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401(k) rethink on the cards?

Could President Elect Barack Obama nationalise 401(k) plans? This may be a provocative question, but certainly the federal administration is likely to play a greater role in designing, supervising and even managing the US individual retirement accounts that invest member's money according to their choices and give benefits based on performance.

It is precisely 2008's performance that is worrying many US employees relying on their own private pensions and that has made some critics declare that "the 401(k) system has failed", as Alicia Munnell, director of Boston College's Center for Retirement Research said it in an interview with the Wall Street Journal.

The extent of 401(k) losses last year is not really clear and depends on each individual's asset allocation. According to a recent Hewitt Associates' analysis of 2.7m employees, the average 401(k) plan balance dropped 14% in 2008 to $68,000, down from $79,000 in 2007. In October and November last year, employees lost on average 18% of their 401(k) plan savings, and some more than 30%.

But despite the significant market declines, savings rates dropped just marginally, from 8% in 2007 to 7.8% in 2008; only 4% of employees have terminated their 401(k) contributions altogether.

There has been a change to a more conservative asset allocation mix: the amount of 401(k) plan assets held in equities is at an all-time low of only 53.8% of assets, on average, compared to 68.1% one year ago and down from 74.2% in 2000.

Thanks to this more cautious diversification, claims Steve Utkus, head of the Vanguard Center for Retirement Research (CRR), "the Bear market's effects on 401(k) is not really the ‘401(k) to 201(k)' phenomenon, with accounts being slashed in the wake of falling markets, as reported in the press".

According to a CRR examination of nearly 3.5m active and deferred participants in approximately 2,200 defined contribution plans, most participants' balances either grew, or fell slightly, in part because of continuing plan contributions beside diversification: 34% of
participants experienced rising or flat balances during the first 10 months of 2008 and another 10% saw balances fall by modest amounts, from between -1 to -10%. Still, the majority has been heavily hit by the 2008 bear market, a fact that has pushed forward several proposals of reform.

The question is no longer one of automatic enrolment, raising contributions, diversification, and minimising costs. Now there are calls for the government to guarantee a modest level of return on 401(k) accounts. Teresa Ghilarducci, professor of economics at New York's New School for Social Research, wants government-sponsored Guaranteed Retirement Accounts that would provide a minimum rate of return of 3%, on top of inflation. Interesting is what comes from the Center for American Progress, a Washington think-tank: its senior fellow Gene Sperling proposes a government-sponsored Universal 401(k) plan open to all, with the federal government making regular contributions to these accounts.

However, this ‘progressive' alternative may be unrealistic, not only because of the costs, but also because Obama's other advisers think differently. Roger Ferguson, member of the Transition Economic Advisory Board, and president and CEO of TIAA-CREF, which manages retirement savings for 3.6m individuals and 15,000 institutions, favours strengthening the plans with automatic participation and savings, as well as good advice to workers.

One view Ferguson shares is on wider use of annuities to guarantee an income floor for retirees. For several reasons, such as high costs, annuities  are not popular today among retirees. "Many retirement accounts fail to include a payout mechanism to ensure retirees will not outlive their savings," wrote Ferguson in the Wall Street Journal. He proposed that 401(k) plan automatically convert "all or a portion of the account balance to a low cost annuity at retirement".

One certainty is that no one is planning greater reliance on defined benefit plans, also sorely affected by the 2008 bear market - so much so that the plan sponsor companies had to lobby Congress for relief from stricter pension funding rules mandated by the Pension Protection Act of 2006. They got it with The Worker, Retiree, and Employer Recovery Act (HR 7327) approved on 10 December last year.

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