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Benefits Column

Feeling Good About Retirement?

A lot has changed in the past 25 years when it comes to company-sponsored retirement programs. In this column, Harnett explores the roots of the current shift from defined-benefit to defined-contribution plans, and notes that innovation in core retirement design is at an ebb point right now.

Tuesday, July 6, 2010
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My dad had a great philosophy when it came to retirement. "Build a life you never want to retire from," he always said.

His viewpoint was in stark contrast to many of my parents' friends and neighbors who held government-related jobs and traded better compensation for richer pension benefits. I remember many of those adults bemoaning their work lives and dreaming about their post-retirement years.

It's a good thing most of them are out of the workforce. A June 19 New York Times article says many states are cutting back on their pension benefits as they fight to stay fiscally solvent.

As HR leaders, you know the government is simply following the lead of private-sector employers.

How did the concept of pensions get started? It was a government idea. From the time of the Roman Empire through the Civil War, most pensions were extended to soldiers who became disabled through battle injuries.

In 1875, the American Express Co. created the first non-government pension plan for employees, but it was Alfred Dolge, a felt and piano manufacturer, who envisioned the modern company pension.

Dolge established a pension fund designed to provide from 50 to 100 percent of wages to long-term employees who could no longer work due to disability, which often coincided with advanced age. The company withheld one percent of each worker's pay, placed it in the fund and added six percent interest each year.

So, why did businesses become invested in their workers' financial security? Some believe it stemmed from the nation's shift away from an agricultural society as well as the 10-year increase in average lifespan between 1900 and 1930.

In 1920, for the first time, more people lived in cities than on farms. Employed workers' incomes were now threatened by recessions, layoffs and failed businesses. This social change coupled with people living longer made them increasingly fragile economically.

Many employers became comfortable with their paternalistic roles in providing defined benefit plans for employees. In 1985, according to Towers Watson research, 89 Fortune 100 companies offered a traditional DB plan to newly hired employees, while 11 offered account-based plans (hybrid and defined contribution).

A lot changed in the last 25 years. Mike Archer, a principal and North American retirement leader for Towers Watson explains that, "the capital-market crises in 2002 and 2008, new legislation and regulatory requirements plus a need in some industries to reduce benefits to compete in the global market" played a role in only 17 Fortune 100 companies today providing new employees with a traditional DB plan.

Ray Goldberg, vice president of benefits strategy and economics at Marsh & McLennan Companies Inc., says, "there are four key risks associated with retirement planning: contribution risk, investment risk, longevity risk and interest rate risk."

"As employers shift from DB to DC plans, these risks mostly shift to employees," Goldberg continues. "But most employers share the contribution risk -- or saving enough money -- by adding dollars to the employee's account."

But, do employers bear any unforeseen workforce implications when they shift away from traditional pension plans? Archer indicates there are at least two.

"Most DC accounts have heavy equity allocations," Archer says. "With this investment mix, people don't retire when the market is down. And employers usually want employees to retire when the economy is bad and there's high unemployment."

The other issue facing employers is that "employee engagement plummets when defined benefit plans are reduced or eliminated," Archer says. "It's not a permanent reaction, but it is a distraction."

One consideration for employers who would like to or need to retain a traditional pension plan is to invest with less volatility by placing more money in bonds.

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Innovation in core retirement design is at an ebb point right now. Cash balance plans were seen as a great innovation but, according to additional Towers Watson research, legal and regulatory uncertainties discouraged many employers from converting to or creating hybrid plans. The shift to defined contribution-only approaches accelerated as a result.

And that leaves a lot of employees with a DC plan as their primary retirement saving option. Participation can vary depending upon age, income and profession with at least one in four employees opting out.

A potential plan-design innovation from Archer is to allow employees to choose each year between a cash balance and DC fund. "This would allow employees to tailor compensation to their own needs," Archer says.

As HR executives, you've tried to help your employees fight the urge to spend now instead of save for later with auto-enrollment and auto-escalation strategies. You've also put interactive education programs in place and offered target-date funds as an alternative to employees actively managing their investment choices. Some of you removed the loan capability from your DC plans. Others created a 70 percent employer match on the first eight percent invested, instead of 100 percent on the first six percent.

But it's hard to protect employees from themselves. As Archer summarized, "Defined contribution plans have inherent workforce-management issues and allow for leakage. You can design a lot of that away, but not all of it."

As for me, I'm glad I decided to follow in my father's footsteps. I'll continue to save, continue to work and hope to build a life where I never have to consider full retirement.

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