About a week ago, there was a syndicated column in the Tulsa World written by a Bloomberg View columnist. The thrust of his comments seemed were today Fortune 500 companies are switching from defined-benefit plans to define-contribution plans. His says that in 1998 over half of these companies offered defined-benefit plans and by 2013 that number has fallen to 7%. Although he says that this does not have to be a detriment to the employees, but because employees don’t understand and make smart use of those plans, it is. The result will be that these employees will not have a comfortable retirement. The reason he cites for the majority of companies making the shift is to save money, in only 9% of the cases has it been done by “employee preference”. In order to help theses employees, something needs to be done. And he offers several options.
As an early “victim” of this trend, I have some experience with this, and consequently some thoughts. My company made the switch in the early 80’s before it had become common practice. I wasn’t asked my preference and was told that the primary reason was for the company to “save money”. The company was in some financial difficulty at that time, but I had been in the defined-benefits plan for at least 15 years or more and was not particularly happy about the switch. As I learned more about the details and my options, I was not happy with some of the assumptions that had used in some of the roll-over options. But I came to believe that neither plan was perfect. There are advantages and disadvantages to both, but in the end, I believe that the switch was beneficial to me.
Having said that, I would not argue with his definition of the current trend. Many, if not most, companies are making the switch, and although “freeing up money” might be a more accurate description than “saving” money, they are doing it for their benefit. He says that because most employees don’t understand and make “smart use” of these plans, it’s a problem. I would not argue with any of that. When he comes to suggesting options, however, it’s interesting that education and training is not one of them . All his options address and save employees from the fate of an inadequate retirement, by making up the difference for them in some way. They would not have to take responsibility. Like defined-benefit plans they would automatically provide them a retirement they would enjoy. It’s not what he says in his column that bothers me, but what he leaves out either intentionally or because he doesn’t really understand the issues involved. So I would like to add some things I think he should have said, but didn’t.
Starting with defined benefit plans, the big advantage is that as an employee it’s all done for me. All I had to do was sign up and the company funded it and promised to pay me a retirement income based on several options that I could make at retirement. The amount to be paid with most of these plans is based on a multi-factor formula that includes the number of years of employment and one’s average salary over some period of time. I must confess, that although I got an annual statement each year that showed the income I would have if I retired at the time the statement was prepared, I never quite figured out what that would be like in 20 or 30 years when I reached retirement age. The amount always looked small, but I knew it would grow as I worked more years and as my salary grew. But the formula was long and complicated and I did not know how to guess at how many more years I would continue to work for the company or what my final salary might be. So I assumed that it would be OK. My wake up call came just before the company announced the switch. As the manager of a man in my organization looking at retirement, I got to talk to him what our benefits people calculated how much his retirement plan income would be. He had been in the plan for over 30 years, I knew his salary, and was amazed to see how small the benefit was by comparison. He decided he could not live on that so he would take the option of working longer. I spoke with our HR VP about this man’s decision and the size of the number. He told me that was not unusual. For most people, the benefit plan number would not give them what they wanted or needed, but if they had been investing in our company matched savings plan, between the two, they would probably be OK. But the savings plan was optional, required the employee to make a contribution and had it to be managed in the same way as today’s defined-contribution retirement plans.
So the defined-benefit plans may not necessarily be sufficient to provide a comfortable retirement, by themselves. One may not understand that until retirement time, and then it’s too late. I did not really understand what my retirement plan was worth until we converted to a defined-contribution plan. The new plan had a specific current balance of money that was mine. It was portable. I was vested in the defined-benefit plan, but if I left the company for another job, the amount of my retirement benefit was frozen at my last salary and years of service. That could be really low. A friend of mine a few years ago told me one of his problems when he retired was that he had changed jobs several times. And although he had been vested in each company’s individual benefit plan, he had not been in any one of those organizations long enough for each and all those plans together to be worth very much. He would have obviously been better off with a defined-contribution plan. In each plan, the current balance would follow hem, and continue to grow because of investment income.
Other disadvantages of the defined-benefit plans are that most cannot be inherited. If you die before you retirement, your wife may get nothing. If you die shortly after you retire, your wife may continue to receive some income, depending on which option you picked when you started retirement, but your other heirs may get nothing. In a defined-contribution plan, you heirs get whatever money is in the account at your death whether you had started retirement or not. Of course, in a defined-benefit plan, it’s all done for you. The company has the responsibility to manage the funds deposited each year which means they also have the investment risk. But the retirement fund can also be under-funded at any given point in time, which can put your benefits in jeopardy. There’s no free lunch and there are no perfect solutions.
I retired before I quit work. I decided to leave my company and do other things when I turned 55. My retirement fund was not quite where I wanted it to be, but I decided that if I stayed out of it for 5 years that with an average investment return, it would be where I needed it to be. It worked out for me. But I could not have done that with a defined benefits plan.
Employee education and training should be one of the options for companies making the conversion. My company did that, and it should not be particularly expensive. But education and training is only half of what is needed by employees. Employees also need motivation. We’ll look at both of these in the next installment.