Redrawing the Route to Retirement
Ken Eason, 57, recently made what he describes as "one of the major financial decisions" of his life. The accountant's employer, Devon Energy (DVN), had offered Eason and about 3,400 co-workers an unusual choice: Stick with the company's traditional pension and 401(k) retirement plans or stop the clock on both and switch into a new "super 401(k)."
The new plan would provide workers with employer contributions so generous, a significant number could reasonably expect to do better than they would in the traditional defined-benefit pension plan. In return, employees would have to cede to the Oklahoma City company much of the control over their investment decisions. Eason and other Devon employees had until the end of the fall benefits enrollment season to make up their minds. Once the Nov. 15 deadline passed, their decisions were irrevocable. "It's a very tough choice," said Kim Wilkerson, 46, a manager who oversees alliances with other oil and gas companies.
Devon's new super 401(k) is at the cutting edge of a trend that's reshaping retirement benefits. Traditionally, employees have wielded decision-making authority over their own 401(k)s, by electing whether and how to invest. But as a growing number of employers have scaled back or eliminated defined-benefit pension plans, government and corporate policymakers have realized 401(k) participants haven't done a very good job of managing their savings. Emboldened by recent legal and regulatory changes that shield employers from lawsuits, more are starting to make changes to 401(k) plans with the goal of taking the decision-making out of employees' hands. "It's the wave of the future," said Jack L. VanDerhei, research director of the Fellows Program at the nonprofit Employee Benefit Research Institute.
As a result, these new 401(k)s are starting to look more like a traditional pension plan, in which the company makes decisions about funding and investments. The big difference, of course, is that if the investments don't work out, it's the employee's problem, not the company's. Some 34% of employers are automatically enrolling workers in their 401(k) plans. Many are funneling these contributions into diversified investment programs, most of which automatically become more conservative as retirement nears. About 35% are also prodding employees to agree up front to divert a larger percentage of their salaries each year into the 401(k). The goal is to get everyone to kick in enough to qualify for the maximum in matching funds from the company. Employees can opt out of any of these plan features, but few do.
Not many companies are going as far as Devon. Come Jan. 1 the company will set up accounts for employees who switched over from the traditional pension plan. It will also start automatically enrolling new employees--who are ineligible for the old pension plan--in the new 401(k) at a 3% contribution level.
Rather than rely on employees to take the initiative to save, Devon plans to save for them--by making annual contributions to these accounts in line with what it would have spent to provide a traditional pension benefit. Depending on an employee's tenure, the company will put 8% to 16% of annual compensation into the 401(k)--regardless of whether the employee kicks in a dime. For those who put money into the plan, the company will also match it dollar for dollar up to 6% of salary.
Add it all up, and Devon workers who divert 6% of their pay into the super 401(k) could receive as much as 22% per year from the company. While many companies that freeze pensions increase their 401(k) contributions, Devon "is one of the few coming close" to what's required to compensate employees for the loss of a pension, said EBRI's VanDerhei.
Why is Devon being so generous? Devon does not expect to save money by switching plans, but like many companies it's looking to decrease the pension liabilities on its books.
But it has another agenda: Amid boom times for the oil and gas industry, the company is facing a labor shortage that is expected to become more acute over the next decade as 57% of its U.S. workforce becomes eligible to retire. HR executives are betting the super 401(k) will be attractive to younger workers, whose preferences for defined-contribution over defined-benefit plans are well documented, in part because they can take the money with them if they change jobs.
In return for its largesse, Devon plans to impose an unusual degree of control over how its contributions are invested. Under the new plan, employees are required to use "target date" funds. Already available in many 401(k)s, the funds recently got a big boost when the U.S. Labor Dept. approved their use as a default investment for accounts established under automatic enrollment programs. Designed to provide workers with all they need within one portfolio, the funds put investing on autopilot: Employees simply select the fund that most closely matches their expected retirement date and the funds' managers do the rest of the work, by shifting into a more conservative mix of stocks, bonds, and other asset classes as retirement approaches. Devon's target-date funds will consist of low-cost investments in its $614million defined-benefit pension plan, including alternative investments such as real estate investment trusts and inflation-indexed securities.
The company is even trying to help employees with their finances beyond the 401(k). Like a growing number of companies, including IBM (IBM), Devon is making free one-on-one counseling sessions with financial planners available to employees. The advice will come from a Fidelity Investments division that administers 401(k) plans, including Devon's. "We want to be sure participants are making smart decisions," says Paul Poley, vice-president for human resources at Devon and one of the plan's main architects.
For Devon employees, the big decision--the new 401(k) vs. an old-style pension--loomed large in the days leading up to the Nov. 15 deadline. On Nov. 12, some 31% had yet to weigh in. "I expected the choice to be obvious," said David Klaassen, internal communications manager. Klaassen, 37, had spent a few hours reading the brochures the company mailed after Aug. 1, complete with a forecast of his projected benefit under each plan, and playing with the online tool actuaries from Towers Perrin designed to help employees crunch the numbers. For Klaassen, like many in the 35-to-45 bracket, the outcome would sometimes change, depending on key assumptions, such as his expected retirement date and investment returns. He chose the old pension plan.
For employees on either end of that age range, the choice tended to be more clear-cut. The vast majority of those under 40 gravitated to the super 401(k). "I have enough time to make up for a downturn," said Marla Freeman, 25, a communications specialist who has already saved $11,500 in her 401(k). Like many in the under-40 crowd, Freeman says she believes she has the potential to earn greater long-term returns in the 401(k) in part because, unlike a pension, the account can continue to grow even after an employee leaves a company.
Scott Coody, 31, a senior investor relations analyst, noted that while he got his "tail kicked" in the bear market of 2000 to 2002, he's more worried that Devon may one day freeze the pension benefits of existing employees like himself: "The pension is perceived as no-risk. But I think it's a little naive to bank on a benefit that's been promised 30 years in the future." Coody, a diligent saver who has already paid off his home, also pointed out that you can name your children to inherit a 401(k), something not possible with a traditional pension.
Kim Wilkerson, 46, who joined the company about three years ago, also went with the new 401(k). With relatively few credits built up in the pension plan, Wilkerson figured the 401(k) gives her a better chance to accumulate a bigger nest egg. Rather than invest in the target date fund for her expected retirement year, Wilkerson said she's likely to pick a fund intended for younger employees. She figured her long-term returns will be greater that way, since she'll have more exposure to equities. "I think I can handle a little more risk."
For most over 50--including accountant Ken Eason--the traditional pension was generally the plan of choice. Because a pension plan multiplies an employee's years of service by the average pay in the final years of work, a large portion of a person's pension is typically based on earnings in the last decade on the job, said Ron Gebhardtsbauer, a senior pension fellow at the American Academy of Actuaries. That's why most older employees would find it hard to replace the additional benefits they would have earned by staying in the old plan. Besides, "with a pension, I'm going to get that check every month," said David Templet, 58, a manager in the environmental health and safety department. "With a 401(k), who knows what the market will do? At my age, it didn't make sense for me to take that risk."