Taking Stock of Your Retirement Plan.

As more companies make a pension switch, you may find that you have lost ground, Here's what you can do to preserve your nest egg.

WHEN NICOLE JOHNSON-Reece changed jobs 14 months ago, she never realized that the price would be so steep. After eight years at AT&T, she left to take a career-boosting position as Bell Atlantic's staff director of ethnic marketing. But the elevated status served to depress her retirement funds. Even though the 31-year-old professional has a 401 (k) account with her former employer--she intends to transfer the money into an individual retirement account (IRA) later this year--there's another undisclosed sum that she will never be able to touch. Those dollars were part of AT&T's traditional pension plan, which means that Johnson-Reece couldn't get a cent unless she was on the job another 34 years.

As of January 1, 1998, AT&T officially converted their traditional formula into a newfangled cash balance retirement plan. The ironic part: if Johnson-Reece had stayed with the company just one more month, she would have been able to take her money and roll it over into a Bell Atlantic savings account or an IRA. "Unfortunately, I had to lose out on the cash balance option. With a traditional pension, you can't touch a penny until age 65," says Johnson Reece. "With a cash balance plan, the money is there if you need to get to it. The old, traditional pension was created during a time when employees were expected to stay at a company for life. With downsizing and people regularly changing jobs or careers, cash balance plans are more suitable."

MEETING THE NEW CHALLENGES OF RETIREMENT

Welcome to the brave new world of retirement finance. Like Johnson Reece, you're probably trying to build your nest egg while weighing today's dizzying and daunting options. Major companies are reengineering their pension plans to meet the needs of a younger, transitory workforce and transforming their old-fashioned plans into new portable, money-saving models. Even President Clinton has decided to get into the act. During his State of the Union address, he proposed the establishment of Universal Savings Accounts, or U.S.A.s. The program would use 11% of the projected federal budget surpluses over the next 15 years--approximately $500 billion--to increase Americans' retirement savings. The widely debated initiative would act as a government-sponsored 401 (k), matching trust fund dollars with money workers would save in their own U.S.A. accounts. The objective: help aging baby boomers (particularly low-income families) build a nest egg.

With such developments, no one can afford to be passive in mapping out his or her retirement. You have to plan smarter, start earlier and become more market focused. If not, you run the risk of tarnishing your golden years.

The biggest and most controversial vehicle has been the cash balance program adopted by major corporations, including AT&T, Bell Atlantic, Bell South Corp., Chemical Bank, American Express and Xerox. Under the new format, employers annually contribute a percentage of each employee's pay to an "asset pool" that accrues interest. This may be tied to the rate of the 30-year Treasury bond or other investment vehicles. In essence, they're hybrids of the traditional defined benefit model and a defined-contribution plan like a 401(k) or a 403(b).

For decades, pensions fell under the category of a defined benefit plan, in which employers made regular payments for all employees and guaranteed them a set amount of benefits upon retirement. The calculations were based on years of service by the highest average salary, and administrators determined how pension assets were invested. Companies bore the responsibility for making sure money was available by the time an employee was ready for his or her retirement bash. Think of it as the check an employee receives along with the golden watch.

The defined-contribution plan, on the other hand, differs in that the employer establishes individual accounts, but the employee contributes a percentage of his or her pay-which your company may or may not match. Retirement dollars are based on how much money has been accumulated in each employee's account. Under this system, the employee controls how the money is invested and shoulders the risk.

The main reason major companies have made the shift to cash-balance plans is simple: to save money and provide a kind of "portable" pension for their employees. For one, it takes fewer people to administer these programs. Secondly, distributions to employees who leave the company are easier since they are paid what they would be worth today--not an algorithm of future value. Another factor: experts say most employees didn't understand or appreciate the conventional process--even though management spent millions on administrative costs.

Now corporations are steadily phasing out the paternal pension and passing on the task to workers. In a survey by the Employee Benefits Research Institute (EBRI), a nonprofit research organization in Washington, D.C. (202-775-6329; www.ebri.org), one company noted that prior to implementing a cash balance plan, the defined-benefit portion of their retirement program was expected to deliver 70% of all their retirement benefits, while the 401(k) component accommodated 30%. As a result of the switch, the 401 (k) portion now provides 70% of such dollars, while the cash balance plan covers the other 30%.

Some assert that cash balance plans level the playing field. Rather than preserving a backloaded pension system that rewards a handful of employees, the new paradigm gives more money to a larger pool of employees up front. The main advantage, however, is that a person who makes a job switch doesn't have to forfeit his or her benefits. In such a scenario, the worker can roll-over the account into another company's 401(k) or your own IRA. However, if you keep the money, then be prepared to take a staggering tax hit, as well as a 10% penalty for early withdrawal (before the age of 59 1/2). "From an employee's standpoint, cash balance plans are more tangible and understandable than traditional pensions where employees are totally clueless about how much money they would have upon retirement," says Paul Yakoboski, senior research associate at EBRI. "Employees can access their personal files and see how much money they accrued thus far."

PLACING CHECKS ON CASH BALANCE

While cash balance plans tend to appeal to younger employees, they can undermine traditional plans that favor older workers who get paid for seniority. Employees in their 40s and up could end up getting the short end of the stick, realizing pension reductions by as much as 25%-30%. "Under the traditional pension plan, the most valuable years to the employee were the later years of work," says David Certner, senior coordinator for economic issues at the Washington, D.C., advocacy group, AARP (800-424-3410; www.aarp.org). "The longer you were with a company, the greater the contributions to your pension benefits. So, if you were with a company for 30 years, your account accrued more in the last 10 years than in the first 20 years of employment."

So what happens to a worker who has been with a company for 20 years and his or her company converts to a cash balance plan? Certner says that the worker loses the most valuable years of retirement benefits. Rather than getting a large portion of their salary credited to a pension each year, he maintains, employees now receive from 4%-8%.

As a result, these plans are being scrutinized by the Labor Department and consumer groups, including AARP, that are trying to figure out how such plans operate and the effect on employees. Companies have leeway as far as how they convert to a cash balance plan because the IRS has not instituted any formal regulations to govern the hybrids. "A lot of people foresee trouble down the road because so many big companies have now adopted it," says Mike Johnston, a retirement consultant with Hewitt Associates, a management consulting firm in Lincolnshire, Illinois. "It's a pension plan dressed up like a 401(k), and it doesn't fit the technical rules that apply to traditional pensions."

For instance, there are requirements about distributions. Generally, defined-benefits plans allow employees to receive their vested account balances as a lump sum payment or an annuity. Standards have been developed for eligibility, funding and vesting as well as death and spousal benefits. Johnston says employers may have to make substantial changes to cash balance plans once the IRS decides to establish new ground rules.

According to Johnston, the calculations for determining the opening account balance and annual contribution schedules "are all over the place. There's no standard formula for determining each employee's future benefit [the specified amount of money due at retirement] under these plans."

Essentially, the employer designates the value of benefits built up by an employee under the traditional plan, and then places some or all of the value into individual employee accounts. Then, the company establishes a contribution percentage for each employee, anywhere between 3% for younger employees and 10% for older workers. (Balances are determined in two ways: cash balance credit or interest credit based on a fixed rate.) Depending on the way the conversion is handled, experts maintain, some employees aren't going to earn new pension benefits right away.

Many companies, however, see cash balance plans working in tandem with 401(k) plans. In fact, they have increased their matching contributions to 401(k) accounts in an attempt to make up for reduced pension benefits as a result of the switch as well as to hold on to employees. Others are providing transitional benefits for employees nearing retirement, allowing them to stick with their old pension or boosting an older employee's opening account balance.

PLANNING FOR YOUR GOLDEN YEARS

In this new environment, employers are now saying that workers can expect their retirement funds to come from three sources: personal savings, employer-sponsored plans and Social Security. And you, the employee, will probably have to foot the biggest chunk of your post-career cash.

So what should you do? It's imperative to take the time to craft a sound retirement strategy by developing a formula that helps you determine when you can afford to stop punching the clock. The following are some guidelines that may help you:

* Know how your benefit program is structured. If you are unsure about whether your company has converted from a traditional benefits plan to a cash balance program, immediately contact your employee benefits administrator. Get your company to fully explain components of its retirement program and, if necessary, get them to calculate the current value of your package or issue a statement. At that time, you query officials regarding how the company computes your pension.

* Figure out how much you need to retire. Once Lila Robinson, an administrative assistant in AT&T's transaction services division, evaluated her benefits program, she figured out how much she would need to retire comfortably. She's currently working on a plan that would prepare her for life after work--a nest egg worth roughly $1 million. The 48-year-old mother of three--ages 28, 21 and 19--is currently taking advantage of both her company 401(k) and cash balance plans, in which she has made contributions of $20,000 and $10,000, respectively. Also, Robinson has used her IRA to develop a blue-chip portfolio. "When AT&T converted to a cash balance plan, I [was fortunate enough to have] a manager who had a financial background and was willing to go over the information with employees to help them understand how the plan worked, what the benefits were and reassure us it was safe," says Robinson. "What I like about the plan is that the money is portable and you can also tap into the funds for emergencies, to buy a home or finance education. I was able to borrow against the funds in my 401 (k) and cash balance plans to pay for my daughter's college education. The interest rate was lower than if I had taken out a commercial loan."

While Robinson knows her pension money is there for the taking, she plans to pay back any loans and reinvest her money. She adds: "I'm saving to build a nice financial cushion, especially since I plan to retire well past the traditional age of 65."

* Supplement your retirement income. Nicole Johnson-Reece took stock of her losses when she left AT&T--and took action. You should, too. "We're looking for better, more flexible ways to maintain our cash and increase our hope chest," says Johnson-Reece, who's married and has a two year-old daughter. "I know when I retire Social Security is barely going to exist or not at all. So, it's important that my husband and I make plans now to prepare for that time."

Johnson-Reece and her husband started investing in high-technology stocks to grow their investment portfolio and tapped a planner to help them create a 15- to 20-year financial plan. By following this formula, they can expect to find comfort in their golden years.

DEFINING BENEFITS

These days, American businesses are offering a number of retirement plans. The chart below provides details on the characteristics of traditional defined-benefit, defined-contribution and cash-balance plans.

                  Defined-Benefit Plan       Defined-Contribution
                  (Traditional Pension)      Plan (401k, 403b)

Beneficiary       Rewards older and longer   Significant accruals
                   service employees          at younger ages
Structure of      Generally, no employee     Employee and/or
 Plan              contributions, no          employer makes
                   individual accounts        contributions to plan
                                              to fund all employees
Risk Level        Employer bears             Employee bears
                   investment risk            investment risk
Benefits          Benefits are based on      Benefits payments based
                   formula tied to years      on money accumulated
                   of service and salary      in each individual's
                                              account
                  Benefits defined as life   Employee selects a menu
                   annuity                    of investments,
                                              usually mutual funds
                  Usual form of benefit is   Usual form of benefits
                   monthly income             is lump-sum payment
Portability       Usually not portable       Portable
Insurance         Pension Guaranty Corp.     No Pension Guaranty
                   cost and insurance         cost and insurance
Vesting           Plan can require certain   Employee contributions
 Schedule          number of years service    are immediately
                   before vesting occurs      vested; vesting in
                                              employer contributions

                  Cash-Balance Plan

Beneficiary       Significant accruals at
                   younger ages
Structure of      No employee contributions;
 Plan              employer makes regular
                   contributions to a fund
                   of assets for benefits
                   accrued by individual
                   employees
Risk Level        Employer bears investment
                   risk
Benefits          Benefits are defined in terms
                   of current lump-sum equal to
                   "account" balance
                  Accounts credited with interest
                   tied to 30-year Treasury
                  Form of benefit payment is a
                   lump sum or annuity
Portability       Portable
Insurance         Pension Guaranty Corp. cost and
                   insurance
Vesting           Plan can require certain number of
 Schedule          years service before vesting occurs

Source: Employee Benefits Research Institute, Washington, D.C.3