IBM's pension move sharpens focus on 401(k) plans for retirement

BOSTON -- IBM's freeze of its otherwise healthy U.S. pension plan will reverberate through industry not only because it illustrates the erosion of traditional benefit packages, but also because it sharpens the focus on 401(k) plans as a source of retirement security.

With the 401(k) increasingly becoming a de facto pension for many American workers, several experts suggest reforms are in order.

International Business Machines Corp.'s announcement this week drew attention because the security of the technology giant's $48 billion U.S. pension fund stands in contrast to endangered plans run by airlines and other large companies.

However, retirement analysts found IBM's enhancements to its 401(k) more notable, saying the company is transplanting some virtues of traditional pensions that generally have been absent from newer kinds of plans.

Dollar-for-dollar

When the pension freeze takes effect for IBM's 125,000 U.S. employees in 2008, IBM will match their 401(k) contributions dollar-for-dollar on up to 6 percent of salary; previously the match had been 50 cents on the dollar, a common figure.

Perhaps more important, the company will automatically contribute an extra amount equal to 1 percent to 4 percent of employees' pay into their 401(k) plans in an attempt to make sure every employee participates.

Those notions of universal participation and automatic security were hallmarks of traditional pension packages known as "defined-benefit" plans.

Newer plans such as 401(k) packages are known as "defined-contribution" plans because that's all the company is promising -- to contribute a set amount, if it offers a match. The size of the retirement benefits depend on the vagaries of investment portfolios, shifting the risk from the company to the employee.

In 1985, 89 percent of Fortune 100 companies offered traditional pension plans, but that had fallen to 51 percent by 2004, according to Watson Wyatt Worldwide, a human-resources consulting firm. Some 11 percent of the plans in the Fortune 1000 were frozen or terminated for new employees, up from 5 percent in 2001.

Although high-flying returns in pension fund investments sometimes make defined-benefit plans less expensive to run than 401(k) plans -- and pad a company's bottom line -- companies also decry the year-to-year uncertainty of whether they'll have to contribute to their pension funds in the markets' down years.

These costs and complexities, the companies argue, are a competitive disadvantage in industries in which nimble startups aren't saddled with pension obligations.

Not surprisingly, many of the blue chip names that have closed pension funds to newly hired workers or ended accruals in plans altogether, such as IBM, Hewlett-Packard Co., Motorola Inc. and Verizon Communications Inc., are in technical fields teeming with younger, pension-less rivals.

IBM, which had already closed its pension plan to workers hired after 2004, said it expects to save up to $3 billion in pension-related costs through 2010, as the company can stop accounting for benefits that would have accrued after the freeze takes effect. IBM estimated that 19 percent of its U.S. employees would see benefits eroded because of the changes; those people will see, on average, a 12 percent drop in benefits, the company contends.

Legal uncertainty

Another reason for the rise of 401(k) plans is legal uncertainty surrounding a hybrid defined-benefit package known as a cash balance plan, which lets workers accrue benefits that they can take with them if they leave a company, but doesn't pay a lifetime annuity like traditional pensions.

A large part of the controversy involves IBM, which like many U.S. companies moved its employees to a cash-balance plan in the 1990s. Today 86,000 IBM U.S. workers have such a package. But some older workers complained that the packages trimmed their expected pension benefits, and IBM was sued over its plan. Big Blue settled the case but is appealing a verdict that it committed age discrimination.

Less security

But while 401(k) plans carry much less baggage for companies, they also carry far less security for the 50 million Americans who have them. If the plans are going to all but replace pensions, many experts say, then wider changes ought to follow.

For example, Medicaid and other public assistance programs generally exclude pension holdings when determining a person's eligibility, but defined-contribution accounts such as 401(k)s are often considered assets that can reduce someone's ability to get benefits, said Mark Iwry, senior adviser to the Retirement Security Project and a former head of private-pension regulation at the Treasury Department.

Iwry also supports having 401(k) plans automatically enroll employees and increase their contribution level annually unless they opt out, as a way to encourage people to be continually increasing what they put away for retirement.

James Klein, president of the American Benefits Council, which represents companies with pension plans, said people should be allowed to invest part of their 401(k) holdings in annuities, guaranteeing a specific return as an old-school pension would. That's not a widely offered choice now.

He also supports better financial education in schools and in companies to guide people who have to choose how to allocate their 401(k) investments.

"If people are now going to be more responsible for their own retirement income and security, we need to now give them the tools to help them understand this more effectively," Klein said.

That sentiment was shared by Ted Benna, the financial adviser who created these plans in 1980 after noticing that paragraph (k) of Section 401 in the Internal Revenue Code unintentionally allowed tax-deferred retirement accounts.

He said many 401(k) plans could be made more efficient, lowering the expenses and bettering the financial performance for participants.

"We've got 25 years of history now with the 401(k)," Benna said. "We need to look at that history and improve what we're doing, no doubt about it."