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Most Workers Need 401(K) Guidance

February 29, 2016 Mickey Roth, For the Express-News : January 3, 2014
Most Workers Need 401(K) Guidance

A perennially hot topic among investors and investment writers is retirement. I recently glanced at a newspaper article on this subject that was raising two red flags:

  • Many companies have already discontinued their pension plans, and this is clearly a trend.
  • Then, it noted, that by 2030 the Social Security System's Trust Fund will be depleted.

  • These are, indeed, significant items, but they are not as dire as the writer of this article presented them. Providing financial plans for retirement is a true challenge, and sometimes we need to modify those plans.
  • Let's look first at Social Security.

    In 1981, in the midst of a severe financial situation, Congress took a truly brilliant move. The Social Security System, which is funded by taxes deducted from just about every American's paychecks, was running a deficit. So they took the step of raising the Social Security tax slightly in order to balance the system's budget. But then they did something else. A few senators looked into the future and perceived that the “baby boom” was a bubble running through our population. (These were the abnormally large number of births following our WWII soldiers' return home.)

    This population bubble would begin drawing Social Security around 2015, and it made sense to financially recognize this in 1981 with a very modest extra bit of Social Security tax. This increment of tax revenue is what has become the Social Security Trust Fund.

    Therefore, it makes perfect sense, that between 2015 and 2030, this fund will be mostly depleted simply by doing what it was created for. And, this certainly does not raise a red flag for retirees. But, the fact that very many companies are dropping their pension plans is quite another concern.

    Company pension plans have long been wonderful employment benefits of private employers. All of their employees, from president to clerk, were entitled, upon reaching retirement age, to receive monthly cash payments that were a significant percentage of their salary at retirement age. For these recipients, a pension was something that, at least, came very close to allowing them to maintain much of their lifestyle after quitting work. A key part of this is the fact that, generally, the payments from a pension are adjusted upward annually to compensate for inflation. But, pensions are a significant burden for companies sponsoring them, and it is apparent that many of those companies have perceived something new in the retirement arena.

    That “something new” is IRAs and 401(k)s. Perhaps the main benefit companies perceive with these plans is that the bulk of the burden in them lies with the individual; not with the company. Whereas pensions require great legal structure and oversight as well as absolutely prudent investment, in IRAs and 401(k)s, most of these responsibilities lie with the employees. And pensions constitute major financial burdens that must be borne by the company offering them. So, it is quite obvious that very many companies have made the decision to cut their expenses significantly by ceasing to offer new employees a pension and thrusting the burden and challenge to financing retirement totally onto those employees.

    Employees, most of whom have little knowledge of the nature of an investment account, are now charged with running the portfolios that will fund their retirement. And, all of the facets of those portfolios (e.g. expected return, investment risk, asset allocation choices and so on) rest with these generally very naïve investors. It saves their employers the expense of a pension plan, but these workers truly need some assistance. They must understand that there are several very important things they must grasp and carry out;

  • There must be monthly contributions to their retirement fund.
  • Those contributions must be invested in a wisely diversified way.
  • As the retirement fund grows they must not dip into it before retirement.
  • The fund should have an asset allocation that gives a decent return with tolerable risk.
  • And when they retire, their annual distribution from their fund should be a percentage of market value that is less than their expected return.
  • Since these ideas may be beyond the comprehension of many employees, they would do well to consult with a bank or a mutual fund company for guidance in this complex arena.

    Or, perhaps these should be another approach to this complexity. It would make sense to require that, if a company terminates its pension arrangement, then it must, at the least, provide guidance to its employees so that their IRAs and 401(k)s have adequate expected returns that are achieved with reasonable levels of risk. And the distributions must be reasonable and not deplete the fund.

    The bottom line here is that Social Security is okay, but very many employees of companies that are terminating their pension plans are going to need very good and very personal guidance.

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