Experts Say Danger in Individuals Taking on Too Much Retirement Responsibility

With the slow death of the defined benefit plan system comes a greater weight on individuals, who are expected to take up the reigns of responsibility for their retirement future, and are now being asked to pay a higher proportion of their medical costs as well.

With the passage of the Pension Protection Act (See What’s Inside the Pension Protection Act ) and the first of phase of a financial overhaul by the Financial Accounting Standards Board (FASB) in motion (See FASB Publishes Final Standards for Pensions and OPEB) , some expect the fall of the defined benefit scheme in America to speed.

The result is what Matthew Scanlan, head of Americas Institutional Business for Barclays Global Investors (BGI), referred to at a recent panel discussion as an emerging generation of longer-working “chief investment officers,” one which requires individuals to take on more of the costs and responsibility for retirement with what he called a flaw-ridden defined contribution model.

Panelists at a discussion sponsored by San Francisco-based BGI discussed Wednesday morning what the confluence of all of these changes might mean for the future of retirement. The schism between firms offering defined benefit plans and those offering defined contribution plans is pronounced by the growing number of companies trying to get out of the DB business. According to BGI, 39 companies gave up their DB plans in 2002, 46 in 2003 and 71 in 2004.

One dominant message by BGI at the discussion was that the DB sector, of which BGI manages about $803.4 billion in assets, still has a lot of wind left and should not be considered a dying sector. The asset manager has a considerably lower stake in the defined contribution area, holding about $179.4 billion in DC assets.

Defined contribution plans have been ushered in as the base of retirement income in the US; however, Barton Waring, head of Client Advisory Group at BGI, argued that these plans still need work and are so far not providing enough for retirement.The average 401(k) balance is $44,000, and those in their 60s have an average of $140,000 to live on in retirement - a figure that is less than half of the Social Security annuity, according to data from the Employee Benefit Research Institute.

Waring said the current DC product is not a good substitute for DB plans, and at this rate, they will not provide enough retirement savings. He warns that the "worst DB plan is better than the best DC plan," which are "good in theory, but not good in practice." Waring used evidence from Watson Wyatt Worldwide to support his argument, saying that in 2002, the median rate of return for a 401(k) plan was -12.28 and for DB plans, -8.43.

Waring also argued that investment products for 401(k) plans tend to be expensive and that there are too few options when it comes to DC plans in terms of annuitization of payouts.

Annuities were one of the solutions hailed by the panelists to fend off the possibility that retirees will run out of money. Annuities, in which retirees are paid the same amount every month depending how much they saved, "provide a DB-like predictability that they can balance their life on," Scanlan said.

The fact that Americans are living longer presents a problem in terms of making sure individuals have enough retirement savings to carry them until death. It requires more discipline on the side of the individual to save for retirement, said Dallas Salisbury, president and CEO of Washington, D.C.-based Employee Benefit Research Institute (EBRI), at the panel discussion.

According to EBRI's data, if individuals begin saving for retirement at age 20, and save consistently for 47 years in a DB or DC plan, the annuities will be substantial at a 4.8% interest rate; however, delaying saving to age 40 or 50 increases the amount workers will need to contribute for retirement substantially.

Panelist Olivia Mitchell, a professor at the Wharton School who studies the effects of aging, said that one way to offset the effect of the longer lifespan of individuals on retirement income is by getting them to work a few more years, a move that could have a substantial effect on savings. For instance, workers considered to be in the third wage quintile who retire at age 62 will need 17.3% of additional savings when they retire to smooth consumption; however, if they waited until age 65 to retire, they would only need 7.7% of additional savings.

On the other hand, employees that want to work longer will present a problem for employers, who are then faced with "how to get the next generation of workers into the companies if none of them want to leave," Scanlan said.

Also, in addition to asking employees to take more responsibility for their retirement decisions as defined contribution plans continue to gain traction, they are being asked to bear more of the burden of their health care costs - an expense that "continues to create pressure on retirement money," said Salisbury.

He added that health costs are "crunching down on the money available for discretionary spending," displacing the amount workers are able to put toward retirement.

According to BGI, health care costs are growing at twice the rate of inflation and are expected to continue rising (See Survey: Health Care Costs Expected to Climb at Slower Pace in 2007 ).