that pension funds are more risky.
[/QUOTE]
Well if you liked that Transportation Bill, you may end up liking the Fiscal Cliff deal.
Fiscal talks could result in corporate pension funding relief