IV...............................WHY PENSIONS MATTER

To understand why pensions are still important, you have to understand the awkward beast that benefits professionals refer to as the U.S. retirement system. It is not really one "system" but three, which complement each other in the crudest of fashions. The lowest tier is Social Security, which provides most Americans with a bare-bones living (the average payment is about $12,000 a year). The highest tier, available to the rich, is private savings. In between, for people who do not have a hedge-fund account and yet want to retire on more than mere subsistence, there are pensions and 401(k)'s. Currently, more than half of all families have at least one member who has qualified for a pension at some point in his or her career and thus will be eligible for a benefit. And among current retirees, pensions are the second-biggest source of income, trailing only Social Security.

During most of the 90's the decline in pension coverage was barely lamented. It was not that big companies were folding up their plans (for the most part, they were not) but that newer, smaller companies weren't offering them. As the small companies grew into big ones (think Dell, or Starbucks, or Home Depot), traditional pensions covered less of the private-sector landscape. This did not seem like a very big deal. Younger workers envisioned mobile careers for themselves and many did not want pension strings tying them to a single employer. And most were able to put money aside in 401(k)'s, often matched by an employer contribution.

It happened that 401(k)'s, which were authorized by a change in the tax code in 1978 and which began to blossom in the early 1980's, coincided with a great upswing in the stock market. It is possible that they helped to cause the upswing. In any case, Americans' experience with 401(k)'s in the first two decades of their existence was sufficiently rosy that few people shed tears over the slow demise of pension plans or were even aware of how significantly pensions and 401(k)'s differed. But 401(k)'s were intended to be a supplement to pensions, not a substitute.

From the beneficiary's standpoint, pensions mean unique security. The worker gets a guaranteed income, determined by the number of years of service and by his or her salary at retirement. And pensions don't run dry; workers (or their spouses) get them as long as they live. Because the employer is committed to paying a certain level of benefits, pensions are known as "defined benefit" plans. Since an individual's benefit rises with each year of service, the employer is supposed to sock money away, into a fund that it manages for all of its beneficiaries, every year. The point is that workers don't (or shouldn't) have to worry about how the benefit will get there; that's the employer's responsibility. Of course, the open-ended nature of the guarantee -- the very feature that makes pensions so attractive to the individual -- is precisely what has caused employers to rue the day they said yes. No profit-making enterprise can truly gauge its ability to meet such promises decades later.

A 401(k), on the other hand, promises nothing. It's merely a license to defer taxes -- an individual savings plan. The employer might contribute some money, which is why 401(k)'s are known as "defined contribution" plans. Or it might not. Even if the company does contribute, it offers no assurance that the money will be enough to retire on, nor does it get involved with managing the account; that's up to the worker. These disadvantages were, in the 90's, somehow perceived (with the help of exuberant marketing pitches by mutual-fund firms) to be advantages: 401(k)'s let workers manage their own assets; they were a road map to economic freedom.

Post-bubble, the picture looks different. Various people have studied how investors perform in their 401(k)'s. According to Alicia Munnell, a pension expert at Boston College and previously a White House economist, pension funds over the long haul earn slightly more than the average 401(k) holder. Among the latter, those who do worse than average, of course, have no protection. Moreover, pensions typically annuitize -- that is, they convert a worker's retirement assets into an annual stipend. They impose a budget, based on actuarial probabilities. This might seem a trivial service (some pensioners might not even realize that it is a service). But if you asked a 65-year-old man who lacked a pension but did have, say, $100,000 in savings, how much he could live on, he likely would not have the vaguest idea. The answer is $654 a month: this is the annuity that $100,000 would purchase in the private market. It is the amount (after deducting the annuity provider's costs and profit) that the average person could live on so as to exhaust his savings at the very moment that he draws his final breath.

So the question arises: what if he lives longer than average? This is the beauty of a pension or of any collectivized savings pool. The pension plan can afford to support people who live to 90, because some of its members will expire at 66. It subsidizes its more robust members from the resources of those who die young. This is why a 401(k) is not a true substitute. Jeffrey Brown, an associate finance professor at the University of Illinois at Urbana-Champaign and a staff member of the president's Social Security commission, notes that as baby boomers who have nest eggs in place of pensions begin to retire, they will be faced with a daunting question: "How do I make this last a lifetime?"