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Central Pension Fund Your Retirement Security 401(k) Plans: A Risky Retirement Gamble Recently there has been a great deal of public interest directed to 401(k) retirement plans as employers in increasing numbers are attempting to substitute these types of plans for traditional pension plans, known as defined-benefit plans. In traditional defined-benefit plans negotiated by IUOE Local Unions, employers are obligated to make contributions and the plans are responsible for investing the funds and paying lifetime benefits to participants when they retire. On the other hand, in 401(k) plans employees are obligated to make their own contributions, invest the funds themselves, and receive a lump sum payout of the funds at retirement. Because of these differences, while 401(k) plans may be worthwhile as supplements to traditional defined-benefit pension plans, by themselves they offer little hope of retirement security. By themselves 401(k) plans are nothing more than a risky retirement gamble. The reason that 401(k)s are so risky compared to defined-benefit plans is that 401(k) participants must assume sole responsibility for three primary retirement risks that do not exist for defined-benefit plan participants. Each of these risks can destroy or severely erode the retirement value of such plans. The three primary risks that 401(k) plans place on participants are: accumulation risk, investment risk and longevity risk. Accumulation risk is the risk that the participant will not deduct enough money from every paycheck over the course of his or her working life to accumulate sufficient funds for retirement. Investment risk is the risk that, even if sufficient funds are accumulated, the participant will not invest the funds in the right mix of investments, such as stocks, bonds, certificates of deposit, etc., to enhance and preserve the accumulated funds. Longevity risk is the risk that, even if sufficient funds are accumulated and invested properly, the participant outlives the funds and the money runs out. In traditional defined-benefit plans it is the plan, not the participant, that assumes these risks. Accumulation risk is addressed at the bargaining table where IUOE Local Unions negotiate a contribution rate which all employers are required to make to the plan. The participants are then entitled to benefits based on those contributions regardless of whether the employer becomes delinquent or defaults. It is up to the plan to collect the contributions, not the participant. Likewise, in defined-benefit plans, the plan bears the investment risk not the participant. The plan retains professional investment managers to choose the investments, and, regardless of the investment returns, the participants are entitled to the benefits defined in the plan. Indeed, the benefits of defined-benefit plans are guaranteed by the federal Pension Benefit Guaranty Corporation (PBGC). 401(k) benefits are not guaranteed by the PBGC. Finally, defined-benefit plans have no longevity risk whatsoever. Defined-benefit plans pay benefits in the form of lifetime annuities, that is, monthly benefit checks for life, regardless of how long the participant lives. And, furthermore, all defined-benefit plans must offer joint and survivor annuity options, which permit participants to choose to have their benefits paid for their own lifetime and, thereafter, for the lifetime of their surviving spouse. Choosing this option means that the monthly annuity amount will be somewhat lower than that paid for just the life of the participant, but it is a valuable spouse protection that is not available in 401(k) plans. In conclusion, by any measure 401(k) plans are risky retirement business, offering none of the protections afforded by traditional defined-benefit pension plans. This being true, the question is why are so many employers trying to get out of defined-benefit plans and substitute 401(k) plans? The answer to this question, and the question of how 401(k)s can be utilized as supplements, but not substitutes, for traditional defined-benefit plans, will be addressed in future issues of the Operating Engineer. Originally
Published in the International Operating Engineer |