Pension Trends   Volume X, No. 1, March 2009   

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In this issue...

No Rabbit in the Hat
          

No Rabbit in the Hat

The numbers are staggering. By some estimates, Americans lost $10 trillion of wealth in 2008. Whether any of us can conceptualize just how big $10 trillion is, we each have a pretty good idea what our share of that loss is. And, what is more important, we have come to realize that the loss is real; no magic or abracadabra will instantly bring our investment portfolios back to where they were only a year ago.

Just as most experts expect real estate values to rise from today’s prices at something close to the rate of inflation rather than bounce right back to pre-crash prices, a rapid stock market correction is also unlikely. So, if this is the new economic reality, not merely a severe glitch, how do you adjust your plans for your retirement? Here are some practical actions plan participants and plan sponsors might want to consider.

Plan Participants

If you are plan participant in a defined benefit plan, you are among the lucky ones. Unlike participants in 401(k) plans, the value of your accrued benefit (the benefit you have accumulated to-date) has not decreased. For many of you, you have the added protection of your accrued benefit being insured by the Pension Benefit Guaranty Corporation.

What is not guaranteed is that your employer can afford and is willing to continue to add new benefit accruals each year. In most instances, it is within the employer’s authority to freeze the plan and cease future accruals. Since this is outside your control there is nothing you can or should do.

If you are a participant in a defined contribution plan (for example, a 401(k) or profit sharing plan) you have probably seen a 24% to 40% decrease in the value of your account. Whether you are 24 or 64 years old, if you “do the math” you will see that if you once expected to have enough in your account to retire at a reasonable standard of living at age 65, it is now much more likely that you will have to wait until age 67 or 68 to achieve that same standard of living. Delaying retirement, albeit an undesirable result, is one way you can still achieve your retirement goals.

An alternative is to increase the amount you are contributing to your 401(k) plan and try to catch up to your original target of retiring at age 65. Increasing your 401(k) contributions now rather than waiting for a few years is tremendously valuable. Again, if you “do the math,” $1 contributed to your 401(k) plan today can be worth $2 contributed just a few years later.

A third strategy is working after retirement. For example, rather than delay your retirement, go ahead and retire at age 65. However, rather than immediately collecting your social security benefits, plan to work part-time for a few years to supplement your income. Waiting two years to collect your social security benefits can add several hundred dollars to your monthly social security checks.

Plan Sponsors

In difficult economic times like these, most plan sponsors are concerned about the cost of doing business, including the contributions they make for employees to a retirement plan.

For sponsors of defined contribution plans, there is usually no requirement that a plan sponsor make a contribution. It is generally at the discretion of the plan sponsor whether to contribute to the plan each year, but you should check your plan to be sure. Some plan sponsors have written into their plan or have communicated to employees that they will or expect to make a matching contribution each year. If your 401(k) plan requires that you make matching contributions, the plan can be amended to temporarily freeze or eliminate that provision. Depending on the plan’s wording, you may be obligated to make a matching contribution for the portion of the plan year that has transpired prior to amendment, so waiting to the end of the year may be too late.

If a 401(k) plan does not require matching contributions, but the plan sponsor has regularly made discretionary matching contributions, then employees may have come to expect a matching contribution each year. In such a situation, effective communication to employees regarding the suspension of matching contributions is key. In many cases, employees are grateful they still have a job and don’t begrudge losing a matching contribution, but we are still encouraging our clients to make efforts to explain any necessary changes to their retirement plans.

For sponsors of defined benefit plans, there are two alternative approaches for dealing with the drop in the value of their plan assets due to the bear market.

One approach is to lower or freeze benefits. This has the affect of reducing or eliminating future contributions to the plan. The reduction can be temporary or permanent. But—and this is key—changes to benefits in a defined benefit plan can only be prospective. Generally, after an employee works 1000 hours in a year, a benefit cannot be taken away. So, if the intent is to reduce costs, taking the formal actions necessary to reduce future benefit accruals should be done by mid-May to assure the change is effective before employees work 1000 hours (some plans require less than 1000 hours; such an amendment must be effective earlier in that case).

For some of our clients – small business owners who sponsor defined benefit plans – the goal is not to reduce costs since all or the vast majority of each dollar that goes into the plan is for the ultimate benefit of the business owner. These plan sponsors are in the unique position of having the opportunity to control their own retirement destiny. Regardless of how much the stock market drops, a small business owner who sponsors a defined benefit plan can retire when intended with the amount of retirement income intended. This result is achieved by making additional contributions between now and retirement to make up for investment losses. This may or may not be financially doable today or tomorrow, but it remains a viable option.

Contribution limits for defined contribution plans effectively take away this option for small business owners who sponsor 401(k) plans; it simply may not be possible to increase contributions enough to make up the difference.

What Not To Do

In addition to discussing some proactive steps you or your client may want to consider, we close with a reminder of two things not to do:

1. If you or your client sponsors a defined benefit plan, do not wait until the end of the year to tell your actuary you want to make a smaller contribution this year. Let the actuary know before your employees work 1000 hours.
    
2. In our opinion (and that of many others) it is not likely that the stock markets will recover to the point that participants in 401(k) and other defined contribution plans can sit back and wait for their accounts to catch up with their original retirement goals. The adage that “hope is not a plan” applies to the predicament that 401(k) participants find themselves in today. You will need to develop a new strategy to achieve your retirement goals.

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This newsletter has been published in order to share general information with our professional contacts. The information presented in this newsletter should not be acted upon without first seeking the advice of a CPA, attorney or other benefit professional. 

Pension Trends, Volume X, No. 1, March 2009
Copyright © 2009 Independent Actuaries, Inc.