The average pay for white collar and blue collar workers met in a sort of merger, an intersection of two lines on graph (as it later appeared decades later). Those lines joined together for one brief moment in 1975 and never touched again. The college graduating class of 1975 would be the sought after white collar worker for a rapidly changing economy. The first wave of boomers had finally emerged leaving their blue-collar counterparts and their union negotiated pay packages to struggle while their self negotiated pay headed toward the stratosphere.
This change in the workforce produced a group of workers who were lured by higher paying jobs that offered better wages in return for company loyalty. The generation before them saw their affiliation first to their union and then to their employer. Optimistically, union officials referred to this as a "swing of the pendulum", a hope that these events would reverse themselves if they just waited long enough.
With that noticeably larger and more negotiable paycheck and the move away from the security of organized labor, the companies offered a pension to their employees that changed the way many employees felt about retirement.
These defined benefit pensions, often run by the employer, offered employees a chance to create great wealth through time. The higher the wage, usually achieved over a lengthy career, the greater the contribution to the employee's retirement. The longer an employee stayed with the company, the greater the pension payment that would be waiting for them at the end of their careers.
Essentially, the Faustian bargain was simple for everyone to comprehend. If an employee remained loyal, each year of service would amount to a substantially larger payout. Those promises, never legally binding and often included in the profit and loss statements of the business, not only created the desired loyalty the company was seeking - in part because they were not transportable - but gave these employees the assurance that their hard work would allow them to relax in retirement.
When the 401(k) plan was discovered buried in the tax code by Ted Brenner 25 years ago, it was not seen as beneficial to these pensioned workers as their current plan. The difference between defined benefit and defined contribution is simple.
One is based on payments made by the company, invested for the sake of insuring the money would be there sometime in the future with that contribution based on wages. So of your wage grew from the day you started at $30,000 at age 25 and you received 3% raises every year afterwards, your take home pay would be near $80,000 by age 65. Each year, the defined benefit grew as well.
Defined contribution plans essentially changed who was making the payments for the future. Regular pre-tax deductions, which 401(k) plans rely on, meant that the employee needed to make the contribution themselves through payroll. With that tax incentive, deferred until later when supposedly your tax bracket would be less, and because it was directed by the employee, companies were free of the obligation of defined contribution plans. Now the employee would be responsible for directing their investments.
Two things resulted from this shift. The retirement plan depended on the investment skill of the employee and the time horizon until retirement. Younger workers, the ideal candidate for these plans, were no longer tethered to their employer. Older workers had to find a way to make up for lost ground.
But this required two additional things of all employees. The first was participation, which pensions provided without any effort on the employees part and the second was an understanding of how dollar cost averaging worked over a long period of time.
That fundamental change created a new breed of employee: one that was forced to be savvy enough to direct their own investments and achieve the same guaranteed results that pensions would offer.
Companies further enticed workers into these 401(k) plans by offering to contribute to the plan as well. Matching funds became the free money lure that helped create the new employee loyalty. Savvy employees understood the power of the matched contribution and companies used it as a bargaining chip to attract good talent.
One problem remained and despite most best efforts to solve the conundrum, employees were still faced with making investment decisions. Frozen by the enormity of their choices, the gravity of the results, and lack of understanding they needed to make sound, conservative decisions, kept far too many employees on the sidelines even when matching funds were available.
Faced with deciding not only where to invest the money, but how would they achieve similar returns to the ones that the pension would have provided. Even now, the problem persists. The 401(k) is now the primary plan offered to employees yet only 70% of the large company employees participate in a meaningful way. Smaller companies (of less than 100 employees) were surveyed and reported that only 16% of their workers participated in their self directed plans.
While the reasons are many for the lack of consistent participation, none are very good.
When financially solvent companies begin to see the benefit of jettisoning their pensions in favor or 401(k) plans, all workers lose. The older the employee, the larger the possible loss should the employer freeze the plan.
Freezing is the new buzz word among profitable companies. Freezing a pension basically wipes away the obligation of the company to direct the money it has invested on their employee's behalf. That cut-off point leaves employees close to retirement with lost benefits and a short window of opportunity to recover them.
Younger employees saw their careers as more mobile and the ability to change employers and move their money with them was paramount. Older employees, who had begun to dream of the future and the fate of that money were left to fend for themselves.
The success behind a self directed plans is time and consistency. With a work career ahead of them, a younger employee has time to invest in their future and if done in a consistent manner, it also allows them to ride out market lows and highs and ultimately benefit.
The older employee has a smaller investment horizon and should they invest according to their age - more conservatively as the get older - the returns they can expect will be significantly smaller.
The exact number of frozen plans is not well known nor is it widely publicized. It appears, from the latest figures published by the PBGC, the Pension Benefit Guaranty Corporation, that the stampede began with smaller companies whose businesses were at risk due to unwieldy plans. Larger businesses whose markets had become more global and whose pensions became liabilities also jumped on board. Figures as of 2003 suggest that 9.4% of private pension plans have been frozen.
The federal corporation created by the Employee Retirement Income Security Act of 1974 (ERISA) and currently protects over 44 million people. It does so without tax revenues. The effects of frozen plans is still not fully understood by the corporation.
It is anticipated that the frozen plans will in fact become better funded and as a result, allowing companies to pay a smaller premium to PBGC. If the defined benefit plans are eventually eliminated, and many believe that freezing is the first step in this process, the cost to the PBGC will be lower as a result of a smaller group of participants affected.
Pension obligations require a good idea of how many workers the plan has, how old they are, and how long they might live. These actuarial problems began to loom large as many plans failed to meet the contributions necessary to keep the plans solvent. Losses in the stock market of 2000 laid waste to many of the poorly run plans. Unable to meet those obligations, companies declared bankruptcy. The PBGC protects the pensions of companies although they do not guarantee full payments to the pensioners.
Pensions do not require any market diligence on the part of the employee. 401(k) plans do. The alignment of retirement to the markets is considerably tougher for an employee who lacks the investment skills to direct their retirement to the best advantage.
For the older worker, the shortened time frame presents some problems. Best case scenario requires a stock market that is both vibrant and successful, year after year and especially at the point of retirement. This would allow the investor to take greater risk as they get older to ensure they would have the best returns in the shortest amount of time. Then picking the exact moment, when the markets were at their peak, to retire would require skills that few workers possess.
In hindsight, the failed effort to privatize Social Security leaves one leg of the retirement picture still in place. Part of the "three legged stool", pensions were supposed to be the main source of retirement income, savings the other, and Social Security, the paycheck of last resort. With those pensions now in jeopardy, it would be wise if Congress took another look at what corporate America is attempting to do.
Using the claim that global competition has forced many of these pension changes no longer seems adequate. With each stock buy back, an effort by many companies to illiquidate the markets to prop up earnings reports, the shareholder-centric mentality at all costs needs to be addressed. And as much as I hate to say it, Congress needs to be the arbiter.
Perhaps they should authorize the PBGC to service these plans rather than simply insure them. Using tax incentives, PBGC could match company contributions and guide them in making better actuarial decisions. Currently the PBGC collects premiums from pension plans under ERISA. A change in how the corporation operates would require an amendment to that Act.
Our lawmakers need to step in and do what they enjoy the most: cut taxes. Or at least offer lucrative tax incentives to businesses to protect their pensions. A clear understanding of the consequences of these actions is imperative. Each time a pension plan is frozen, a future income is minimized. That lost income is money that would have been spent by folks who would have treated it in a disposable manner. In other words, this money would have kept the economy strong for years into the future.
By taking a gander at the 70 million or so boomers who would like to retire and by doing some simple math, a tax incentive now would help keep future generations from supporting a good portion of these retirees in poverty while buying time to search for an equitable solution for the future woes of Social Security.
Otherwise, I believe those income income figures from thirty years ago will converge again thirty years into the future. Although this time it will be retirees meeting the rising income of service sector workers.
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