IBM announced last week that it would freeze the old-style pension plans it provides to more than 100,000 employees and instead offer an improved version of its 401(k) plan. This is no run-of-the-mill accounting change or cut-costing measure. It is a major philosophical and economic shift for a bellwether corporation.
It means, in short, that International Business Machines is moving away from paternalism and giving workers more control over their own retirements. The U.S. government should do the same in reforming Social Security.
The IBM decision is good news as well for taxpayers, who ultimately could be left holding the bag if the Pension Benefit Guaranty Corp., a federal institution that insures pensions, can't meet the obligations of overextended companies.
Of course, IBM is in no danger of becoming the next Delphi. At last report, it had revenues of about $100 billion, after-tax profits of $8 billion and loads of cash. IBM's pension plan, with $48 billion in assets, is robust. But 40 years can pass between the time someone joins a company and the time he retires. Things change, as GM employees now know. It makes far more sense for workers to carry their retirement assets on their own backs, rather than counting on the company to ante up decades later.
There are two kinds of pensions. Defined benefit (DB) plans, or traditional pensions, involve a promise from a company to provide monthly checks to retirees at a specific rate, depending on how long they worked and at what salary. DBs are headed for the dustbin of history -- and good riddance. There were 112,000 of them in 1985 and just 29,000 today.
Second is the defined contribution (DC) plan. Its paradigm is the 401(k), named for an IRS provision. A quarter-century ago, 401(k) plans began sprouting. Some 43 million U.S. workers now have them.
A 401(k) allows workers and employers to put pre-tax income into an account that's mainly composed of mutual funds (IBM offers more than 200 choices). Dividends, interest and capital gains pile up tax-deferred, and the account is owned by the worker. IBM's 401(k), with $26 billion in assets, is the nation's largest.
IBM says that, starting Jan. 1, 2008, it will freeze the DB benefits of current workers and instead enhance the DC plan. New hires go straight to the DC.
Under the new 401(k), IBM will match, dollar for dollar, employee contributions of 6 percent of pay (the match is now 3 percent) -- and, in some cases, up to four points more.
This is not altruism. IBM figures it will save about $500 million a year through the changes. Probably more important, however, the company gains certainty (the funding requirements of DBs fluctuate), and it provides workers with a stronger sense of responsibility and more confidence in a comfortable retirement.
Some disagree. Lee Conrad, a labor organizer, said after the IBM news: "Employees are going to be losing out on all kinds of benefits. You've got to wonder what's going to happen to the next generation of workers."
No, you don't. A study released last September by the Employee Benefit Research Institute and the Investment Company Institute found that Americans do a fine job with their 401(k) plans. Even with the rotten stock-market conditions of the early 2000s, the average account balances of 401(k) participants rose about 40 percent, to $91,000. And remember, these workers still have two decades to retirement.
Employees have, on average, two-thirds of their 401(k) money in stocks -- an appropriate share -- and they are investing more in "life-cycle" funds, which shift to bonds as retirement nears. Loans from the plans are modest and declining.
More financial education wouldn't hurt, but DC plans are working exceptionally well, and complaints that people are too stupid to manage their own money are dead wrong. After all, a record 69 percent of Americans own their own homes -- a far more difficult and risky purchase than the slow accumulation of mutual fund assets over 40 years.
IBM's decision offers a good model for reforming Social Security. Let new workers waive Social Security taxes and benefits and choose a 401(k); let current workers freeze their benefits and pay lower payroll taxes while boosting their 401(k) as a substitute. The U.S. government will have a sounder fiscal future when, like IBM, it stops treating adult American workers like children.