As states look for ways to trim massive deficits, the battle over public employees' pay and benefits continues to heat up. Wisconsin, long a champion for workers' rights, has been in the news much lately as state workers and their supporters continue to protest cuts to state employees' compensation that Gov. Scott Walker says are necessary to plug a multimillion dollar hole in the state's budget.
One way some states are addressing their fiscal woes is by slowly changing public-sector employees' retirement plans to mirror those of the private sector. During the past three decades, businesses of all sizes have shifted away from traditional defined-benefit plans, which guarantee retirees a specified payment each month, to defined-contribution plans, also known as 401(k)s, to which employers contribute a portion of the workers' retirement funds.
Utah, where lawmakers voted last year to make a partial changeover to a defined-contribution plan, is the latest state to make the shift. In doing so, it follows similar actions by Alaska, Colorado, Georgia, Michigan, Ohio and several others that offer some form of a 401(k)-type plan, notes The New York Times.
Putting "Workers in a Much More Difficult Position"
Defined-contribution plans are more attractive to employers than traditional pension plans because they reduce the risk that companies (and increasingly state and local governments) will be on the hook for decades to come paying monthly pension stipends to retirees who are living ever longer lives.
"That all makes sense from the standpoint from the profit-maximizing firm or cost-minimizing government," says Ronald Filante, a Pace University finance professor. "But it certainly puts workers in a much more difficult position." That's because 401(k) plans leave it up to employees and the stock market to ensure the amount is sufficient to last through retirement.
Defined-contribution plans, whether they take the form of 401(k) plans or Individual Retirement Accounts (IRA), also are more costly and less efficient than properly administered defined-benefit plans, argues David Cay Johnston, a columnist at Tax.com.
In a recent column, Johnston writes:
Efficiency means that more of the money workers contribute to their pensions -- money that could have been taken as cash wages today -- ends up in the pockets of retirees, not securities dealers, trustees and others who administer and invest the money. Compared to defined benefit pension plans, 401(k) plans are vastly more expensive in investing, administration and other costs.
Individually managed accounts like 401(k)s violate a basic tenet of economics -- specialization increases economic gains. That is why the average investor makes much less than the market return, studies by Morningstar show.
Still, workers have good reasons to be engaged in the process of planning for retirement, Filante says. "Some of this transference of responsibility is a good thing." Financial planning by definition is a very personal process, and it makes a lot of sense for individuals to determine the key variables, such as risk tolerance, expected date of retirement and length of retirement, he says.
One advantage 401(k) plans enjoy over pensions is that workers can take their retirement savings with them when they leave an employer. That's an increasingly important consideration for many people as job turnover becomes more common and frequent.
The problem, of course, is that removing the burden from employers simply shifts it onto the back of employees, who are often ill-equipped to deal with retirement planning. The challenge many workers face is that they're just not good investors, says Lewis Altfest, a finance professor also at Pace University. Investing requires knowledge of how markets work, and few people, for example, understand how bonds work and when is the best time to buy them.
Surveys also show that many workers with 401(k) plans haven't saved enough for retirement -- even after factoring in amounts from Social Security. "The median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain [his or her] standard of living in retirement," according to research cited in a recent article in TheWall Street Journal.
The inherent volatility of investing in stocks combined with current low interest rates make it even more difficult for workers to save for retirement. Safe investment vehicles, such as certificates of deposit or money-market accounts with interest rates of about 1% to 2%, don't provide nearly the return needed to help build a retirement nest egg.
Another Job That's Becoming Your Job
For those reasons and others, both professors agree that from a worker's perspective traditional pension plans are a better deal. "All things being equal, as an employee, you probably want to have a defined-benefit plan," says Altfest, who also owns his own wealth-management firm. "But it will be more costly to the corporation and therefore more valuable to the person."
It's exactly those employer-borne costs that companies and governments are looking to ditch, which means it isn't likely that defined-benefit plans will be making a comeback anytime soon.
As with many other things that Americans have learned to become responsible for in recent years -- from pumping their own gasoline to managing their families' health care -- the winds of change mean U.S. workers will be the ones most responsible for ensuring they have enough money set aside to make it through retirement.