Revolution in the way Americans plan for retirement

In a shift with important implications for baby boomers and the future of the economy, US workers are increasingly preparing for retirement by customizing to their own investment taste specialized savings accounts.

The so-called 401(k) revolution has now reached a point where more workers are putting aside money in these individual but company-provided tax-deferred pension plans than are covered by the long-established corporate retirement funds.

The result is that more and more Americans are now able to manage their own retirement wealth - for better and worse. If, for instance, the stock market were to continue to rise as it has in recent years, many individuals who handle their portfolios wisely may be able to retire early, with a Lexus in the garage. But a dip in the market or some wrong investment could leave them threadbare later in life: more years with the Hyundai, dependent mostly on a minimal Social Security pension.

"If we get into a bear market, the assets in these [401(k)] plans are going to go down," warns San Francisco-based pension consultant Gary Blank, of William M. Mercer Inc. "They may not be adequate."

The Senate plans to vote today on two bills that could boost even further the importance of 401(k) plans. The bills aim primarily to raise the minimum wage by $1 to $6.15 an hour. But pension reform is attached.

One bill, offered by Sen. Edward Kennedy (D) of Massachusetts, would increase the minimum wage 50 cents on Jan. 1, and another 50 cents a year later. It also contains provisions aimed at making it cheaper for smaller companies to set up 401(k) or other pension schemes.

A second bill, proposed by Senate majority leader Trent Lott (R) of Mississippi, stages the minimum-wage boost over three years and includes more ambitious pension-law changes. It, too, reduces costs for small firms wanting to set up plans. In addition, it allows individuals to set aside more wages in 401(k) accounts - $15,000 a year by 2005 instead of $10,000 this year.

In effect, noted one close observer, the Lott bill will potentially trim the profits of owners of small businesses that pay minimum wages. But it will offset this to a degree by allowing these owners to set aside more of their own earnings on a tax-deferred basis.

Most big firms offer employees a combination of a traditional pension and a 401(k) plan. The companies' matching contributions to the 401(k) plans typically amount to a maximum 6 percent of wages.

But standard pension plans are less likely to be offered in high-tech industries. And many medium- and small-size firms offer no pensions at all.

Mr. Blank says he can count "on one hand" the number of Silicon Valley companies offering employees traditional pensions. Most firms instead provide 401(k) plans as their primary retirement tool.

Riding stock market to retirement

If the return on stocks and bonds matches in the future what it has averaged in the past seven decades, the owners of 401(k) plans may do well.

One academic study finds that for today's 39-year-old employee, his or her 401(k) plan may well be worth more when retiring about 2025 than the value at that time of a Social Security pension.

"This is a very significant thing," notes Harvard University economist James Poterba, one of three authors of a new National Bureau of Economic Research (NBER) paper.

In 1996, 30.8 million workers - 30 percent of the private sector - had 401(k) plans, up from 19.5 million in 1990. Traditional corporate pensions covered 23.3 million workers in 1996, government figures show.

This money is managed by the companies. If the stock market bustles and there is a surplus, companies can keep the extra funds and pay corporate the extra funds and pay corporate income tax on them. If the funds are inadequate, the companies must make up the gap to cover their pension obligations.

The pension industry has been lobbying in Congress for a few years for legislation that would make it easier for smaller firms to set up plans, as growth in 401(k)s has slowed to about 9 percent a year.

"The low-hanging fruit has been picked," says Harvard Professor Poterba. Close to 100 percent of companies with 1,000 or more employees offer 401(k) plans.

Baby boomers wary of Social Security

In addition, employees often have been pressing their bosses for 401(k) plans. The stock market boom and stories raising questions about the solvency of Social Security have focused the attention of baby boomers and others on retirement financial security, notes Frank Roach, a principal with Buck Consultants.

Mr. Roach suspects that the Social Security Administration mailing, now under way, to all those covered by Social Security will be a shock to many. It will include an estimate of the size of their pension when they retire.

"It will make people more aware that they can't count on Social Security alone for their retirement," he says.

Even if the high returns offered by the stock market in recent years fade to a more normal 12.7 percent per year, 401(k) plan owners should pile up substantial sums.

Poterba and colleagues David Wise of the NBER and Steven Venti of Dartmouth College, Hanover, N.H., estimate that an average all-stock portfolio could hold assets valued at $181,400 in 1992-value dollars in 2025 and $247,100 in 2035. By comparison, the average Social Security pension value will be $103,400 in 2025 and 2035.

(c) Copyright 1999. The Christian Science Publishing Society