Employer-sponsored retirement plans and their participants have benefited enormously from the longest sustained bull market in history. Now, however, the economic and investment landscape is uncertain, creating new challenges for employers and employees alike. It may well be that during this prolonged period of prosperity we neglected an important lesson from pension plan history.
Why did the Employee Retirement Income Security Act come into being? In the uncertain economic times of the 1960s and early 1970s businesses failed. Some of those companies - most notably The Studebaker Corp. - failed to fund company pension plans. Employees suddenly found themselves not only without jobs, but also without any prospect for retirement security. ERISA was enacted in 1974 to safeguard workers' retirement assets. However, more than a quarter century later, we might have come full circle and employees may yet again find themselves unemployed and without the means to retire.
How has this happened? Over the past two decades, we witnessed two very positive developments in employee benefits: broadly based company stock ownership and the growth of the 401(k) plan. Stock ownership has proliferated because of the economic benefits both for the employee and the company. Employees' sense of ownership often is expressed in enhanced commitment and increased productivity. The growth of self-directed retirement plans also provided economic benefits for employees while fostering good will, as workers received assistance from employers to meet retirement savings goals. Unfortunately, these two positive developments might well be in conflict.
This conflict occurs because assets in 401(k) plans are heavily concentrated in employer stock. Recent surveys indicate that 30% to 40% of plan assets are in employer-owned equities. In some well-known companies, this percentage exceeds 80%. This concentration has occurred for two reasons.
First, some employers make contributions to employee plans in company stock or provide incentives for workers to opt for employer stock or in many cases provide a match to the employee's contribution in the form of company stock.
Secondly, many employees choose their company's stock from among the plan's offerings because they are more comfortable making an investment they think they understand and in which they have faith.
Yet, clearly, this concentration of assets in a single stock ignores a fundamental principle of retirement savings investment: diversification. Unfortunately, it is becoming painfully apparent that more Americans' retirement savings are contingent upon the success of a single company. If a prolonged economic downturn brings about business failures, workers will once again not only lose their jobs but their hopes for a secure retirement as well - Studebaker revisited.
Even under less gloomy scenarios, the problem of overconcentration of 401(k) assets in employer stock should be addressed. Fortunately, there are steps plan sponsors can take. The first thing that can be done is a simple change in plan design. If companies invest in employer stock on behalf of plan participants or if they match participant contributions with employer stock, participants should be given the option to move their money and diversify across other investment options within a reasonable period of time. To the extent that employees may be overinvesting in company stock, employers can take an active role in educating them about the consequences.
Many companies already have developed quality education programs that stress fundamental investment principles such as diversification. Some plan sponsors recognize the need for even more formal education and for some employees, more help. Increasingly, forward-thinking companies see the need to provide employees with unbiased investment advice to help them develop well-balanced investment strategies. Absent these programs, employees are left to seek advice at the water cooler or in Internet chat rooms.
Employers need to arm employees with the right options and resources to prepare for their financial futures. The measures outlined above - sound plan design that doesn't overweight company stock, education and objective investment advice - may help ensure those needs are met. The problem of overconcentration of 401(k) funds in employer stock can be solved by the private sector in the best interests of both corporations and employees. If companies fail to take action on their own, at some point Washington undoubtedly will.
