MAY
2001
2001
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Honey, the Market Ate My 401(k)
Unlike many financial advisers who tout 401(k)s as the core of retirement planning, the UAW strongly prefers to negotiate defined benefit pension plans, though many UAW members currently enjoy such plans as supplements to their defined benefit plans. Together with Social Security, these defined benefit plans are the rock-solid core of an approach that has been tested and proven for decades. Currently, hundreds of thousands of UAW retirees or their surviving spouses receive regular pension checks. Unlike those Americans who depend on personal investments and savings, these UAW retirees don’t have to worry that they will outlive their investments. Defined contribution plans, including 401(k)s, have been growing in popularity.
As of the second quarter 2000, defined contribution plans had $2.5 trillion, while defined benefit plans had $2.2 trillion. Employers are attracted to 401(k)s because they shift responsibility from them to their employees. Under a defined benefit plan, a company ultimately has to finance the pensions it has promised or negotiated. If investments go sour, the company still has to pay. Many workers, too, have become overly attracted to 401(k)s. And it’s
no wonder. With the tip of a hat to Regis Philbin, Eastman Kodak promotes participation in its 401(k) plan with the teasing slogan: Be a 401(k) millionaire. It was easy to be a NASDAQ genius when the market was soaring, but will the bear market cause people to rethink the role of 40l(k)s and other defined contribution plans? People forget that these plans were in vogue once before. In 1929 at the crash that signaled the start of the Great Depression, 10,000 companies had defined contribution plans. But by the end of the Depression, only 300 of these plans had survived. Besides market risk, 401(k)s are flawed in other ways that make them undependable as the foundation of a retirement plan. Rather than treat 401(k)s as a retirement reserve, too many Americans borrow heavily against them or cash them out when they leave an employer rather than leave them for retirement. Cautious savers who see the value of a stream of income they won’t outlive (that’s what a defined benefit pension does), convert their 401(k)s into annuities when they retire. An annuity purchased by an individual from an insurance company will take 15 percent to 20 percent off the top. Based on the most recent Pension Benefit Guaranty Corporation rates used for calculating the value of a pension, it takes about $99,000 to purchase a $10,000-a-year annuity at age 65. That same annuity beginning at age 60 would cost much more. Unlike pensions, these annuities aren’t guaranteed by the federal government, and insurance companies in serious financial trouble have defaulted on annuities. The UAW is not against 401(k)s as supplements to Social Security and defined benefit pensions. They offer tax-deferred ways of saving money which can enhance retirement, provide a hedge against inflation, and help purchase a car or make other major purchases in retirement. But for working Americans, 401(k)s should be the icing--not the cake.
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The
experience of the New Haven Foundry workers, who avoided dumping their
pension into 401(k)s just as the bear market was devouring $4 trillion
in value, underscores the wisdom of the UAW philosophy toward retirement
security.