Finance: 401(k) PLANS
THE CREAM OF THE CROP IN PENSIONS, TOO
The Business Week 50 show imagination in helping employees plan for retirement
Two months ago, we introduced the BUSINESS WEEK 50, an elite group of companies culled from an already elite group, the Standard & Poor's 500. To make the list, the companies had to meet high standards on such criteria as sales growth, profit growth, and return to shareholders. Their innovation and initiative in such areas as technology and marketing helped them get to the front of the pack. Well, we wondered, are these companies just as forward-looking when it comes to providing retirement programs for the employees who contribute mightily to their success? More specifically, how good are their 401(k) plans?
The 401(k) is becoming the principal retirement vehicle for U.S. companies and their workers. This defined-contribution pension plan has a major advantage for today's mobile workforce: Employees don't have to hang around 5 or 10 years to vest. It's also the pension program of choice for most of the newer and faster-growing companies, since there are no lingering liabilities to haunt the company in the decades to come, as might be the case with the traditional defined-benefit plan.
Defined-benefit pension plans account for two-thirds of all employer-based pension and retirement savings, but the 401(k) and other defined-contribution plans are growing at a rate of 12.5% a year, vs. 7.5% for defined-benefit programs, according to Access Research Inc., a Windsor (Conn.) financial-services consulting firm. True, most of the BUSINESS WEEK 50 do not depend solely on the 401(k)s to fund employees' retirement. But, we thought, if these companies are leaders in their industries, perhaps they might also be so in the development of 401(k)s.
We surveyed all 50 companies, including such giants as General Electric and Intel as well as relatively unknown high-achievers such as Andrew and Tyco International. We asked them about the kinds of investment options offered and how plan participants use them. We inquired about employee participation rates, whether companies match contributions, and if so, how much and under what terms. All but 8 of the 50 companies returned the questionnaires. Highlights from the survey are in the table on page 107.
DAILY VALUATION. By and large, the 401(k)s of the BW 50 are excellent programs. We compared the results of the survey against the 1997 Marketplace Update, a national report on the pension plans of small, midsize, and large companies prepared by Access Research. The BW 50 offer more investment options: 8.8, vs. 6.9 for the large-plan group of the Access Research survey. Merrill Lynch & Co., one of the nifty 50, offers 27 choices, but after all, it is in the investment business. Another 13 companies have 10 or more selections in their plans.
BW 50 participants also have higher- than-average allocations to diversified equity investments, 34% vs. 26% (table). Even more striking is that the employees of the BW 50 have 35% of their money in company stock, vs. 26% for those in the Access Research survey. Of course, the BW 50 are all publicly traded. That's not the case with all the companies in the Access Research database.
Perhaps one reason for the strong commitment to equities is that 83% of the companies offer daily valuation of the 401(k)s. On any day an employee can find out what the value of his or her 401(k) plan is. That's a useful feature, especially in volatile markets. And if these participants want to shift their investment options in response to changes in the markets, 86% of the companies allow them to make a change in their investment allocations at any time. Furthermore, 91% of the surveyed companies allow participants to borrow from their 401(k) accounts. The Access Research survey found that only 59% of the large company plans--those with over 1,000 employees--gave participants loan privileges.
But beyond this, some of the BW 50 companies are making innovations in their 401(k) plans that have the potential to make an impact on all defined-contribution programs. Compaq Computer Corp., for instance, working with mutual-fund giant Vanguard Group, developed a 401(k) intranet to make the retirement plan more accessible to employees (page 110).
And Travelers Corp., the insurance and securities giant run by Wall Street whiz Sanford I. Weill, is trying to win regulatory approval for a bold plan to contribute stock options to its employees' 401(k)s. It would work like this: Employees would get options worth 10% of their salary, with a $4,000 limit. Plan participants would be able to exercise up to 20% of their options a year and would have to exercise within 10 years. Participants would not forgo any other match to get the options, since Travelers does not make any contributions to the 401(k).
CARROT APPROACH. The proposal is running into resistance, primarily from the Internal Revenue Service, which is now reconsidering its initial go-ahead. Travelers wants to be able to take a tax deduction equal to the market value of the options, just as the company would with cash or stock. Stock options as normally granted are not tax-deductible. Unlike cash or stock contributions, there's virtually no up-front cost to the company in granting options. To implement the options plan, Travelers will also need to obtain approval from the Labor Dept.
While many companies elsewhere use videos, seminars, and even prizes to encourage employees to participate in the 401(k), some of the BW 50 are taking bolder approaches. Federal Home Loan Mortgage Corp. enrolls newcomers in the 401(k) and withholds 3% of salary as the employee's contribution unless the employee specifically opts out.
Amgen Inc. and MBNA Corp. get 100% participation by automatically enrolling employees and making the contribution for them. "It's intended to encourage people who do not initially participate on a voluntary basis to do so later when they see what they can receive through tax-deferred compound earnings," says David W. Spartin, vice-chairman of MBNA America Bank, a credit-card issuer. The company kicks in an amount equivalent to 1% of salary for those who don't participate. For those who do--some 80% make their own contributions--the company matches 50% on the first 6%. Amgen goes even further, with a 3% contribution to the 401(k). That ensures that those who can't afford to make any contributions don't get left behind. David Boyd, a 40-year-old marketing manager for Amgen, contributes 10% of his salary to the 401(k), but he didn't always. "I started and stopped quite a few times, mostly because I didn't have the cash flow," says Boyd.
About 92% of Amgen employees do make contributions from their own paychecks, and for them the company match is 100% of the employee's contribution up to 5% of salary--a relatively rich plan. Debra Costa, associate director of human resources at Amgen, says the 401(k) is a strategic tool to compete for top personnel against companies that often have defined-benefit plans as well. "We're in a recruitment mode, hiring new staff," she says. "We have to be competitive with large pharmaceutical companies, biotech companies, and high-tech companies in general."
In judging 401(k)s, it's important to remember that they are only part of a larger benefits package. Schering-Plough Corp. does not match employee contributions because it funds a tax-deferred profit-sharing program that can award up to 15% of a participant's pay. Intel, unlike most of the other high-tech BW 50 companies, does have a defined-benefit pension plan. Columbia HCA/Healthcare Corp. doesn't have a defined-benefit plan, and it shows the lowest 401(k) participation rate, 37.6%, in the BW survey. However, the hospital-management company does run two other defined-contribution plans with $27 billion in assets "with a large participation rate," says a company spokesperson, who adds that company officials are not concerned about the lack of interest in the 401(k).
Perhaps one of the most striking things about the 401(k)s of the BUSINESS WEEK 50 is the large amount held in company stock. In part, this comes about because 38% of the companies will match an employee's contribution only with company stock. Johnson & Johnson puts one-third of its match in company stock, and employees have the choice of how to invest the remainder. Phillips Petroleum Co. matches 25% if the employee is investing in company stock. Otherwise, it's 15%. Abbott Laboratories, Bristol-Myers Squibb, and Merck match in company stock but do allow those employees close to retirement to choose other investment options for their matching funds.
Indeed, in some companies, even when employees have the choice of other investment options, they tend to go for what they know. Look at Abbott Labs. Until January, 1996, employees had no choice: All of the 401(k) money went into company stock. Then the company added four investment choices and the chance to reallocate. Today, 68% of the employees' regular investment still goes toward stock and the total plan remains 90% invested in Abbott shares.
WHO KNOWS BEST? "We gave people a door to diversification, and almost no one went through it," says William H.S. Preece, director of retirement funds at Abbott Labs. "What people have done defies all that they teach you in business school, but when you look at the results, you can't say it was a bad decision." In the last 16 months, the company's stock has outperformed the s&p 500 by 50%.
Nor is Abbott Labs all that unique. Since 1981, the stock of Merck & Co. has delivered three times the return of those in the s&p 500. So even if a Merck employee had his or her money spread among several different investment options, the Merck portion, because of the appreciation of the stock, would, over time, weigh more heavily in the 401(k) retirement plan.
Of course, not everybody works for a BW 50 company. But even if you do, remember that the fortunes of companies change. It's still smart to diversify your 401(k) plan.By Jeffrey M. Laderman in New York, with Larry Armstrong in Los Angeles, Joseph Weber in Philadelphia, Nicole Harris in Atlanta, Leah Nathans Spiro in New York, and bureau reportsReturn to top