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How Well Do 401(k) Plans Work, and Who Benefits Most From Them?
When Enron Corp. collapsed over a
year ago, thousands of employees' retirement
savings were wiped out, sparking
quick calls for reform of 401(k)
plans. Some changes were put in place
earlier this year; others are still being
debated in Congress.
But now that the smoke of corporate
scandals has begun to clear, do
problems with 401(k)s still appear as
bad as they did last winter? Should the
system be left alone, merely tweaked,
or overhauled – perhaps converted to
a kind of Super-IRA that would solve
Enron-type problems by removing the
employer from the process?
"We look at what's happened in the
last couple of years, and in general we
don't see that there's a need for a lot of
change in the governmental regulatory
structure," says David L. Wray, president
of the Profit Sharing/401(k) Council of
America, which represents about 1,200
companies that offer 401(k)s and other
defined-contribution plans.
"The Enron situation, which is the
one that gets the most ink, is really a
corporate governance issue, and all the
attacks on 401(k)s under the guise of
Enron were really inaccurate...I would
argue that the 401(k) system is one of
the cleanest, best-managed financial
systems ever invented, and the fact that
we have exceptions does not make me
back off that one bit."
One of the post-Enron reforms is
a federal rule prohibiting corporate executives
from trading a company's stock
during "blackout" periods when employees
cannot trade – typically when
a plan is changing providers. While he
supports the prohibition, Wray notes
that Enron insiders who unloaded vast
amounts of Enron stock didn't do it
during the 13-day blackout period in
the fall of 2001. Most did it earlier. The
problem with the blackout was it came
as the stock was plummeting.
Though experts have a wide range
of views on the need for change, almost
all agree the health of 401(k)s is vital to
millions of Americans. Over the past 20
years, 401(k)s and similar defined-contribution
plans have replaced traditional
pensions – defined benefit plans – as
the primary source of retirement funds.
According to a study by The
Vanguard Group mutual fund company
of Malvern, PA, at the end of 2001
there were 23 million participants in
defined-benefit plans and 57 million in
defined-contribution plans. With about
$1.6 trillion in holdings, 401(k)s contained
about 80% of the defined-contribution
assets. There were 392,800
401(k) plans with 70.6 million eligible
employees, of which 45.9 million were
participating.
In 2001, about 50% of American
workers were not offered any kind of retirement
plan at work. Of those who
did receive coverage, nearly 30% were
offered only defined-contribution plans,
15% had defined-contribution and
defined-benefit plans, and about 4%
received only defined-benefit plans. The
figures show a nearly complete reversal
of the situation 20 years ago, when
more than 30% of covered workers had
defined benefit plans and only a smattering
had defined-contribution plans.
At Enron, employees had the lion's
share of their retirement assets in Enron
stock – causing disaster when Enron
shares became worthless after the company
declared bankruptcy. That situation
was not typical, however. Vanguard
says that among all its 401(k) participants,
only 14% of assets are tied up in
employer stock. (Approximately 47%
of Vanguard plans do not offer employer
stock. Among those that do, 25% of
assets are in employer stock.)
The majority of financial experts
agree that for most workers, 25%
is too high. While employees at highly
successful companies such as Microsoft
have become rich in employer stock,
this is not likely in most cases. If a
company runs into trouble, the employee
with a lot of employer stock
could lose both a job and the retirement
savings. Consequently, most people
are better off with greater
diversification.
"There has certainly been a lot more
attention paid to the benefits of diversification"
since the Enron debacle, says
Olivia S. Mitchell, professor of insurance
and risk management at Wharton
and director of the school's Pension
Research Council. "If nothing else, I
would hope that participants would
move away from single-company stock."
She says, however, that reports from
industry consultants indicate employees
have not shifted significant assets out
of company stock. A Vanguard survey
showed that employees tend to believe,
incorrectly, that their employer’s stock
is less risky than the market as a whole.
"So perhaps there is less of a lesson
learned than one would anticipate,"
Mitchell notes.
Currently, many companies that
make matching contributions with
their own stock require that participants
hold on to it for some period
of time. Among Vanguard plans, 68%
of companies that made matching
contributions in employer stock had
some sort of restriction on selling it.
Most common were requirements that
participants hold it until they reached
a certain age or left the company.
Companies that offered their stock as
an optional way to receive a match
rarely had such restrictions.
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