Definition of variable benefit plan

What is a variable benefit plan?

A variable benefit plan is a type of pension plan in which the payout changes based on the performance of the plan’s investments. 401(k) plans are an example of a variable benefit.

Key points to remember

  • A variable benefit plan refers to a type of qualifying plan, such as a retirement account, whose value fluctuates with the market value of its investments.
  • Defined contribution plans like 401(k)s are a common example of a variable benefit plan.
  • Although variable benefit plans can generate higher long-term returns than fixed defined benefit plans, they also expose account holders to market risk.

Understanding a Variable Benefit Plan

Variable benefit plans, also known as defined contribution plans, allow the plan holder to manage their own account. In contrast, a defined benefit plan provides the plan holder with predetermined payments at retirement that do not change and are based on an eligibility formula rather than investment performance.

Variable benefit plans transfer the investment risk from the employer to the employee. Employees may end up with less money from a variable benefit plan if they make poor investment choices. However, it also has the power to make superior investment choices and gain better benefits. Therefore, the employee’s ability to make smart investment decisions is critical in variable benefit plans.

History of variable benefit plans

People have been investing in financial markets for retirement for as long as the history of capitalism itself. The American Express Company first offered its employees a pension plan in 1875, establishing the first private pension plan in the United States.

As the life expectancy of Americans increased throughout the late 19th and early 20th centuries, the problem of how to provide for the retirement of members of the growing middle class became increasingly important. Congress sought to encourage the growth of private pensions by making contributions to these accounts tax-deductible in the 1920s. By 1929, there were 397 private sector plans in the United States and Canada.

The growth of pension schemes exploded after World War II, when unions began to strike in large numbers, demanding payment of pensions. From the end of World War II to around 1980, defined benefit pensions, or a pension in which a worker is guaranteed a predetermined set of benefits until death, were a major form of retirement security for American workers.

The pressure of maximum yields

But these types of repos placed great pressure on American companies, which faced increased competition from foreign competitors and shareholders who demanded maximum returns. This has led the private sector to rely more on variable benefit plans, in which the company’s contribution is defined, but the actual payout depends on the performance of pension investments.

Since the early 1980s, workers’ access to defined benefit plans has declined. According to the National Compensation Survey conducted by the Bureau of Labor Statistics, in 2020 only 15% of private sector workers participated in defined benefit plans. By comparison, around 65% of employees in the private sector had access to a defined contribution plan.

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