Not only has it been a volatile year in the stock market, it's been a little frightening in the retirement-plan arena, too. Recently, we've heard about problems with stable-value or GIC (guaranteed investment contract) funds, the possibility of big companies like UAL (UALAQ) failing to meet their pension obligations to employees, and the negative impact of rising interest rates on pension payouts.
The best way to combat fear is to get the facts. That's what we'll do today.
What's Up with Stable Value?
So far, what we've seen are problems with retail mutual funds that invest in GICs. But many of you may be investing in stable-value funds within your 401(k) plans. In a rising-interest-rate environment, these types of funds offer good protection because they invest in very short-term insurance contracts.
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Is there cause for alarm in your 401(k)? I spoke to Gina Mitchell, president of the Stable Value Investment Association. She explained that the rules for stable-value mutual funds (outside of company retirement plans) and stable-value investment choices (inside company retirement plans) are very different. The SEC is scrutinizing the valuation of the wrap contracts used in stable-value mutual funds (they don't exactly fit into the models used in the Investment Company Act).
The SEC does not have jurisdiction over 401(k)s (and other company retirement plans). There are, however, very strict accounting specifications that stable-value funds in company retirement plans must meet for both the American Institute of Certified Public Accountants (AICPA) and Financial Accounting Standards Board (FASB). These institutional stable-value funds must meet certain criteria for valuation of the underlying investment contracts and they are not in violation at this time.
So the good news is that institutional stable-value funds are still a viable option for investors seeking protection from the volatility of both the stock and bond markets. Stable-value funds are not facing the same problems currently plaguing retail mutual funds.
What Security Blanket?
It's troubling to hear the potential broken promises big companies like Enron or UAL make to their employees. Bad things can and do happen to companies many thought represented "safety."
One of the historical advantages of choosing an annuity payment versus a lump sum from a defined benefit plan (the traditional pension plan) has been that it was guaranteed up to a certain amount by the Pension Benefit Guaranty Corporation (PBGC). I've already written about the troubles the PBGC has had. Now it looks like UAL may add to its burden.
What's an average investor to do? We may have to turn once again to our old friend: diversification. We've talked at length about the defensive strategy of spreading your assets around in different asset classes. Perhaps you should also consider diversifying where you contribute to your retirement nest egg. Instead of relying solely on your company retirement plan (primarily the traditional defined benefit pension plan), you may want to contribute more to an IRA or a 401(k), if you have one. 401(k) plans can be rolled over to an IRA when you leave a company--whether from termination or retirement.
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One more word of caution to those of you investing in a company retirement plan: If you have the option of company stock in a 401(k) plan, use it sparingly. That was what clobbered some Enron retirees when the company imploded. According to EBRI (Employee Benefit Research Institute), at year-end 2003, 16% of 401(k) plan participants' assets were in company stock. My advice is this: Limit your company stock allocation to 5%. If something "bad" happens to your company, it could affect not only your retirement plan, but potentially your ability to earn your current salary (human capital). It's a double whammy, so keep that additional risk in mind when you're planning your retirement investments.
Shrinking Pension Payouts
If you have a traditional defined benefit pension plan, you may be in for an unpleasant shock as rising interest rates translate into a smaller lump sum payout. That's because the actuaries who calculate your benefits use a designated interest rate in their formulas. When those interest rates go up, the pension lump sum is likely to go down.
Some of you may have done retirement projections that use company calculations of how much you would receive at a certain age. These company calculation statements typically show what you would receive if you took various types of annuities (single life, joint life, period certain, etc.) or if you took a lump sum. If you are closing in on retirement (within one or two years) you may want to ask your human-resource contact to show you what those numbers would be if interest rates rise .5%, 1%, 2%, etc.
With new company projections in-hand, you can begin to look at a range of possibilities for your lump sum and how that affects your retirement planning. Depending on how much of an impact interest rates will play in your own situation, you may want to increase your savings in other types of accounts or, if it means taking a larger lump sum, investigate the possibility of retiring a little earlier than expected. Of course, this is only one of many factors that need to be considered.
Source: forbes.com - 08-26-2004