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How Promising Are Pension Plans?

For example, a k-plan investor who had a target of, say, 70 percent stocks and 30 percent bonds in 1995 might have found by year-end that he actually had close to 80 percent of his total investment in stocks, simply because the value of the stocks had grown so much at that point. Rebalancing to regain his target of 70/30 would call for him to sell some stocks and put the money into bonds. This would lock in those winnings, but would also reduce future returns if stocks continued up -- as, it turned out, they did.

On the other hand, a rebalancer would have had more bonds, which did better when stocks slumped, and indeed even rose in value as interest rates sank. Thus, from 2000 through 2002, traditional pensions, with their professional management, a bit more than caught up.

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"My guess is, when you plug in the 2003 numbers," which are not yet available but would include a big stock rally, "you'll see a bit of what happened in 2002 starting to reverse itself again," Schieber said.

The numbers do show the value of rebalancing, particularly as you get older. The discipline of the process not only captures price spikes in the different investment categories, it smooths out return volatility a bit. And 401(k) plan participants need to remember that when they reach retirement and start making withdrawals and using that money to live on, it gets harder and harder to recoup losses in down markets.

Now, back to why traditional pension plans seem to be in trouble and 401(k)s do not.

One obvious explanation is that there is nothing specific to measure 401(k)s against. Traditional plans are called "defined benefit" plans for a reason. They include a formula that defines how much of a pension a retiree in one of these plans is entitled to. It's often a percentage of pay times the number of years the employee has worked for the company.

It's possible to add up those future payments and figure how much they are worth in today's terms -- their "present value." If that present value is greater than the value of the plan's investments, then the plan is "underfunded" and will not be able to make the promised payments unless markets improve and/or the employer ponies up more money, sometimes a lot more money.

If the employer is itself in trouble, as United Airlines is, it can't do that, and the plan lands in the lap of the government's pension insurance agency, which itself is now underfunded.

Now, it should be said that a great many traditional pension plans are not in trouble. Many are fully funded, despite the downturn, and others are operated by healthy, profitable companies that can make up the shortfalls. But there are enough underfunded plans operated by troubled companies to spell big potential trouble for the system.

In the case of 401(k)s, there is no "promise." Whatever it adds up to at retirement is what you get. It seems clear that a certain number of k-plan participants will find themselves short in their later years, but it's hard to gauge how many.

Schieber, however, suggests another factor in the troubles, or lack of them.

He notes that during the boom years, when traditional plans were getting double-digit returns, companies stopped contributing new money to them. So, while their funding appeared adequate during a strong market, there was nothing being added on for the inevitable "rainy day" that began in 2000.

In part, Schieber said, this was because during the 1980s, Congress tightened up the rules, so that companies were effectively barred from adding new money if their plans were fully funded. Also, "fully funded" was measured against benefits that employees had actually earned rather than against projected benefits that they eventually would be entitled to at the end of a full career.

"We used to argue that you fund all the way up to this projected obligation," Schieber said, but the new rules, designed to raise revenue by limiting tax-deductible pension contributions, changed employers' viewpoint. "People said, 'Oh, we're supposed to be funding to the currently accrued obligation.' They changed where they were supposed to go," he said.

Meanwhile, 401(k) participants kept on putting in their regular contributions. Rates of return may have declined, but "balances didn't fall" because workers were putting in more money, Schieber said.

He is more optimistic than some about the 401(k) system. He noted that 70 to 80 percent of workers who have access to k-plans participate, and employers typically match 50 cents on the dollar up to 6 percent of pay.

"For most people that's almost 9 percent of pay going to these plans. Nine percent of pay over a 25- to 30-year period really does become a substantial amount of money," he said.

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