Advice on retirement planning is being offered by many entities and forms of media these days. Those of us in the early baby boom generation are bombarded by offers to have dinner and listen to lectures as to how to invest retirement accounts. Financial institutions offer brochures and television advertisements on the subject, most of which seem to involve sailboats and wooden docks with smiling grandchildren. What’s going on here?
We are seeing the confluence of legislation and business and societal developments that have occurred over a period of many years. First, the baby boom generation is a large cohort within the population. At young ages, they required the building of new schools. In later years, they needed more housing. Now, as they approach retirement age, they are focused on the decisions that need to be made for retirement. There are many of us, and whatever we need or can be sold will be discussed at length in media. New products that we might need, from the basic to the embarrassing, will be prominent on television, radio and the Internet.
Second, this generation appears to be wealthier than earlier generations. This isn’t true for everyone, but despite some stalling of wealth increases in recent years, more people have the ability to retire than was previously the case. There are many statistics as to the amount of wealth that will be passed on to future generations in the next 30 to 50 years, and the amounts are in many trillions of dollars.
The third factor is the enactment in 1974 of the Employee Retirement Income Security Act. ERISA established rules for the proper funding of retirement plans, fiduciary standards, reporting and disclosure requirements, and individual retirement accounts. Prior to ERISA, there was scant regulation of retirement plans and minimal funding requirements. The result was many woefully underfunded retirement systems. The best known case of this problem involved the manufacturers of Studebakers. That company maintained a pension plan, but did not fund the benefits as they were earned, nor were they required to do so by the law in effect at the time. When Studebaker decided to stop making cars in the United States and closed its plant in Indiana, many workers got either a fraction of their benefits earned or, in some cases, nothing at all. One worker at the plant committed suicide. A mere 11 years later, at the instance of both Republicans and Democrats, Congress passed ERISA. This new law spawned many types of service businesses to help with compliance, and provided much work for lawyers in interpreting the statute and litigating many thousands of cases on the law’s meaning and application. The result has been a far better understanding of retirement benefits, more regulation to ensure that retirement plan participants are treated fairly and within the law, and much higher levels of funded retirement benefits. ERISA and its many subsequent amending laws have been criticized for their complexity, but these laws have increased the retirement wealth of Americans substantially.
A fourth factor in the growth of discussions about retirement and retirement assets is the decline of pension plans. Pension plans are a form of defined benefit plan, which means that the employer defines the benefit to be received at retirement and then provides the funding to permit payment of those benefits. The risk that there will not be sufficient funds to pay the benefits is on the employer, so if the stock market declines and the assets in the plan are worth less, the employer must eventually make up that loss. Defined benefit pension plans were once the norm in large corporations and in government service, and they remain the dominant form of retirement benefit for government service. The problem that was perceived in defined benefit pension plans was that the unfunded portion of the plans was a liability of the employer, and could reduce its stock value. In addition, it was possible in some cases to postpone payment of funding liabilities, which simply created greater liabilities later. And there were problems when assets in the plans were not carefully invested. It became the perception that defined benefit pension plans were too great an expense to be continued, at least for the non-union work force, and a great many of them were terminated. They remain important in government service and in unionized industries.
In recent years, legislators in some states have noticed the growth in unfunded liability for government retirement plans, nearly always the result of earlier legislators postponing or forgoing needed funding for budgeting purposes, or increasing benefits as a way of garnering votes, and have called for curtailment of these types of plans, at least for new employees. A more careful analysis of such proposals sometimes shows that the replacement plan could be more expensive than the defined benefit pension plan, and provide lower benefits less efficiently. Defined benefit pension plans, if properly funded and administered, have been shown to be more efficient in delivering levels of benefits than other types of plans. But they do place a liability on the books of the state or business maintaining the plans, and that can cause concern to legislators and shareholders.
The replacement plans, and the plans in effect for most businesses, large and small, including most law firms, is the defined contribution plan. In this type of plan, the employer makes a contribution, and the employee may also make a contribution, required or voluntary. Whatever is contributed is invested and, at retirement, the employee gets whatever is in his or her account. Thus the investment risk is shifted from the employer to the employee. The employee generally has decision-making authority as to the investment of the retirement account, often choosing from mutual funds or similar investments provided as a menu by the plan administrator. A future article will discuss why this investment method has proved to be such a poor idea. In any event, participants in these plans spend much of their working life making choices as to the investment of their retirement accounts, with varying degrees of success. At retirement, many of these plan participants roll their accounts over to an individual retirement account at a bank or other financial institution. Now, they must make a decision as to how those funds will be invested. They will not receive a monthly payment from a pension plan maintained by their employer, but instead whatever amount they choose to withdraw from the rollover IRA. The choice as to where to invest the retirement funds and when to withdraw them will be for the individual to decide, a departure from the employment years, when the individual had at least the guidance of the menu of investment choices that had been offered to him or her. It is for that reason that we see so many offers made to help manage retirement funds — individuals who had some assistance, through the employer’s plan, on investing, can now choose from the universe of investment opportunities. Many of those opportunities, but not all of them, will be for skilled investment advice that will help to ensure a comfortable retirement. More freedom carries with it the chance of making more mistakes, which could affect the quality of retirement living.
This is the backdrop against which important decisions are being and will be made that will determine how people will live their retirement years. In subsequent articles, I will discuss the complex rules on minimum distribution of retirement benefits and estate planning for retirement benefits, as well as other developments in the wide-ranging field of retirement living. These involve not only financial decisions about retirement assets but also issues such as health care decisions in retirement, Social Security and Medicare benefits and financial planning. •
Robert H. Louis is a partner and co-chairman of the personal wealth, estates and trusts department at Saul Ewing. His practice includes estate, tax and retirement planning for individuals and closely held businesses. Louis can be reached at firstname.lastname@example.org and 215-972-7155.