A number of studies done by life insurance companies only confirm and quantify the obvious – baby boomers of all ages believe there is a retirement crisis in America. Although the real estate and stock market crashes of the last few years brought the problem into the open, this malaise had been bubbling under the surface for quite some time.
Today, let’s review how we got here, where we went wrong and, most importantly, what we are able to do in order to get our retirement plans back on track.
To understand how we got to this point, we should remember that by the mid-eighties, the Defined Benefit Pension Plan (DBPP) was the retirement planning vehicle of choice for the more highly compensated employees in a closely held corporation. As the name suggested, the employer’s DBPP was designed to pay a guaranteed pension for life to the retiring employees. To meet that obligation, employers hired professional managers who chose the most promising investment vehicles available in order to meet the return assumptions that were built into the plan.
Because it became too expensive for employers to fund these DBPPs, the Defined Contribution Plan, known by its IRS code section, 401(k), took over as the primary retirement accumulation vehicle. While the switchover seemed reasonable enough at the time, the inherent limitations of the 401(k) structure didn’t become evident until much later.
The basic 401(k) concept is simple. The employee makes a pre-tax contribution, which was usually matched by the employer, into the plan. Then, the employee has the sole responsibility to invest his/her money in the limited number of mutual funds offered by the plan provider. The hope, of course, is that the invested money will have grown sufficiently by the retirement date to provide enough additional income for the life of the employee and his/her spouse.
If one focuses on the desired outcome of maximum asset growth by a specific date, the practical limitations of 401(k) plans now become apparent. For starters, compare the professional management and virtually unlimited investment choices of DBPPs to the individual employee’s selection and “management” of a very limited collection of mutual funds. Most importantly, the guarantees that the DBPPs provided have now been replaced by stock market assumptions. We all know, unfortunately, how unreliable the stock market has been over the last ten years and how unpredictable it’s likely to be in the future. Therefore, planning for and achieving a specific retirement objective will be quite difficult.
In light of these facts, what can the professional or business owner do to get his/her retirement plan working again for his/her benefit? My first recommendation would be to change plan providers, if necessary, to allow the firm’s principals to carve out their own plan assets into a self-directed 401(k) outside of the main plan. Once that is done, the employee can then pick investments from the entire universe of vehicles, including many that are not subject to the vagaries of the stock market. In addition, the principals now have the ability to hire competent professional advisers to help them manage one of their most important retirement assets.
Once this investment flexibility has been regained in the 401(k), I believe it’s very important to integrate the plan’s assets and strategy with a personal portfolio and other assets (real estate, business value, annuities, life insurance policies, etc.). Finally, an overhauled retirement plan needs to de-leverage one’s financial structure and implement a saving plan in order to enhance a wealth accumulation strategy for the long term.