“Someday” is Closer Than You Think
A look at how employers and employees can make the most out of today’s 401(k) plans
According to Professor John Page, of Tulane University’s A.B. Freeman School of Business, the formula for a successful retirement is simple: Save 15 percent of your income, live on the rest, and never get divorced.
Of course, Page is aware of just how many people will follow that advice – not a lot. That’s why most financial advisors tell clients to pay themselves first by setting aside part of their paychecks right off the bat, before the money has a chance to land in their pockets.
Even better is taking advantage of so-called defined contribution retirement plans, such as 401(k) plans, which allow workers to invest pretax dollars often matched by their employers.
Unfortunately, not everybody has gotten the message. The days of depending on a defined benefit retirement plan, such as a pension, are gone for most workers in the private sector. But employees depending on 401(k) plans for retirement aren’t socking away enough of their paychecks, which means that a lot of them are going to have to keep working longer than they had planned.
The Center for Retirement Research at Boston College says that in 2013, the median savings of working households ages 55-64 with 401(k) plans was only $111,000 – down from $118,000 in 2007.
No sure thing
Years ago, many entry-level workers shared a similar goal: get a job with benefits, including a pension, and keep that job until retirement. As recently as 1983, 62 percent of workers had defined benefit retirement plans, the Center for Retirement Research reports.
Pensions were popular with employers, Page says, because they allowed companies to court and keep workers without having the cost of the benefit appear on their financial statements. In 1961, for example, General Motors satisfied its workers with a 2.5 percent wage bump coupled with a 12 percent pension increase.
In the 1980s regulations took effect that forced companies to list their pension obligations. The results were shocking.
“Most large companies owed more to their workers than they had in equities,” Page says. Since that time, no publicly traded company has started a defined benefit plan.
Pensions have remained prevalent in public sector jobs, says Jared Llorens, associate professor with LSU’s Public Administration Institute. He says offering a pension allowed states and municipalities to pay lower wages than the private sector.
But even public-sector pensions aren’t a sure thing anymore. Emmett Dupas III, a retirement planning consultant with Northwest Mutual Wealth Management, says states and municipalities that underfunded pension plans are scrambling to find the money to pay retirees. Dupas points to the dispute between New Orleans and the city’s firefighters as an example.
Another longtime retirement pillar, Social Security, is also under the microscope. When the benefit debuted, life expectancy was much shorter than it is now. Today, the average person gets back all of the contributions he or she has made into Social Security in six years, Dupas says. But that retiree may go on to collect the benefit for another 25 years.
On your own
With defined benefit plans disappearing, and the future of Social Security worrisome, 401(k) plans take center stage in many workers’ retirement savings. In 2013, 71 percent of workers had defined contribution-401(k) plans, according to the Center for Retirement Research, while only 17 percent had defined benefit plans.
The economic downturn that began in 2008 led some employers to reduce their match or eliminate it altogether, Dupas says.
But most have restored the match. In part, this is because of regulations which require a certain match if highly compensated employees (who may also be owners) want to take the maximum deferment themselves.
Besides the match, companies have a few other ways to encourage enrollment in their defined contribution plans, says Claude Silverman, a partner in Ericksen Krentel Financial Group’s wealth management section. One is to offer a good mix of investments from which to choose. A company should first develop an investment policy statement and then pick out a wide array of options that appeal to investors of different ages and varying amounts of risk tolerance.
It’s also good to encourage automatic enrollment, he says, whereby new employees automatically contribute unless they opt out.
“That has resulted in some increase in participation rates,” Silverman says. It’s also possible to bundle automatic enrollment with an automatic increase in deferral rates over time.
Education helps, too. If employees understand the ups and downs of the marketplace, they won’t panic when they see the movements of their investments, says Jay Butcher, head of payroll company Netchex in Mandevile. Make sure workers understand the value of investing pretax dollars and encourage them to seek advice in drawing up a complete retirement plan, which takes into account all of their assets along with the expenses they foresee.
And if employers make their match every pay period, Dupas says it helps employees to see that their retirement funds are growing steadily.
Employees should also be counseled to reconsider their investment choices at regular intervals.
“As we get older, we become more conservative,” Dupas says.
A few companies are looking at combination plans, which include a defined benefit plus an ending benefit. But for most of us, the retirement we get will be the one we save for.
“If I participate in an employer-sponsored plan, it’s my money,” Butcher says. “I can invest where I see fit. [When it’s] time to retire, I can enjoy the returns or, if I took too much risk, I bear the penalty.”
As employees zero in on retirement, they’ll face more financial decisions.
“Start taking a closer look at your plan and your asset allocation,” says Andree Schneider, a financial advisor with Raymond James & Associates, Inc. At age 70-and-a-half, employees face a required minimum distribution, and that distribution is taxable. You may need advice to help you coordinate your retirement income with Social Security and to decide how much you can withdraw every year without running out of money.
Advice can also help you resist the urge to skim off some of that nest egg for a boat, or a time-share, or a vacation.
“There’s always the temptation to make that one-time impulse purchase for some reason,” Silverman says.
Essentially, following a plan can help ensure you don’t run out of money in what are supposed to be your golden years.
On Your Own
The number of workers covered by a defined benefit retirement plan has fallen sharply as defined contribution-401(k) plans take hold.
Defined benefit (pension plans) only:
Defined contribution-401(k) plans only:
Source: Center for Retirement Research at Boston College
Workers nearing retirement had a decline in their 401(k)/IRA plans.
Median 401(k)/IRA accumulation of working households with 401(k) plans in those nearing retirement:
Source: Center for Retirement Research at Boston College