Reforming Pensions the Right Way: First Do No Harm

Commentary by Pete du Pont

The rash of corporate corruption and the roller-coaster ride of the stock market has led many in Congress to call for reforms to the laws governing personal retirement plans - 401(k)s.

Some in Congress are arguing that we should return to traditional professionally-managed defined-benefit pension plans since they have often outperformed personally-controlled defined-contribution plans, such as 401(k)s.

But there is an important difference between the two. Traditional pension plans have dwindled from 175,000 in 1983 to fewer than 50,000 today, because while they do offer a specific benefit, the formula for calculating it is heavily weighted toward rewarding workers who spend a lifetime with a company - a career pattern that is now the exception, not the rule.

With 401(k)s, on the other hand, the worker owns the assets and can take them from job to job and pass them on to heirs. That's why there are now about 42 million participants in 340,000 401(k) plans with $1.7 trillion in assets.

Another benefit of 401(k)s is that most employers match a certain percentage of the worker's contributions. In about 2,000 plans, mostly large ones, all or part of the employer contribution is in company stock. There is nothing wrong with that. Sometimes though, many employees invest a large percentage of their own contributions in company stock, and so become over-invested in their employer's stock.

That's what happened at Enron. About 63 percent of employees' retirement money was invested in company stock. When Enron imploded, some $1 billion of savings disappeared. As Enron showed, putting all your financial eggs in one basket - even if its stock in the company you work for - is not prudent.

Congress seems to be concentrating on taking the "risk" out of investing for retirement. But without some measure of risk, there cannot be any reward. This is why Congress shouldn't be in the business of investment advice. Besides, if there are limitations on the amount of company stock an employee's account can hold or if employers aren't allowed a full tax deduction for stock contributions, employers may decide to reduce their contribution or forgo it all together.

Another major reason some 401(k)s perform poorly, is that many employees are not very good investors. Many of their mistakes, however, could be avoided if employers gave assistance to their workers. Yet there is a reason this isn't currently happening, and its not because Congress has failed to mandate it. Most companies rightly believe they can be held legally liable for investment advice. If they had recommended, during the early ‘90s for example, that employees should concentrate on tech stocks, after the dot-bomb, those employers could have faced a lawsuit.

Absent advice, many employees exercise no investment choice at all. To protect themselves, most employers "default" them into a money market fund - a safe investment, but one that promises a return too low to provide a comfortable retirement income.

To address this problem, a recent NCPA study suggested employers should be encouraged to voluntarily advise their employees to invest in diversified portfolios that broadly reflect the market as a whole, and to default employees who do not exercise a choice into such plans. The only exception would be employees who specifically "opt out." The carrot for the employer would be a legal "safe harbor" from lawsuits.

By shielding from liability companies that help their employees invest prudently, employers would be encouraged to solve the abuses in the system without new burdensome regulations.