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Today's Commentary: 08.09.06
Congressional Inertia, Part One and Two
On August 4th, 2006, Congress approved a heavily debated bill that could have an effect on not only pensions but also how your 401(k) and similar self directed retirement plans work. While it is too early to tell exactly how this will impact the average worker, I can give you some of the basics of these changes and how you can be diligent when they eventually take place. Most of the changes, it should be noted are not scheduled to take effect until 2008.
The move from defined benefit plans to defined contribution plans changed the retirement landscape when they were first adopted over three decades ago. The flaw in the plan, as many of us found out rather quickly, created a situation that put many people at risk of not investing in the right mix of investments and worse, allowed some people who needed it most, to simply sit back and do nothing.
The company had little more to do that provide the opportunity and sometimes, although this sentiment has waned in recent years, a match for employee contributions. Employees were left to sift through the choices and determine where to direct their money. Few knew the basics of investing. Even fewer knew how much risk their choices had or whether they were prudent places to direct their retirements.
As a result, far too many investors simply did nothing. Although there was a plethora of financial education offered from risk assessment to the lessons learned from Enron employees, the plans languished in a nether world of half hearted investments or worse, low risk alternatives to growth.
We prodded and pleaded with workers to take charge of these plans. We used fear. We painted a bleak picture of the future. We mostly failed with only half of the workers eligible to participate actually doing so.
Congress viewed this as an evil inertia, a state of non-investment that Wall Street worried about enough to lobby for change. Inertia by the way is Isaac Newton's First Law of Motion and states that a body will remain at rest or in motion until a force changes its direction or compels it to move. Congress with the help of Wall Street seeks to be that force. That may prove to be unfortunate.
While actual statistics vary on the exact number of investors on the sidelines or under-invested, the bill will change these plans and the role your company has in administering them significantly.
It will take several years for the plans to evolve into the new structure, which will give you time to get your own house in order before your company with the assistance of a truckload of financial advice from Wall Street steps begins to implement the bill. But when that change does happen, the current participants may be the ones most deeply impacted
Here, in a nutshell, is what will happen to the plans of those who are not currently enrolled or have taken the default investment.
401(k) plans and similar self-directed plans will no longer be completely self-directed. This is an enormous change in philosophy giving your employer the right to step in and direct the plan without your approval. If the company deems that your plan is not growing at an acceptable rate because you are underinvested in money market accounts or are not invested at all, the company can change your plan. Doing so on your behalf, if you fall into one of the categories I just mentioned, will be a considerable improvement over the way these plans are introduced to newly hired workers. Legislation was not needed to change this lack of interest. The fiduciary responsibility of helping employees achieve a retirement goal was supposed to begin with the employer in conjunction with the plan. Failure to do so should have resulted in penalties not legislation.
When these plans were first introduced, they provided an important shift in roles, one employers were all to happy to shed as they turned away from pensions (which they had control over) to 401(k) plans (which they did not). The idea behind this Congressional bill attempts to help the less-than-savvy employee by taking their misdirected money and putting it into higher risk stock and bond funds or a diverse mix of funds designed to provide additional growth. While millions of words have been dispersed over the years helping folks determine risk, this bill gives your employer the omnipotent role of determining that difficult to pinpoint factor. Can they do what so many have failed to do?
The bill will also allow the employer to make increases in contributions on your behalf. The bill does not actually require such actions but the incentive to allow for minimum step-ups such as 3% one year, 4% the next, and up to 6% in subsequent years seems on the surface to be a good thing. There is no requirement for employers to match "step-up" increases with their own funds. Could this be the new wage increase?
Automatic enrollment for new employees also seems to be a positive move in the right direction. Employees will be enrolled in the plan although the waiting period for eligibility will not change in many cases.
And lastly, Wall Street will be there with advice. Opponents of the bill harbor a realistic fear that the advice would not be completely trustworthy. The investment community convinced Congress that they would be, keeping the clients best interest at heart and promising to direct them to the best investment. The worry was based on the possibility that these "advisers" would direct investors without much savvy to investments that might better serve their firms profit margins and not their "client's best interests". Really?
The best investor is a skeptical one. Free lunches like free advice are often not free or very satisfying. Even if the changes the legislation brings actually helps workers who may not have invested or done so with any success do better, your best path will always be the one you choose. It is the one you feel most comfortable taking because you have educated yourself on the possibilities and potential.
You are the reason Wall Street exists. Stay in control of that situation which is something you can do without Congressional assistance. If you do you will be a better investor.
Part Two
Mention the word pension to someone over the age of fifty and they will either wince or drift off into a fond recollection of a time gone by when the world spun on the notion, albeit quant, that the company you worked for cared enough to concern itself not only with the here and now but your future as well.
Mention the word pension to someone younger and the reaction will be quite different. How in the short space of one workerıs career could the landscape change so dramatically? The simple answer is legislation.
While governments were designed to protect and serve, only the naïve believe that this is how your government operates. The creation of the Pension Benefit Guaranty Corporation was one such attempt to keep solvent the pension plans of companies that ran into financial trouble. Rather than allow the promises made to disappear completely as they did before the creation of the agency (Employee Retirement Income Security Act of 1974 or ERISA), legislation was passed to protect workers from a total loss of post-work income.
To ensure that the 44 million workers covered by pension plans received some of the monies promised, the PBGC, acting as an insurance company began charging companies premiums. These were levied against both single and multiemployer pension plans and in the process guaranteeing that some of the promised pension benefit up to $45,614 at age 65 would be there at retirement no matter the fate of the company.
The PBGC is not backed by the full faith and credit of the federal government but does rely on Congress for changes in how it does business. This oversight by Congress was amended this past week in a 907 page bill approved by both the House and the Senate.
Unfortunately, the intended consequences of the bill will probably not align with Congress's supposed intentions while giving the companies who promise benefits they can ill-afford to deliver the time to get back to even or wait for further bailout legislation down the road.
The PBGC's main problem is not the multiemployer pensions. Those seem to be doing just fine (more on these plans further on). The single employer pensions however have prompted the agency to ask for a better way of collecting the necessary funds to continue its operation. They may have, in the process, unwittingly spelled the end to the pension as we know it.
The new pension bill forces the hand of too many under funded pension plans. By requiring them to get their plans to even in seven years (after the bill takes hold in 2008) using accelerated payment schedules, some companies will be under a great deal of pressure to get those plans current.
Not only does the bill allow for additional time, when you add in the special concessions for troubled industries, the bill begins to look very weak indeed.
While it is perfectly healthy for employees to plan from a worse case scenario, your pension plan, the PBGC feels, should be required to do so as well. Far too many plans do exactly the opposite. The new bill will force companies "at-risk", the ones who have under funded their plans into an accelerated payment plan or face penalties of up to $1250 per person.
The "at-risk" designation does not take the financial health of the company into consideration only the current funding of their pension promises. Even with the tax breaks offered to companies to get their plans fully funded, the cost of increased penalties and premiums may be more cost effective that trying to get their plans near solvency. An "at-risk" company is determined by the percentage of the planıs funding against full solvency.
To add to the long list of downsides this bill offers, the long catch-up period will lead to future abuses as companies reach the seven-year deadline (to 100% funded). The restrictions on future promises is almost a mote point as well as the bill provides for easy conversion of these plans from a defined benefit plan (the kind of plan that increases the employee's benefit over time) to a cash balance pension (one that divvies the pension payment based on the available cash balance in the plan).
IBM changed to a cash balance plan in 1999 and in doing so angered employees to the point they felt compelled to file a discrimination lawsuit. On Monday, the case was dismissed, overturning the federal court ruling in 2003 stating that it had indeed discriminated against older, soon-to-be-retired employees. At the time, IBMı's plan was fully funded.
That ruling along with this bill will allow more companies to switch to these combination plans that are part pension, part 401(k). This nod to younger workers comes at a time when most older workers have built retirement plans around those estimated benefits.
The second no less heinous option is the freeze. This allows companies with under funded plans the option of halting their pension obligations in the hopes that this will better allow for replenishing the fund. Hard freezes allow troubled industries such as the airlines and autos to take up to 17 years to get back to even.
Without the legislation, several companies, including NorthWest and Delta had threatened to dump their plans altogether. With the legislation, these companies will be allowed to postpone their day of reckoning by continuing to under fund their plans, offer peace promises to their workers and unions, and avoid the costs of increased premiums.
Bankruptcy and even more often, mergers and acquisitions take pensions out of existence dumping the burden back on the PBGC. Companies who have been able to keep their plans 100% funded may also see the two-year enactment period as a grace period of sorts. These businesses are also increasingly vocal about the burden of responsibility they carry because of their ability to keep their plans funded.
Multi-employer pensions were also given a loophole as well. Although many of the plans are solvent, given the opportunity, the trustees of these plans can lower benefits based on their estimations of solvency.
Not all pension problems were addressed in this bill. The public sector pension program, which does not come under the protection of the PBGC has its own problems that pale in comparison and are looming on the horizon.
This bill solves only a small portion of what it set out to do. Thatıs unfortunate. But hey, it is an election year.
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