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Do you want to work at Wal-Mart when you are
80?
Reality Check
How many people want to retire wealthy?
How many people plan on retiring wealthy?
How many people in this room have started planning for retirement?
The Numbers
To have a retirement income of 65,000 per year, you must have $3 million dollars at age 59 when you retire.
This requires $16,000 in annual contributions starting now.
If you wait until age 30 to start, those contributions jump to $33,000 annually.
The Current State of Pension
Emily BrazilHunter Lewis
Jennifer MargolesJoel Desmond Moskal
Kara MyersJed Staufer
Overview
Background and Traditional Pension Systems
Current State of Pension Systems
Application of a Modern Pension Plan
Q & A
Background Information
What is Pension?
Pension is an account partially or wholly funded by an employer or organization that is a source of income for retired employees.
Main Types of Pension Plans
Defined Benefit Plan
Defined Contribution Plans
Defined Benefit Plan
Traditional style of pension
Considered nearly obsolete
Used by companies like General Motors
Defined Benefit Plans These plans are basically a giant
fund that a company adds money to each year.
The fund consists of a mix of stocks, bonds, and cash that is supposed to appreciate enough over time that it can pay benefits to the retirees.
Defined Benefit Plans
The money that is added to the account is completely paid for by the company
This money is not earmarked for specific employees
Instead, calculations are made to determine how much money is needed to cover all pension liabilities for each year.
Mechanics of Defined Benefits
A specific dollar amount that is needed to pay all fiscal pension liabilities is determined.
This amount is then discounted back to the current time at a “discount rate” to establish how much money must be added to the fund.
Mechanics
This “discount rate” is mandated by the government, and it is the current 30-year treasury yield.
In the past, pension fund investments performed well, and treasury rates were high, which led to a lower net present value, and therefore less needed funding.
Current State of Pension Plans
Issue 1:Under-Funded Pension Plans
Under-funded Pension Accounts
The dot-com bubble burst in March of 2000.
Trillions of dollars have evaporated in the form of capital losses since 2000
Pension fund investments are part of this figure.
Under-funded pension accounts
These capital losses have compounded the damage when they are paired with the higher discount rate that has been used in the past.
Example
Case In Point
The fund needs $1,000,000,000 and only has $537,534,600
This shortage of $462,465,399 is still needed to cover the upcoming pension liabilities.
Where does the money come from?
Case cont.
Capital Expenditure accounts
Cash reserves
Cash from earnings for the current year
Example
IBM Defined benefit plan Under-funded by 2.3 billion for 2003
alone. Cash needed to fund pension account
will be taken from pretax income 2003 earnings per share may be
revised downward by as much as $.30 per share
Example General Motors
Fund worth $40 billion--twice the value of their market cap.
Currently their account is still $32 billion under-funded.
It needs 9 billion just to get through the next 2 years.
At least some funding will come from cash reserves.
Proposed Solutions Unfortunately, the solution that
keeps coming up, is to dissolve defined benefit plans completely.
The companies then want to adopt less expensive defined contribution plans, which will be explained in a few minutes.
Current State of Pension Plans
Issue 2:Corporate Scandals
Corporate Scandals
Enron and Worldcom were the two biggest corporate scandals in U.S. history.
Fraudulent activities led to billions of dollars in investment losses, including a handful of pension funds that collapsed, leaving retirees with nothing.
Corporate Scandals
Enron’s pension fund consisted of a 401(k) for employees that was comprised solely of Enron stock.
While the company was on the verge of disaster, executives told employees to buy up the stock so the price wouldn’t collapse while they all dumped their shares.
Corporate Scandals
When the truth about the company emerged, the stock price plummeted, and employees were locked out of their accounts.
All they could do was wait and watch as their nest eggs were crushed.
Corporate Scandals
Worldcom had a similar effect after reporting over $9 Billion in falsified earnings
Their market cap went from nearly $132 billion to nothing, and even more retirement accounts and pension funds were wiped out.
Corporate Scandals
Parties that were affected by these debacles include: Individual company pension participants
Several state pension funds such as California
Individual investors
Effects of Enron/Worldcom
After the scandals, almost all pension systems changed drastically
Concepts like diversification reared their head
Investments other than a company’s own stock were made available for employees.
The New Plan
Defined Contribution Plans
Defined Contribution Plans
New age pension systems Includes plans like
401(k) IRA’s Profit Sharing
Used by most modern companies like Level 3 Communications
Level 3 before Enron Prior to the Enron scandal, Level 3
pension was only offered in the form of a stock purchase matching program
The company matched salary contributions to purchase Level 3 stock, with a rolling 3 year vesting period
All employees that participated had their entire retirement in Level 3 stock.
Vesting A waiting or holding period for
benefits that is used as a strategic retention tool.
It promotes loyalty and longevity with a company
During the tech boom, retention was very difficult so rolling vesting was a good retention tool
Level 3 after Enron
The Enron debacle showed that the plan that was in place could leave employees with no money for retirement if the company failed.
The Pension director and investment committee developed an entirely new program to protect the employees.
Level 3’s New Pension Plan
Starting Jan. 1, 2003 a diversified 401(k) plan became available.
Employee contributions are put into one or several mutual funds.
Level 3 matches the contributions, and the money is used to buy units of the Level 3 Fund.
Level 3’s New Pension Plan
Employees have the immediate option to transfer that value to one of the mutual funds, without any penalties or fees.
The vesting period is still 3 years, but contributions vest 100% after 3 years.
Reasons for the Change
The new system protects the employees from loss if the company fails, while giving them the option to increase their ownership in the company.
A diverse list of mutual funds offers a portfolio structure for all participants, even those close to retirement.
Reasons for the Change
The new system allows the employees to decide how much to invest.
The company is only liable for matching contributions, not for paying retirees a salary from an account that can become under-funded.
Plan now or this is your future.
Questions or Comments?
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