What do IBM, Motorola, Lockheed Martin, Verizon, Northwest Airlines and Alcoa have in common? They are among the many large companies that recently announced plans to curtail their defined benefit pension plans, by either making new workers ineligible or capping benefits for existing employees at their current levels, or both. Clearly, it's not just the troubled airline and automotive industries that are feeling the pressure from increasing global competition. Even strong companies in stable industries are citing cost concerns as they switch emphasis to defined contribution plans. While companies shift the burden of retirement savings more squarely to the shoulders of individual workers, another trend is becoming clear: When it comes to their own retirement savings, many employees are not taking up the slack.

While many of the nation's many small companies have relied for years on 401(k)-style retirement plans, larger and more established firms traditionally took the more paternal approach of a defined benefit plan. With these plans, the employer commits to pay a set monthly amount to each employee beginning at retirement. Because the payments continue until the end of the retiree's life, defined benefit plans represent a significant expense and long-term obligation for the company. The benefit amount is generally based on a percentage of salary during the employee's final – and most highly paid – years of service. In addition to contributing the money, employers take on significant administrative obligations and fiduciary risks as a result of managing investments, employing trustees, custodians and actuaries, and making benefit payments. "When equity and fixed income markets are strong, and businesses is stable and consistent, defined benefit models work well," said Chris Reagan, managing director, Investment Advisory. "In the late 1990s, when the stock market was booming, many plans actually became over-funded."

Times – and Retirement Plans – Change
Today, however, it's a very different story. Increased global competition has made it more difficult to fund generous defined benefit plans. Especially in industries with tight margins, companies are straining to compete with businesses, whether foreign or domestic, that do not have expensive pension obligations. In addition, volatile equity markets and low interest rates over the past several years have meant the underlying equity and fixed income investments in the plans haven't performed very well. As a result, overall returns may not have kept pace with a company's payout commitment.

In contrast to defined benefit plans, defined contribution plans establish only the amount an employee can contribute, not the benefit that will be received at retirement. With the exception of employer matching profit sharing contributions, the accounts are entirely funded by the employee. By switching to a defined contribution plan, such as a 401(k), an employer can shift the responsibility for saving, as well as investment performance, to the employee.

"Defined contribution plans give the average person the job of managing his or her own retirement account," said Reagan. "However, it may not be a job they want or can do well." About one-third of American households has saved nothing at all for retirement.* A large percentage of employees who have access to an employer-sponsored defined contribution plan are not taking advantage of it to put aside funds for retirement. Of those who do participate, a large portion are not contributing enough or investing too conservatively to achieve the growth they'll need for the future. "Insufficient savings, longer lifespans and increasing costs of healthcare are setting the stage for a perfect storm, especially as the baby boom generation moves toward retirement," said Reagan.

Designing a Plan to Work
"Studies of investors have shown that it's human nature to take the path of least resistance," explained Reagan. "But defined contribution plans generally require initiative on the part of the employee – to sign up and select investments." As an employer, you can structure your retirement savings plan to work with – not against – your workers' natural tendencies. For instance, by instituting automatic enrollment in the plan for all employees as soon as they are eligible, you take away the initial big hurdle. Additional measures for increasing participation include making salary raises a trigger to increase an employee's plan contribution. You can also change the plan's default investment vehicle from a money market fund to a risk- or time-based portfolio. Of course, employees still have the option to not participate.

Mesirow Financial's investment advisory professionals can help you structure, design and implement an attractive and cost-effective retirement plan as part of a comprehensive employee benefits package. We provide guidance with selecting investment offerings and designing an education program to help participants understand the plan and their investment options. In addition, with expertise in a number of employee benefit areas, including qualified and nonqualified plans, group life and disability insurance and voluntary insurance programs, we can help plan sponsors create a compelling overall package to help you not only attract and retain qualified employees, but also control costs. For more information or for help designing a retirement plan, please contact your Mesirow Financial representative.

*Source: The New York Times, February 5, 2006.

This article originally appeared in the 2006, 2nd quarter edition of the Mesirow Financial Quarterly. Click here to access the current and all past issues of the Quarterly.