These days, very few people get guaranteed pensions and they are almost always 401ks instead.
If you are running a business, isn’t it cheaper to provide pensions? You can invest the money in the same sort of funds that a 401k is invested in, but money not paid out (say, both retiree and spouse die) can be pocketed where 401k goes to whoever is a beneficiary like kids, extended family, charities, pets, etc).
In: Economics
Wall Street didn’t like people to have a guaranteed monthly income. So they invented the 401k, which is a less stable retirement account. That is subject to the ups and downs of the stock market. Which can decrease in value during a downturn in the stock market. That’s why there are less companies that have pension plans.
2 reasons. First off, they are much preferred by corporate America. A pension creates a debt obligation for the company. If Ford has a pension, Ford has thousands of employees paying into it, and creating a real obligation to pay out to them in the future. With a 401k Ford gives you your employer match, and then they’re done with it.
Second, the reliability of a pension is basically 0. Back in the late 80’s or early 90’s one of the airlines was facing bankruptcy, largely based on it’s massive pension obligation. The courts allowed them to bankrupt out of the pension obligation, and restructure. Basically thousands of employees who had paid in for decades were told to pound sand, and the airline kept right on going without having to pay out.
Interesting note, the 401k was created to create a retirement account for a small group of executives at Kodak who were exempted from being able to contribute to their pension program. Corporate America saw the beautiful product of that lobbying, and realized that long term it was way better for them, so they started the shift.
I am not a financial expert but my understanding is that a 401K can run out of money if you outlive your nest egg. The business owner stops paying in as soon as you retire. Owners also limit their contribution if an employee doesn’t pay in their full amount. If the market falls, owners don’t lose anything or risk anything.
A pension on the other hand, is guaranteed income for life. Often, partial payment is included for a surviving spouse. If the market falls payments are still made. Risk is on the owner here.
There is a reason that pensions are down below 10% of most businesses now. It’s the one thing that unions are having trouble fighting for. People go for the raise and give up the ability to retire at a decent age.
Unless I’m missing something, how is a pension cheaper for the employer?
With a pension, the employer must guarantee certain payment upon the employee retiring and set aside funds, the employee generally does not often contribute to this fund and pockets their entire paycheck, minus taxes of course. This was also liability for employers in a market downturn.
With a 401k, employees must fund their retirement themselves by deducting from their paychecks, with employers only sometimes contributing a small portion as a match. It’s up to you to invest properly, if you buy stupid assets and lose on your position, well, that’s your fault and your employer isn’t liable.
Pensions have largely been discounted because number one, they’re more expensive for employers, and number two, employees began to prefer the flexibility and control of their own retirements. I know I don’t want my retirement hanging on the promise of a fund managed by people who I know nothing about purchasing assets that I don’t know of. Wall Street called pension funds dumb money because most of these asset managers had no experience in investing.
To summarize, 401ks became more popular for both employees and employers since they are cheaper for employers, and offer more flexibility, control and accountability for employees.
It’s cheap and less of a risk for the company. With a pension, a company would still have to pay the worker even if they went out business. They have the responsibility to make sure they have enough for the worker as laid out in their defined benefit. It’s a long term liability.
With 401k, everything is shifted onto the employee and the company isn’t stuck with anything.
Why would anyone want a pension from a company that might not be there in 30 years.
52% of Fortune 500 companies since 2000 went out of business
Pensions are a bit of a relic from times when many people worked for one company for most of their lives. It benefits people who stay in a company for long periods because the payouts are tied to last salary drawn. This doesn’t really work out as well for modern careers where most people don’t stay that long in a single company.
Pension funds are also rather expensive for companies and there was a history of some companies bailing on their pensions (this involves the govt picking up the bill in some cases). It really turns out bad when people are living much longer – as older pensions were designed around retirement at 60 with average lifespan of 68. Nowadays a person who survives until 60 has a better than even chance to make it to their mid 80s.
401k’s are tied to the person and basically doesn’t matter how many companies a person works in or for how long. The downside is that it requires that a person diligently contributes.
Because the rich get richer, and the tax code is designed for the very wealthy.
Corporations and their shareholders are better off without pension debt on their books, whereas employees would be better off with pensions instead of having to allocate part of their earnings towards 401Ks. But guess which won out?
Pensions rely on couple things. One a lot of population growth. You need younger workers to pay for older workers pensions. Two you need a pretty stable job market where people work for the same company for decades. Ideally you would also have a lot of big, stable companies that pay good wages and offer good benefits.
This environment existed during the period pensions thrived, but it would be hard to make it work today.
In fact I would argue even the 401k system is having problems largely for the same reasons. The population pyramid has only gotten worse and people switch jobs more now than ever before. I’m going to guess IRAs will become the focus and we might look back on 401ks as a relic just like pensions.
Retirement consultant here.
The main reasons 401k plans have replaced pensions:
1. Employees take all of the investment risk in a 401k, employers take all of the risk in a traditional defined benefit pension
2. The amount of contributions an employer needs to make for a 401k are highly predictable, whereas pension required contributions can vary wildly
3. 401k plans tend to be less expensive for the company
4. Employees tend to prefer 401k plans, despite them often being less valuable
Combine all of these and it’s a no-brainer for companies to eliminate the pension and replace it with a 401k
Happy to expand on any of the above if you’d like.
Edited to add: regarding your question of isn’t it cheaper to provide a pension?
Answer: it depends on the plan. You can design pensions and 401k plans to be cheap or expensive. You can make a very generous 401k that costs the company way more than a bare bones pension, or you can do the opposite.
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