The last time the stock markets took a big downturn, in 2002, an interesting thing happened. It wasn’t just those with 401(k)s/403(b)s and IRAs who were affected, although they were. By that point, 401(k)s had been in existence for over 20 years, about half of many people’s working lifetimes. People nearing retirement age watched the stocks in their savings decrease in value by about one-third over seven months and decided they couldn’t afford to retire. Others had already retired and had to draw out a much larger percentage of their savings than planned to meet their expenses.
Workers earning pensions were affected too, even though a change in the market doesn’t affect the monthly amounts already owed to them. Federal regulations require that companies pre-fund much of their employees’ pension benefits, and most of these funds are held in stocks. When the stock markets plunged, employers lost millions, perhaps billions, of dollars in pension funding. But their liabilities, the amounts they would some day have to pay out to retirees, didn’t decrease. Companies suddenly owed their pension plans–big time.
This took companies by surprise, since they’d been happily riding the tech bubble with the rest of us. Bad surprises are not good for the stock price of a public company, and over the next few years, many companies decided that responsibility to their shareholders meant they couldn’t have another surprise like this one. They froze their pension plans. Put simply, a pension freeze means that employees–new employees or all employees–stop earning additional benefits. What they have at the time of the freeze is what they have when they retire.
Most companies that froze their pension plans replaced them with a 401(k) or something similar. In essence, they shifted the burden of stock market fluctuations–the risk of having to deal with something like what we’re seeing this year–onto their employees. Now it will be the employees, not the companies, looking at the stock market and deciding what they can and can’t afford.
This shifting of employees onto the nonexistent mercy of the market had recently slowed down. Fewer companies made the switch in 2007, and very few new companies have announced freezes in 2008. However, with the markets taking another dive, and with new pension funding legislation taking effect this year, that could change rapidly. Even more people may soon be hitched to the rollercoaster that an unregulated market becomes.
Now imagine yourself at the end of 2007, having just told the boss to piss off, having made an ass of yourself at the best holiday party ever, planning to retire January first and live off your 401(k). Then remember what happened to the markets in January. Then remember what’s been happening to prices all year. Unless you bought an annuity (which you should have done anyway, but that’s another post) with a cost of living increase built into it, or have a small pension from a frozen plan, your Social Security payment is the only part of your retirement income that is going up instead of straight down.
And that is why your Social Security is not invested in the market.
Update: Reminder to self–no blogging when sleepy. All of the above was written in response to Al Franken’s ad supporting Social Security in its current, secure form. This is one of the reasons I support Franken.
When even Warren Buffet stands up and says that the stock market return assumptions on which we pin our hopes for retirement are pollyannaish, it’s ridiculous that we still have politicians talking about privatizing Social Security (which Coleman has, even though he calls it something else) as though the potential for reward could outweigh the risk. Social Security is there to carry us through when nothing else does. If we put it in the hands of the people who got us into the current financial mess, we might as well just call it Social.