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Friday, October 28, 2005

The Pension risk

In the last few years, about 200 to 2005, pension plans have become a wasted effort in the eyes of employers. Companies can’t afford the programs, and are "dumping" them at an alarming rate. Of the several reason why companies "dump" their plans is the continuous pay out and long run debt that is acquired by having the plans. Another is that Congress is encouraging companies to drop pensions and go towards defined-contribution plans. Congress has created laws that prevent workers from suing for their "entitled" money.

All the while CEO’s are retiring in rapid numbers and receiving huge lump sum retirement packages. Take Leo Mullin, former CEO of United AirLines, who received a $16 million retirement package. A package that said he worked 28.5 years, when only 21 years were actually worked. CEO’s have benefit programs that allow them to receive bonus years when retiring. These CEO’s are retiring before their packages are no long available, while their workers don’t have any idea and are left to chance.
People today are being told "you are on your own for retirement," but they hear this too late in the game for it to be of any use to them.

What I want to know is how this is an efficient way of running a company? Pension plans are in general viewed as being a substitute for wages. Companies have to agree on the promised contribution (e.g., 5 percent of salary or wages) each year. If the firm owns the pension fund the firm should choose the funding and portfolio strategy with the highest net present value to it. This leads to two polar-opposite solutions: underfund and buy risky assets, or overfund and buy high-grade bonds. Firms are only allowed to dump pension plans is if the pension fun is greater than the amount or benefit acquired by the bankruptcy. Pension plans are costly for companies in the long run and the short run. The long run is the actual pay out of several people, who retire with in time frames, not just one person, but general age groups. In the short run the cost of setting aside money, that in all rights isn’t there, is enough of a reason to avoid pay outs of any kind. The tax write off that employee’s benefit from is one of the main reason why people liked pension plans. Their money wouldn’t be cut and divided into smaller amounts.
The more companies that dump their pension plans onto the PBGC, which is the Pension Benefit Guaranty Corporation, the bigger the burden it is for other industries to keep carrying pension plans. It’s a continuous downfall, as more and more pensions are dumped, more weight is put on other companies and more money is needed for the programs, which in turn lead to them being dumped as well.

One might say that there should be a law against this… well there is, in a way. When Studebaker fell they went back on promises of pension, which lead congress to make the ERISA, which is the Employee Retirement Income Security Act of 1974. This Act established minimum standards for retirement plans and created the PBGC to guarantee them. However the PBGC is not founded by taxpayers. It’s a volunteer funded program that has too much falling down on it. Its duties have become so extensive in minor pay outs that’s its going to collapse in less than 3 years, or so its believed. In order to keep going PBGC would need a multi-billion dollar taxpayer bailout, which won’t be happening given its requirements of funding. The congress that created the program will avoid all please for help and let the program fall apart leaving millions of Americans with no money and not way to survive their retirement.

Congress was been pushing the use of the 401(k) system, which was never intending to be a retirement program. It was a tax break out that congress awarded to executives. We have seen just how unsafe it is by the Enron disaster. People can’t rely on a program that is all guesswork, but then again that’s what pension plans have become.

The more large companies file for bankruptcy the worse the market will get, or so that how I see it. Large companies can’t keep themselves afloat because of its workers. Programs are "dumped" and employees are lost or fired due to being laid off. Unemployment goes up and more money is put out in the form of unemployment checks. The amount of money needed to support pension recovery programs will make taxes increase, and less spending. If the idea alone of saving money for a retirement you can’t plan for anymore isn’t enough to make people spend less. I see the whole "dumping" of pensions to be a huge economic problem and not just for the people you are losing their only source of income.

Why do companies provide retirement plans or health benefits rather than just give us a large rate of pay? It appears to be driven by tax law. There are advantages to both employer and employee to put money through these channels to reduce tax liability, but only because of tax law.

Why not just pay employees the full amount and have them invest the money themselves? The only reason not to is lack of faith that people will actually make the investment.

What is a retirement plan? It is nothing but a promisory note from SOMEBODY to pay out money at a later time. This can only work if the money exists. If the money is to come from a particular company, they must fund it from their own revenue stream OR from some sort of investment portfolio.

A friend of mine pointed out that if you depend on the same company for both job and pension, you have very poor diversification of your assets. If that one company goes under, you are truly hung out to dry. If are so foolish as to also invest in their stock to the exclusion of other investments you are even more exposed. This was the case with Enron - at least in part due to choices on the part of the employees themselves.

When given a choice, I chose a defined contribution plan because the money in it was in MY name. It could not be defined down or diluted. I have invested it in several diversified funds. I am very glad I did because I can choose the level of risk and, barring government interference, it is MY MONEY. No bankruptcy can get it all.

A simple maximization of present value is not enough. You must allow for some risk control so that you always protect the principle, especially if you can't afford to wait out a downturn.
You assert that 401k was intended for executives. Is there a source for this? you got me curious, but all I have turned up so far is this http://www.401khelpcenter.com/401k/whitehouse_origin_of_401k.html
I have an article from time that was talking about it. will find it and let you know. I can't for the life of me remember its title, but I will get back to you on the investors thing.
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