I work on defined contribution plans all day, every day, and I witness firsthand their ability to build wealth for American families. New designs and auto features have increased the retirement preparedness of those eligible for 401(k), 403(b), and 457(b) plans.
The transition away from defined benefit plans to defined contribution plans isn’t underway, it’s nearly complete, and I can’t imagine a world where we move back.
Much has been written about the benefits of defined benefit plans to employees, primarily lifetime income funded mainly or exclusively by your employer in exchange for a specified number of years of service.
What was underappreciated about pension plans was their ability to create stability among the workforce. Most pension structures create thresholds under which benefits are maximized. Those thresholds become marking points at which employees can capture much of their accumulated retirement. Perhaps working longer increases marginally the benefit they may receive, but upon vesting, employees who no longer wish to work (generally) aren’t forced to do so by financial need, and those that continue to work do so because of their desire to work.
Engaged talent is typically engaged, and disengaged employees can safely retire without being subjected to the vagaries of investment returns.
Much of what actuaries do is predict for purposes of valuation, retention, and retirement and they do so with remarkable accuracy.
Defined contribution plans have increased the volatility of staffing. While there are clear differences in the richness of retirement plan benefits from one employer to another, most have some form of benefit and the ability to defer income. Vesting schedules have been shortened or eliminated and the vesting schedules in place don’t seem to impact employee movement.
These factors are, in many ways, beneficial. Workers aren’t trapped in organizations they don’t want to be in, and retirement portability has been dramatically improved as a result.
The real challenges of the defined contribution system seem to come in retirement, where employers may be negatively impacted in two ways.
Workers who can leave don’t
The combination of market volatility, uncertainty about longevity, confusion about healthcare, and lack of awareness about how accumulations can be converted to income leave many that are able to retire tethered to their employer when they may prefer to be elsewhere or retired.
Higher wages and higher healthcare and related benefit costs are impactful for employers retaining employees who would rather be elsewhere. When faced with the uncertainty of the future, inertia takes over and employees stay employed until certainty improves or circumstances intervene. Circumstances could be health-related or additional incentives paid by the employer to encourage retirement. Neither are optimal for the employee or the employer.
Retention is dictated by unpredictable markets rather than predictable changes in demographics
Numerous academic studies have reviewed the impact of investment markets on retirement timing. If uncertainty creates retirement friction, strong markets are the best lubricant. When markets are performing well, participant hesitancy is diminished, and retirements follow. However, the timing of events can be highly negative for employers. For instance, if we look back at the financial markets crisis of 2008-2009, markets cratered, employers began shedding bodies, but retirement aged employees with seniority were much less apt to retire in the face of the uncertainty, and the workforce aged with younger employees being displaced.
In the current environment, the opposite, and equally challenging event is pushing more Americans out of the workforce. While far from the only issue impacting the current labor force shortage, retirements are an important component. For most, retirement accounts are at all-time highs. When faced with the uncertainty of returning to a more normalized work environment, retirements have increased leaving organizations short employees and scrambling to fill senior position openings.
I am not naïve. While these problems are significant, they are not significant enough to see a rebirth in pension programs. I am also skeptical that changes in how participants elect to receive benefits will move behavior in any meaningful way.
Employers will need to become better at preparing their workforce for retirement and educating them on the resources available when they’re ready to retire. Employers may need to be more targeted in providing flexibility and incentives to retain more tenured employees when faced with retirement accounts that are heavily funded.
We have long believed that pre-retirement education is more effective in helping participants and has a higher ROI than other forms of participant education. If you’re interested in discussing the nuances of pre-retiree education and advice, please reach out to a consultant.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.