Your Money: Distinctions between retirement plans are crucial

March 1, 2001
When it comes to retirement, almost every work situation now requires employees to take an active role - usually the lead role - in planning, funding, and managing resources for the future.

When it comes to retirement, almost every work situation now requires employees to take an active role - usually the lead role - in planning, funding, and managing resources for the future.

In the midst of a dramatically changing economic scene - a global marketplace, intricate trade agreements, new tax laws, health-care reform - one of the most startling, personal, and potentially critical changes of all is being lost in the clamor.

The changes relate to retirement. And, while these changes may be "getting lost" because retirement seems not to have the immediate urgency of current events, they're extremely troubling to many financial-planning experts for the adverse effect they might have down the road on millions of Americans.

The "old" way (is) ... no more

More and more workers now participate in retirement plans that feature defined "contributions," not defined "benefits." But replacing one word with another behind the word "defined" doesn't begin to define the extraordinary ramifications of this trend.

The "old" way typically is what Dad had. Long before receiving the gold watch, he knew precisely what to expect from his employer in a monthly payout - usually for life - after retiring. The benefits were defined, and the responsibility - the funding and management - for those benefits rested almost entirely with the employer.

No more! Today, more and more companies typically establish a plan where employee participants fund and direct their own retirement investments. In such plans, also called "participant-directed plans," employers can decide if they'll contribute at all. Some companies elect to partially fund these plans, but almost all of them give the employee some - sometimes total - control in deciding which investments are selected, if and when to change investments, and whether to participate at all.

It's a task that some experts believe many Americans may not be up to, forcing most workers, especially young ones, to alter how they think about and act on retirement.

Though the defined benefit plans of yesteryear required little of either - thinking or acting - by the employee, the new participant-directed plans can be considered an opportunity for some. Workers who can do the research that's required have a chance to make smart investment choices that can put them ahead of a straight pension. And defined contribution plans can be more portable as an individual changes jobs; the withdrawal provisions for many 401(k) and profit-sharing plans begin at age 59 1/2 rather than at age 62 or 65. They also may contain "borrowing" provisions not available from pensions.

The challenges associated with such plans are numerous. Unlike many pension funds, there are no guaranteed payment schedules with participant-directed plans. Retirement income will be the direct result of how much is invested and the investment choices made by the employee.

The greatest risk

The greatest risk to workers in defined contribution plans often is identical to one of its biggest advantages - control. Also, with 401(k) plans, employee contributions are voluntary, and workers often are inclined not to contribute when the economic pressures of day-to-day living be come too great. In some situations, this can be doubly hurtful, because workers then fail to receive the matching contributions many companies offer.

Securities and Exchange Commissioner J. Carter Beese has suggested that many employees are "inexperienced" in investing and "ill-equipped" to manage a retirement portfolio. He cited studies showing that professionally managed retirement funds usually have more than half of their assets in equities - stocks that contain somewhat more risk, but that historically have offered greater returns over time. Compare this with employee-directed funds, which tend to be heavily invested (other than in their own company's stock) in guaranteed, but lower-paying, investments.

Workers can use several approaches in planning their retirement:

If your employer offers a participant-directed plan, participate in it! The options available through an employer-sponsored plan are key to the success of an individual's total retirement plan.

A Recognize your own limitations when it comes to investing. Educate yourself through employer-sponsored or other types of investing seminars, read and research the financial topics relevant to you, and don't hesitate to seek expert help.

A Acknowledge responsibility for your own retirement, especially if your employer doesn't offer a retirement plan. When it comes to retirement, almost every work situation now requires employees to take an active role - usually the lead role - in planning, funding, and managing resources for the future. This can work to your advantage if you're prepared.

Tax laws now give you another opportunity to fund your retirement - the Roth IRA. You can save taxes on your investments over the years by sheltering any annual growth or investment income in the Roth IRA. Depending on your annual adjusted gross income (AGI), you may invest a nondeductible contribution of up to $2,000 each year in a Roth IRA. You also can make a nondeductible contribution of up to $2,000 for a nonworking spouse; the amount is subject to joint-filer AGI limits. Any dividends and capital gains earned on your investment are tax-free when you take distributions from your Roth IRA after age 591/2 and when the Roth IRA is held more than five years. Nontaxable distributions are available prior to age 591/2 if the Roth IRA is held for at least five years and certain qualified distribution guidelines are met.

One reason people fall short of their financial goals is procrastination. Let's assume that you invest $2,000 at the beginning of each year (about $5.50 a day). At 8 percent annual interest, you earn $160 the first year - not a dramatic number until you watch it grow. After only 10 years, the annual earnings would exceed $2,300. By the 29th year, investments of $2,000 a year plus earnings at 8 percent annually would grow to $224,566, and by the 30th year to $244,692.

Simply put, if you wait just one year to start your Roth IRA, your account value over a 30-year period would be more than $20,000 less than your account value if you start today (assuming 8 percent growth each year). When you set up a Roth IRA is up to you, but seriously consider one because it has the potential to offer financial security in retirement. Because the investment income or growth generated from a Roth IRA is tax-free, you can begin saving immediately on your income taxes.

Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed ( She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.