The question of whether a 401(k)/403(b) or a defined-benefit plan is “better” for an employee is not straightforward, nor even really a “general question”. We can easily come up with pros and cons of both, I think.
It is, however, pretty well agreed that a defined contribution plan is “better” for the employer, as it removes their risk entirely.
You may, or may not, be aware that there are “catch-up” contributions allowed to 403(b) plans if you are over 50.
There has been a recent change that has resulted in a lot of companies offering buyouts to pension holders. I believe Ford had a big program. My pension was with Lucent which inherited it when AT&T split up. I did talk to my financial planner.
Despite what your link said, the pension had a very good rate of return. My planner was impressed. However, it had one drawback. It was reduced to pay for insurance for my wife, so that if I went she’d get 50% of my pension. And if she went my kids would get nothing. We bought an annuity which increases in return as time goes on and which doesn’t vanish when I do. My research indicated that there are better ones than what I god, but which can’t be inherited.
The amount of the lump sum payment is determined by government rules. It was a lot more than I was expecting!
Before 401(K)'s came in the biggest desire for engineers who moved frequently was for “portable” pensions. Back then such people were a minority as lots of people worked for IBM or AT&T for decades. 401(K)s are great for the current model of frequent job changes.
Mine has. But the problem with 401(K)s is not that they are scams, it is that they make it much easier for people to screw up their retirement. People don’t participate or don’t max out their contributions, they put the money in terrible investments, they borrow and thus stop contributing or worse they take money out and pay the tax penalty. If everyone made good choices, they’d be fine. Pensions are safer, assuming the company doesn’t screw the employees - sometimes a bad assumption.
And a 401(k) is really not much more than a fancified savings account. Employers don’t draw attention to the fact that what you’re getting is far less than you would under a defined-benefit pension.
That’s probably the most accurate statement, Ascenray - a 401(k) employer contribution is not a retirement benefit, it’s a salary bonus with strings attached. It’s only as useful for retirement as any other part of your salary (i.e., if you don’t screw it up, and your investments perform as expected).
Whether employers should be in the business of providing retirement benefits is another question altogether.
Many years ago, when defined benefit plans were still common in the private sector, I worked for a company that had a large pension actuary division. Basically the actuaries calculated how much the client company needed to set aside this year to assure that pensions would be funded in the future. A lot of assumptions (I think they called them “projections”) went into their calculations – not only what the investments in ther pension fund would earn, but how many years employees would collect, how many woud die before ever collecting, how many would leave the company’s employ before being fully vested, how much salaries would increase, and how much Social Security would be paying.
This last was important because most defined benefit plans had a Social Security offset. Employers usually didn’t go out of their way to explain that when they said if an employee retired at full pension she would receive 80% of her average pay over the last five years she was in their employ, that the 80% included what she’d receive in Social Security.
Pension plans should be managed by a third party. A lot of company retirement plans are not fully funded. I believe United’s was only 50% funded when they filed for bankrupt a number of years back. When I worked for Carter Halley Hail their retirement fund was only 50% funded when they were bought out by Federated. A company will go your years underfunding retirement then when they get in finical bind and it comes to llight they will want relief because the retirement plan is bankrupting the company.
A lot of government retirement pay outs are baised on the last years or three years earnings. An employee who gets a promotion in the last years or works a lot of OT in the last years gets their retirement bumped up. And many “public safety officers” can go out on disability at 50 or 55 after 20 years, and get 80 to 90 percent of their earnings. The bad thing is it is no problem to be declaired disabled. An assistant fire chief goes out on 90% disability from one city and then takes the fire chief’s job in another city.
I remember when it took 20 years to vest in many company retierment plans. With the passing of the retirement insurance program vesting time was reduced to 5 years. That is what started companys to move away from defined benifit plans to defined contribution plans. Also the book keeping with a defined contribution plan there is a lot less book keeping on the company’s plan.
In the Hostess case the employee’s retirement plan are union plans. Hostess was not making payments to the retirement plans. If an union member is not fully vested and does not have payments being made on their behalf they canbegin to loose the amounts that are in their account.
I prefeer a defined benifit plan. In 1 to 2 years I will retire. I can caculate how much income I will have each month to liveon. With a defined contribution plan when I retire I will have a lump sum of money that I will have to make last the rest of my and my wife’s life. How much can I spend each month? What if I am retired only 5 years before I die? I could live very well. But if I live to be 90 then I can not spend as much each month. What if I run out of money before life? It is really guess work.
IIRC:
The age 65 was made comon by the German government old age plan instituted at the end of the 1800’s. Yes, 65 was toward the end of when an average worker could still be productive, not"when they usually die". The life expectancy was in the 70’s though, so it was not considered to be a large burden.
Defined benefit plans were great ideas in a stable situation. However - when the number of employees declines, the market goes sour for several years, or the business filling the plan fund goes bad or shrinks - then the plan suddenly becomes a bigger burden. That’s why defined contribution is so much more popular - what you see is what you get, any shortfall from market problems is your problem not the employers. A defined benefit issue too is it is usually based on “best 5 years of last 10” or similar. As a result, a person may get a lot more than contributions should indicate, as pay goes up over a career. Worst, in many plans, especially public sector ones, overtime is included in that calculation. IIRC before NYC went bankrupt in the 70’s, subway workers would conspire to give all the overtime to the soon-to-retire, thus giving them pensions well above their basic wage. Poor planning.
A pension is deferred earnings - you’ve earned it now but collect later. Airlines were notorious for cheating on this - it was easier for the bottom line to promise money later instead of money now… Then when the money was due, postpone yet again.
A fund for defined benefit requires the company to put in enough money to meet its obligations. In Canada, the fund is managed at an arms’ length by a trust company or accounting firm. (IIRC, in USA or Britain it can just be a function of the company’s accounting department). In Canada, the fund must be audited every 5 years, and any actuarial shortfall must be figured in as larger contributions going forward.
Stelco is notorious in Canada as one of the few companies that pleaded money problems as an excuse to defer contributions to their plan - as usual, it did not help and many pensioners ended up with about a 25% cut in their pensions to stabilize the fund after the company went bankrupt.
Not sure what the rules are in the USA, but I understand one trick was for the company to put its own stock into the fund instead of money - with predictable results when the market or the company hit bad times. (Canadian funds are required to do arms length transactions and be safely diversified). Not sure what the US requirements are for auditing and making up underfunding, but quite a few companies shirked their contribution requirements leading up to bankruptcy, then dumped very badly funded pensions of the US body that handles orphan funds. (Airlines, anyone?)
Public pensions (municipal, state, etc.) are the most notorious because the politicians conveniently exempt themselves from the need to have a fund, and pay employees out of general revenue - thus setting up wildly open-ended obligations.
Add benefits into public or private mix and your obligation likely grows even more wildly.
Y2K was the perfect storm that buggered a lot of pension plans - the dot-com boom busted, so the stock market crashed and a lot of funds lost value; meanwhile, the bond market, where funds are usually parked when stocks suck, hit historically low rates so bonds did not perform the way they usually do. Add to that, business and profits were bad, so businesses did not have the funds to top up the missing money…
Also take note that - when the governments first started getting serious about old age pension / social security issues in the late 80’s, they noted that a lot of people had no pensions; pension vesting was usually at 10 years, so as the job market turnover became faster, funds benefited from a lot of contributions that were orphaned and applied against fewer and fewer long-term employees. Plus, people with short lifetime contributions - get 10 years of a 35-year pension when you turn 65 based on wage rates from 25 years ago? Not much obligation there… (COLA adjustments don’t kick in until you start collecting)
(Some funds were totally paid by the company, some had an employer-employee matching, etc. In the latter, you could get back your half but not the company’s if you left early. Regardless, if it was defined benefit, the company made up the shortfall to ensure the plan stayed solvent… or not.)
The governments started mandating quicker vesting, the right to take a lump-sum with you as a 401k or RRSP, etc. My company’s plan went from 10 years to 5 years and then to 2 years. (now it’s gone). This threw another wrench into plan calculations…
Not true. If you had said that it’s only as good as any other part of your salary that you save for retirement then it would be more true.
However there are additional advantages oiver basic savings…
the pre-tax investment and tax deferral aspects
the rules that make it harder for you to decide to blow it
Oh… did the OP get answered?
Just thought I’d point out that you can get the benefits of both. A life annuity will take the money you have now and provide fixed monthly payments. Annuities have some downsides, but they do solve the issue of regular monthly payments for the rest of your life, even when you don’t know how long that will be.
This is why employees under a defined contribution plan need some kind of professional advice in managing the assets to meet their own needs. There are financial products out there to achieve just about any goal.
The short answer to the OP - companies and politicians created pension plans to give the illusion that employees were earning something, while allowing the executives/politicians to defer much of the cost until later. Well, now it’s later and they can’t put off the cost any more.
They also often promised high pensions as a substitute for high wages; again, promising one day that at a much later time they would add money to a fund. The auto makers, the airlines, assorted municipalities and states all fell into the category of “mouth making promises their ass couldn’t cover”… Buying labour peace then at the expense of much higher costs much further down the timeline, once the responsible administration had collected their wages and golden parachute and moved on.
I don’t recall explicitly putting money into my pension plan, and I certainly don’t recall AT&T giving me a raise to fund my 401K (though they did match.) The pension plan was still active when I left, but I somehow doubt companies stopping pensions and going to 401Ks give raises either.
The love for 401Ks comes in part from the confidence of so many people that they can beat the market, and that they are smarter than professional pension fund managers because - they just are.
In fact, companies that can afford pensions ar switching to 401k-type plans (or in Canada, RRSp type plans). This is because a defined-benefit plan is a blank cheque for the next X years, dependent of future market forces, etc. while a 401 or defined-contribution fund is limited to whatever is put into it at the time - no future obligations.
When you do the computation remember that when you hit 90 you will not want to spend the same amount every month as you would at 67. Neither my father who died at 95 nor my father in law who is still alive and kicking at 97 do. I’ve tried out a lot of retirement savings calculators and I think they are all pretty bogus, which you can tell by playing with the inputs. For instance, how much you need is a percentage of your current income no matter how high that current income is. Most of them are done by companies wanting you to open accounts with them, so there is incentive to scare you. None of them seem to take this decline in expenses into account either.
I think the love for 401ks is that your company can’t screw your pension by fiddling with numbers you can’t see. All the numbers are there for you to see for yourself. No need to worry that the company is underfunding or will go bankrupt.
The cost for eliminating those risks is that we now have the risk of mismanaging our pensions ourselves. Some fools will try to beat the market. Prudent investors simply match the market–that was exactly what the defined benefits plans were doing, when they weren’t cheating. And it’s easy to do; any S&P500 index fund will work.
Yes, but the amount you spend depends greatly on your health level. A healthy 95-year-old may have few expenses, but someone who needs a high level of nursing care might have very high expenses. A former professor of my father’s was in a nursing home that cost over $10,000 per month (I think he had Alzheimer’s disease), and that was over ten years ago. You could, of course get long-term care insurance to manage those costs, but that’s expensive.
If you have advanced Alzheimers does it matter how much money you have? If I’m basically a rutabaga, I really don’t care what sort of treatment I get, it won’t matter. Drown me in my bath, instead…
But unless you’re planning to be super-rich or super-healthy, you can’t afford travel insurance for a vacation at age 95 either. Or a car. Or a private house to maintain, property taxes, electricity bill, etc.
the problem the defined benefit plans have is the same ones 401k’s would have - not so much matching the market as “the market sucks”. If the market sucks, in a defined benefit the company must top up the plan so you can retire on schedule. For a 401k, you retire with no money or you keep working a decade longer.
(Of course, in a defined benefit, there’s the additional benefit that the company can screw you by not contributing enough to the fund, declaring bankruptcy and unloading the fund and their obligations on the underfunded government pension board Guaranteed Benefits | Pension Benefit Guaranty Corporation , etc. )