American retirement increasingly rides the market

As Americans increasingly focus their attention on the future of Social Security, a growing number of states and companies are also looking at the health of their own retirement plans - and pushing further away from traditional paid benefits in favor of models more akin to President Bush's.

It's an approach that's been building in the private sector since the 1990s, punctuated by the likes of IBM closing fully paid plans to new workers and steering them instead toward personal accounts. States, too, have been moving toward systems that expose retirees to stock-market risk but cost the employer less. Michigan has a program in place. California and as many as seven other states may follow suit.

The debate over personal accounts in Social Security, in short, is being shaped in part by broad changes in the nation's retirement landscape, not just by perceptions of the federal program's health. This debate pits the popularity that 401(k) style plans enjoy with many Americans against the worries of many others that their retirement security is eroding on more than one front.

Some of the factors driving the trend in states and businesses are different from those in the Social Security debate. Yet the momentum for change, from governors' mansions to the corporate boardroom, speaks to a broad reevaluation of whether the generous network of pension systems evolved generations ago can and should survive amid modern economic pressures.

"It's a question of retirement-income policy for the whole country," says Donald Segal of the American Academy of Actuaries' pension practice council.

In the 1990s, with workers becoming increasingly mobile and the stock market setting new records, many state and private employees came to believe that they could manage their retirement money better than their pension fund, which favored workers who stay with one employer for many years. Six states responded with pension plans that offered optional personal accounts or hybrids of personal accounts and traditional paid benefits. Michigan went so far as to close its old plan for all new employees.

States remain eager to move more people toward stock-market accounts. The reason is simple: to save money. But in today's more tepid stock climate, workers aren't necessarily eager to invest. In Florida, 4 percent of workers who have a choice are enrolled in private accounts.

Unlike Social Security, which is funded by workers' and employers' contributions, state and business pensions are funded in large part by state investments in the stock market During the past 15 years, the percentage of state pension assets invested in stocks has risen from 40 to 60 percent.

The shift has made pension plans more vulnerable to the vacillations of Wall Street. For employers, private accounts are seen as a way to lessen that uncertainty - and cap their obligations in an era when life-spans are increasing and baby boomers are poised to retire.

That's because traditional pensions, known as defined-benefit plans, guarantee employees a certain retirement income, regardless of how stocks perform. If they nosedive, as happened recently, then the state must make up the difference.

By contrast, with private accounts, also called defined-contribution plans, the employer pays a set amount into an employee's retirement account, and the employee invests in any one of a dozen or so portfolios approved by the state - leaving the employee on the hook if stocks fall.

"It's a cost-saving mechanism," says John Ehrhardt of Milliman, an actuarial consulting firm in New York. "States need predictability in their cost structures."

For states already wrestling with billion-dollar deficits, the new pension burden can be significant. In California, the state paid $160 million to the California Public Employees' Retirement System in 2000. This year, it is expected to pay $2.6 billion. That led Gov. Arnold Schwarzenegger to propose a solution like Michigan's: All new public employees go to a private-account system. Seven other states from Virginia to Alaska are either considering bills on the issue or are conducting studies.

The same forces are at work in business. Some 13 percent of firms surveyed by Aon Consulting in 2003 had instituted a freeze on their defined-benefit plans during the previous two years and 6 percent more were considering the step. It's not that companies are eager to abandon the old benefit system. That system "is the most efficient way to provide benefits," says Mr. Ehrhardt, suggesting it's often difficult for employers, as well as workers, to keep tabs on personal accounts.

But many firms believe they have no choice. The unprecedented drop of both stock prices and interest rates led some financial officers to embrace private accounts as a hedge against future downturns. Moreover, many old-line companies with aging workforces are finding it hard to compete with newer companies, which often keep costs down with 401(k)s.

In Michigan, some people eye plans like Governor Schwarzenegger's warily. "A lot of people don't have the expertise [to invest wisely], and defined-contribution plans are not a cure for everything," says Michael Reaves of the Michigan Association of Public Employee Retirement Systems.