For younger Americans, it’s a movie and television cliché. For older Americans, it was a staple of American life. What are we referring to? The traditional pension plan, also know as a defined benefit plan. Although quite accurate in its depiction, let’s take the old movie cliché: the hard-working father works blue-collar labor for 30 years for the same employer, is a proud union member, and retires at age 50. As part of his years of service, he will receive guaranteed retirement benefits the rest of his life, paid by his former employer, and sits back to relax and enjoy his grandchildren.
It might sound a little corny—straight out of an old black and white sitcom, maybe—but for several generations of American workers and their familes, this was reality. The pension plan benefits were vitally important for retired American workers, and, as recently as 1980, over 60% of private-sector American workers were covered by a defined benefit plan. Today, that number is around 10%.1 What happened?
First, let’s answer a simple question: what replaced the traditional pension plan? In short, the defined contribution plan. And for the last few decades, the defined contributon plan, for many American workers, is synonymous with their 401(k) plan. Although traditional pension plans are not totally obsolete, they have easily been eclipsed by the 401(k) or other defined contribution plans.
Second, let’s explore how these two types of plans are different. With defined benefit plans, employers fund and guarantee a specific retirement benefit amount for each participant of the plan. If the market goes down, the retired pensioner still received their guaranteed benefits. Defined-contribution plans, on the other hand, are funded primarily by the employee, as the participant defers a portion of their gross salary. Employers can match the contributions up to a certain amount if they choose. If the market goes down, the retiree could conceivably see a decline in their retirement benefits, as nothing is guaranteed with defined-contribution plans.
Why the decline of pension plans? It's quite obvious, right? As an employee, a traditional pension plan would generally be preferred, whereas an employer would take the opposite view. So, employers, starting around 1980, began offering 401(k)s instead of pension plans. Even in 2022, the 401(k) is the most prevalent of all employer-sponsored retirement plans, and nothing suggests any major changes will occur in the near-future. Bottom line: defined-benefit plans became too expensive for the employer
Several historical trends made pension plans less common, including:
- Baby boomers living longer
- Diminished influence of labor unions
- A more mobile workforce
Knowing these facts, it’s not unreasonable for older American workers to look back fondly on the good ol’ days, when a blue-collar worker was rewarded for years of service with very generous retirement benefits. Now, with the 401(k) and other defined-contribution plans, it’s up to the employee to make smart investment decisions. We can lament the demise of the traditional pension plan, but the 401(k) is here to stay, and it’s up to you to maximize your benefit.
Notes:
1: EBRI; Department of Labor; J.P. Morgan
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