March 16, 2006
Thursday

With the Dow Jones average above 11,000 again and other stock indexes at five-year highs, workers with 401(k)s and other tax-favored retirement accounts may feel emboldened about investment risks and forget the bear market that tanked their accounts.

Do the math on retirement planning By MARY DEIBEL Scripps Howard News Service Temple University retirement expert Jack VanDerhei illustrates why workers need to save through a 401(k) retirement savings plan when traditional pensions are frozen or terminated. Follow his math: A 50-year-old worker who joined the company 20 years ago is making $70,000 this year when the firm freezes pension coverage and replaces it with 401(k) accounts. Assuming the worker gets 3 percent annual raises until retiring at 65: - The employee's final pay at 64 would be $105,881, and the highest three-year average on which the pension is based is $102,827 had the pension plan not been frozen. Multiply $102,827 times 35 years' work times 1 percent payout, and the worker's pension would have been $35,989 had the company continued traditional pension coverage. - But the employee's three years' pay average before the 2006 freeze was only $67,980. So the accrued pension benefit at 65 is only $13,596 a year, or $67,980 times 20 years' work times 1 percent payout. To make up that $22,393 difference - $35,989 less $13,596 - the employee needs a 401(k) balance of $299,536 to buy an annuity that will bridge the pension income gap. To reach that 401(k) balance, VanDerhei calculates that the 50-year-old worker needs 401(k) contributions of 12.7 percent of pay a year for 15 years, through personal contributions, employer match or both. Also, 401(k) stock holdings must produce a healthy 10.4 percent annual return for each of those 15 years. By comparison, the Standard & Poor's index of 500 stocks returned 5 percent last year, one of its better years lately. The Federal Deposit Insurance Corp. insurance limit for retirement accounts run by banks will rise to $250,000 April 1, in time for people preparing their 2005 taxes to contribute to Individual Retirement Accounts for the last tax year under the new limit. That insured-account cap is up from $100,000, where it's been since 1980. The change, also available for credit-union retirement accounts, affects traditional and Roth IRAs, self-directed Keogh accounts and self-directed employer defined-contribution plans, primarily private-sector 401(k) and government-worker 457 plans. Retirement-account insurance is separate from the $100,000 limit that still applies to other deposit insurance and is based on the accounts' ownership. Neither limit guarantees investment results, only insurance against loss should the bank fail. On the Net: www.fdic.gov.

Yet with company after company freezing or ending traditional pension plans in favor of 401(k)s, workers confront a brave new world of retirement planning in which they should ask: "What do I have to save, and how should I invest it, to make up for the monthly check my pension was supposed to provide for life?"

The answer: You need to save lots and invest wisely, Temple University retirement expert Jack VanDerhei reports in a new study for the Employee Benefit Research Institute.

To be sure, the answer depends on individual factors including age, income, tenure with the firm, pension type, investment choices offered by its replacement and investment returns those options earn.

Still, VanDerhei illustrates the problem by pointing to a 50-year-old worker who has 20 years with a company and makes $70,000 this year, when the firm freezes pension coverage and replaces it with 401(k) accounts. So instead of collecting the $35,989 pension on retiring at 65, the freeze cuts that yearly pension benefit to $13,596.

To make up the pension shortfall, the employee's 401(k) contributions each of the next 14 years must be 12.7 percent of pay to produce a 401(k) balance of $299,536 to buy an annuity that will bridge the retirement income gap, VanDerhei calculates.

Yet few Americans save that much that regularly in their retirement accounts, and fewer still get that sort of return, to judge by the Federal Reserve's survey of consumer finances, the most detailed measure of Americans' family wealth.

According to the latest triennial Fed survey released this month, families who saved anything the previous year fell by more than 3 percent, to 56.1 percent of families, while their real before-tax income fell 2.3 percent on average from 2001 through 2003.

At the same time, the percent of families with 401(k)s and other retirement accounts fell 2.5 percent, while the number of workers eligible for these plans dropped as well, and workers ages 55 to 64 - those closest to retirement - had median balances of just $60,000.

"God knows what people will do if they're handed $60,000 at retirement," says Alicia Munnell, director of the Center for Retirement Research at Boston College and a former Federal Reserve and Treasury official.

It would be one thing if this were a new trend; but it follows on the 1998-2001 Fed survey that also found 401(k) accounts came up short even at the height of the 1990s bull stock market.

However, "these plans have shifted all the risk and responsibilities for retirement savings from the employer to the employee, and many employees make mistakes every step along the way," the Boston College center concludes in analyzing the Fed surveys.

Munnell says modest steps may undo some mistakes:

- House and Senate pension bills let employers automatically enroll workers in 401(k) plans with a starting contribution of 3 percent of pay in hopes of reversing the current situation where a third of workers don't participate.

- Also, employers will automatically roll 401(k) balances between $1,000 and $4,000 into Individual Retirement Accounts when employees quit. Currently, only balances of $4,000 must be rolled over into an IRA, so many job-hoppers cash out and have no retirement savings.

A third proposal bothers Munnell, however: The House-passed plan authored by Republican leader John Boehner of Ohio to let the same mutual-fund company that runs the 401(k) plan advise which funds individual employees should buy and sell and how their portfolios should be balanced so long as potential conflicts-of-interest are disclosed.

Boehner warns that the Senate's insistence on independent advisers "equals no new advice for America's workers" if it increases employer costs and red tape.

Senators led by Jeff Bingaman, D-N.M., have blocked the House version before and hope to do so again when House-Senate negotiations resume after the St. Patrick's Day recess. Instead, Bingaman would shield employers from liability if they hire and monitor independent 401(k) investment advisers to work with their employees.

Munnell considers independent advice and education essential if workers handling retirement security risks on their own are to invest wisely and avoid panic, something she confides she knows too well.

"I buy high and sell low," she says. "I do it when I see the Dow plunge even though I know better."

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