How the Changed Pension Landscape Threatens Your Retirement

Are you financially savvy enough to handle the trend away from defined benefit pensions and towards defined contribution programs?  Keep in mind that only 30% of retirees in the U.S. are qualified to handle the transition.  (you can see for yourself by answering the Big Three Questions below).  For that matter, do you even understand the terms “defined benefit” and “defined contribution”?   The odds are against you on this as well.   Over the last 30 years, businesses and government agencies have quietly transferred pension investment risks to their employees.   And with an increasingly volatile economy, retirees are going to see their wealth wildly gyrate, causing all sorts of havoc with retirement planning.   One thing we know:  it’s not going to be pretty.

 

Defined Benefit vs. Defined Contributions

Over the last 30 years, a large shift in pensions has occurred. Rather than an employer guaranteeing a benefit during retirement as is the case with defined benefit plans, the employee (and often times the employer) will make contributions to a defined contribution plan which accumulates over time and is drawn upon by the employee during retirement. One of the most common forms of defined contribution plans available to workers is the 401(k) plan. Since the guarantee of a monthly benefit during retirement is not there in a 401(k) plan, whatever is accumulated from employee/employer contributions and investment returns over the years is what will be available to the employee throughout retirement. In other words, this is the amount that must last throughout retirement.

In the United States, for example, the proportion of private-sector workers with a defined-benefit pension declined from close to 90 percent in 1975 to around 30 percent in 2018. Surveys of multinational corporations report that defined-benefit pensions are considered outdated.  Most companies are shifting to less costly, less risky defined-contribution pension arrangements, regardless of whether it will benefit their employees.

In fact, in just the last 10 years, nearly every state in the U.S. modified its retirement systems by increasing employee contributions, reducing benefits or both, according to the National Institute on Retirement Security (NIRS).  Advocates of switching from defined benefit (DB) pension plans to defined contribution (DC) 401(k)-type individual accounts plans sought to reduce employer costs for unfunded liabilities.  They weren’t motivated at all whether employees would be better off.

Almost by definition, employees weren’t better off because they were tasked with having to make investment decisions without the investment expertise available to these large employers.   For more about this, check out Roger Lowenstein‘s new book While America Aged

Are You Financially Savvy Enough to Plan Your Retirement?

Probably not.   Saving, investing, and planning for retirement can be an exercise in futility if you lack the know-how that is required to be successful. While many people may not have the desire or wherewithal to become retirement experts themselves, they must be able to recognize and rely on sound advice. Yet only about 30% of people preparing for retirement are qualified to investment for their retirement.   This is according to the results of the ‘Big Three’ financial literacy questions developed by Drs. Annamaria Lusardi and Olivia S. Mitchell.   They’ve been crafted to test your  understanding of compound interest, the impact of inflation, and risk diversification.   Answer these Big Three Questions and test your own aptitude:

  1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

a. More than $102
b. Exactly $102
c. Less than $102
d. Do not know

2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?

a. More than today
b. Exactly the same as today
c. Less than today
d. Do not know

3.  Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”

a. True
b. False
c. Do not know

The correct answers are …a., c., and b.   If you’ve answered all three correctly, then you might have the capability to make informed investment decisions.  If you didn’t……well then you will need help.   Professional help.

How to Find Retirement Investment Assistance

The Federal government has created a webpage with retirement tools for investors….but it is sorely lacking.

CNN Money has surveyed some retirement assistance options for all consumers.    They include some  online resources and online calculators to get started with the planning process.   Your employer may offer some free seminars or classes on retirement planning that you should take advantage of. Check with your human resources department. Many 401(k) plans also offer varying types of advice and guidance, ranging from tools and calculators to help you plan, to target-date funds or managed accounts.  You might also have access to a financial adviser, although fees can vary widely for managed accounts and advice, so make sure to ask before you sign up.

If you feel you really need some one-on-one help, or you have substantial assets that you feel require professional management, you might want to consider hiring a financial planner.  They often charge up to 1% of the size of your retirement savings.

 

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