Pension Changes Hit Boomers

Cecily O’Connor
RedwoodAge.com

Now that many US corporations have cut retirement benefits, the changes are really starting to hit the 77 million aging boomers.

The problem centers on the decline in defined benefit pension plans and the subsequent rise of defined contribution plans such as 401(k)s.  Combined with increasing longevity, it’s become unclear whether today’s employer-sponsored retirement programs can support boomers’ long-term financial security, according to an analysis by The Conference Board. 

"The changing definition of retirement raises controversial questions, especially from a societal point of view," noted the report, which focuses on some of the retirement questions being asked today. Those thorny questions include, "What is the responsibility of the corporation to provide a safe and secure retirement for its employees?" 

A defined benefit pension plan promises participants a specific monthly benefit at retirement. Participants generally are not required to make contributions, or make investment decisions about the assets. A defined contribution plan, meanwhile, provides an individual retirement account for each participant. The savings are based on the amount contributed by the employee and employer, and are also affected by expenses, gains and losses in the portfolio. In addition to 401(k)s,  defined contribution plans include 403(b)s, employee stock ownership and profit-sharing plans.

‘Haven’t a Clue’
Many boomers are feeling stuck when it comes to juggling financial demands as they plan their retirement, uncertain about how to invest and manage the assets. Some boomers, too, are wrestling with how to cover health care costs if they retire before Medicare eligibility kicks in. Meanwhile, other adults are planning to work longer, realizing that income from Social Security may fall short of financial needs. That’s mainly because Social Security cost-of-living adjustments have not been keeping pace with inflation.

The Conference Board report, based on presentations and discussions by senior human resources executives at a recent retirement conference, pointed out that changes in retirement benefits have resulted in many issues that plan sponsors, policymakers and academics need to resolve. 

"We are asking employees – who should be seen as consumers, not investors – to take on significant risks that they haven’t a clue on how to manage," according to the report. 

In recent years, the management of retirement assets has been increasingly shifting to the individual worker. About two-thirds of companies that once offered a traditional defined benefit pension have either closed the plan to new hires or frozen it for all participants, according to 2007 analysis from the Employee Benefit Research Institute.

While legislation, including the Pension Protection Act of 2006, has sought to bring more stability to retirement offerings, many experts disagree whether the new rules will stabilize the system, or encourage more companies to scale back their defined benefit pension plans. Executives attending the conference pointed out that as more companies discontinue defined benefit plans, they’ll need to change their overall retirement programs so they work more effectively for employees.

Either way, employees face big challenges. The first concern is that employees will outlive their retirement income and experience a significant decline in their standard of living as they move from the accumulation phase. Recent surveys show that scenario isn’t off the mark: many people are underestimating their life expectancy and overestimating how much money they can draw from savings. 

The other danger is that employees are investing more than they should in equities, due in part to the limited options for their defined contribution assets, inflation and market volatility. Even though many employers are using target fund dates, whose allocations are invested according to the individual’s age, some experts believe these funds are generally too risky for the average employee, according to the Conference Board. 

Rethinking Retirement
Today’s boomers are the longest-living group to ever enter retirement. When surveyed, seven out of 10 report that they want to continue working in retirement, said Anna Rappaport, senior fellow on pensions and retirement for The Conference Board, and an author of the report. That’s why  innovative employment options must be initiated to accommodate the "third age," or the period between full-time work and total retirement, Rappaport said.

"Policymakers, employers and individuals need to rethink how retirement fits into the way people live their lives," she said.

One option is phased retirement, in which an employee moves from full-time to part-time employment before retiring. Already, phased retirement is an attractive option, with 48 percent of current retirees transitioning into retirement through part-time work, mostly on their own. And more people are expected to incorporate this work style in the future.

Another option to make retirement more secure is to create vehicles that provide lifetime income, such as flexible annuities. This could be done by offering employees opportunities to purchase income annuities with their defined contribution assets. Programs that allow a rollover into IRAs with institutional annuity rate purchases are another way to accomplish this.

To be sure, annuities tend to be somewhat controversial in the financial planning community because they can be risky for some investors, and generally are not viewed as a one-size-fits-all investment.

Meanwhile, questions remain about whether there should be legal requirements for the employee or the employer to purchase a lifetime income benefit. Right now, "it’s unrealistic to require a mandated annuity beyond Social Security," according to the report.

Thanks to provisions in the Pension Protection Act, automatic enrollment is another retirement plan design that’s being incorporated into defined contribution offerings. Auto-enrollment, combined with increased education, has been pretty successful at ensuring workers of all ages are more prepared. However, significant work still remains.