Recent data from the US Bureau of Labor Statistics shows that only 15% of private sector employees currently have access to pension plans, the so-called defined benefit retirement plans. Back in the late 1970s, employers gradually phased out traditional pension plans as the implementation of the 1978 Tax Reform Act allowed employees to contribute pre-tax income to 401(k) accounts for self-managed retirement savings. Some employers believed this could reduce enterprise risks and long-term financial burdens, ultimately improving profitability. However, data suggests that pension plans are more cost-effective compared to 401(k) plans, leading more employers to reevaluate their initial decisions.
In a recent move, multinational tech giant IBM decided to halt company matching contributions to 401(k) accounts and reintroduce defined benefit pension plans for full-time employees. Under this “new” pension scheme, the company will annually contribute 5% of an employee’s salary to the pension fund, money that was previously allocated for matching employee 401(k) accounts.
As per the plan, IBM pledges to provide a 6% annual return for the first three years to employees’ pension accounts. After three years, the return rate will roughly align with the 10-year Treasury bond yield.
This initiative is advantageous for IBM and other companies in various aspects. Companies no longer need to match contributions to employee 401(k) accounts, resulting in significant cost savings and potential further cost reductions through other means. As an employee, this offers you a more secure path to retirement. Why might a pension plan be more suitable for you and your employer than a 401(k) plan?
As an employee, you undoubtedly wish to save for retirement in a stress-free and secure manner, without worrying about the future. Unfortunately, 401(k) plans may not always help you achieve these goals, making pensions a more popular choice. Here are several reasons why many employees prefer pensions:
Pensions provide a fixed monthly payment based on clear criteria such as your years of service or salary level in the years preceding retirement. As long as you work the required number of years in an eligible position at the same company, you can rely on stable payouts.
Moreover, many pension plans offer Cost-of-Living Adjustments (COLA) to help you combat inflation. If you leave the job before retirement but delay pension receipt, the plan administrator may also adjust the benefits using a benefit index, regularly increasing your pension amount.
In contrast, the value of a 401(k) account solely depends on whether you saved enough funds during your working years and must withstand market fluctuations. If life circumstances prevent you from consistently contributing to your 401(k) account, your post-retirement finances may suffer.
Employees participating in defined benefit pension plans receive a fixed amount every month until their passing, providing peace of mind without the worry of depleting retirement savings.
401(k) accounts lack this guarantee. While most people may not exhaust their pension funds, 401(k) assets can deplete depending on the initial savings and investment risk management.
Although there are protective options such as converting a 401(k) into an annuity, these solutions are usually costly and not commonly offered by employers. Additionally, these methods are intricate and may not align with your retirement plans.
Economic downturns and market volatility can also lead to losses in your 401(k) account and other investments. Relying solely on a 401(k) for retirement income may result in significant income instability in your later years.
To sustain retirement with a 401(k), you must diversify your investments and closely monitor market changes. Regularly adjusting your investment portfolio or purchasing guaranteed products becomes necessary for stability.
Due to the complexity of managing a 401(k) account, you might need a financial advisor to assist with decision-making. However, misjudgments can significantly impact your overall financial status.
In contrast, pensions require no risk management actions, shielding you from market fluctuations. While pension funds also invest in stocks and bonds for growth, the pension amount received by retired employees remains unaffected by investment performance. The secure promise of a defined benefit pension is independent of short-term market volatility.
If you meet retirement criteria, such as completing a certain number of years in a qualifying position, you can receive employer-promised retirement income for life. Even if the company goes bankrupt, the US government’s Pension Benefit Guaranty Corporation is likely to ensure ongoing income.
Retirement plans can also benefit employers greatly. Offering secure retirement benefits not only saves money but also enhances brand image and attracts top talent.
Today’s job seekers value employers who provide financial security. Similar to previous generations, Generation Z graduates carry significant debt burdens and seek stability in turbulent economic climates. Many also support older family members financially, limiting contributions to 401(k) accounts and lowering their tolerance for financial risks.
Surprisingly, even fresh out of college, Generation Z young adults place high importance on retirement benefits, wanting to secure their financial future. Among Generation Z graduates, 15% frequently consider retirement planning, while 27% admit to “quite often” pondering the matter.
Furthermore, 65% of Generation Z graduates emphasize retirement benefits when selecting an employer. Hence, firms offering stable retirement security, such as pension plans, hold significant appeal in attracting elite talent.
David Burns, CEO of Vitech, a company providing management platforms for various large pension plans in the US, stated, “Companies that offer pensions demonstrate a long-term commitment to employees, making them attractive to job seekers seeking stability and easing the pressure on employees to make their own 401(k) investment decisions. Furthermore, in a competitive talent market, especially when recruiting experienced or high-demand professionals, pension plans set companies apart.”
In the past, many employers phased out pension plans, believing transferring financial risks to employees could significantly reduce retirement plan costs. However, the reality stands in contrast. The latest research from the National Institute on Retirement Security reveals that defined benefit retirement plans hold a cost advantage of up to 49% compared to 401(k)-type accounts.
The research report highlights that 401(k) accounts incur higher costs, yield lower returns, feature unbalanced investment portfolios, and lack mechanisms to share longevity risks. David Burns added, “Unlike 401(k)s, which are susceptible to market volatility and individual investment risks, pension plans provide a fixed return, enabling companies to more effectively control costs in the long term. Concentrating funds in a retirement fund can generate economies of scale, further reducing administrative and investment management costs.”
Employers can also enjoy tax benefits through pension plans. For instance, employer contributions to retirement funds may qualify for income tax deductions, while capital gains from investments typically appreciate tax-free. These benefits further aid in cost savings for businesses, optimizing budget utilization.
According to data from the Economic Policy Institute, the number of individuals participating in retirement plans has declined in recent years. Voluntary retirement plans like 401(k)s are particularly vulnerable during economic turmoil. In tough economic times, people often prioritize immediate needs over retirement savings, leading to wavering decisions in saving, investing, or withdrawing funds. Making the right choices is crucial as these decisions impact your ability to maintain your standard of living in the future and may even affect your ability to pay bills on time.
Opting for a job with a pension plan rather than mere 401(k) contributions can alleviate these worries, fostering confidence in your future income. Less worry now, guaranteed income in the future. Importantly, employers can enhance their financial benefits by providing such welfare.
Although many consider pension systems outdated, the benefits they offer to businesses and employees may make them a new trend in the future.