There was a time when, after 25 or 30 years of hard work for your employer, you could expect to be rewarded for your loyalty and hard work with a golden watch and a constant flow of checks throughout your retirement. . But times have changed and these regular checks, thanks to a defined benefit plan, are a thing of the past for most workers in the private sector.
In this article, we take a look at the evolution of defined benefit plans over the past several decades towards defined contribution plans, such as 401 (k) s, and suggest ways to ensure you have a reliable income in your post. -job. years.
Key points to remember
- Defined benefit plans in the private sector were once common, but they are rare and have been replaced by defined contribution plans, such as 401 (k).
- Instead, companies choose defined contribution plans because they are less expensive and less complex to manage than pension plans.
- The move to defined contribution plans has placed the burden on employees of saving and investing for retirement.
- The Pension Protection Act of 2006 imposed stricter funding requirements to ensure that employees receive the benefits they are owed.
- Whatever type of plan your employer may offer, you have to fend for yourself if you want a financially secure retirement.
How times have changed for defined benefit plans
Until the 1980s, defined benefit pension plans were the most popular pension plan offered by employers. Today, only 15% of workers in the private sector have access to it, according to the March 2021 National Compensation Survey from the Bureau of Labor Statistics (BLS).
From an employee perspective, the beauty of a defined benefit plan is that the employer funds the plan while the employee reap the rewards in retirement. Not only do employees keep and spend all the money they earn in their paychecks, but they can also easily predict how much money they will receive each month during retirement, as payments from a defined benefit plan are based on a fixed formula.
Of course, there are always two sides to every story. Estimating pension commitments is complex. Companies offering a defined benefit pension plan should plan for the amount of money they will need to meet their obligations to retirees.
From the employer’s perspective, defined benefit plans are a permanent liability. Funding for plans must come from corporate profits, which has a direct impact on profits. A drag on profits can weaken a company’s competitive ability. Switching to a defined contribution plan such as 401 (k), which is primarily funded by employee contributions, saves a significant amount of money.
Over the past few decades, private sector companies have increasingly stopped funding their traditional pension plans, which is known as the freeze. A gel is the first step towards eliminating the diet.
General Electric is an example of a large company that does this. He announced in October 2019 his intention to freeze the pensions of 20,000 US employees and switch to a defined contribution plan to help reduce his underfunded pension deficit by up to $ 8 billion.
Other high-profile examples of large companies that have frozen pensions over the years include IBM, which announced in 2006 that it was freezing its defined benefit plan to switch to employee-funded defined contribution plans. which ultimately saved the company billions. Verizon, Lockheed Martin, and Motorola quickly took similar action.
Corporate America has defended these measures on the grounds that the government has taken action to force companies to fully fund their pension plans. The Pension Protection Act of 2006, for example, imposed more stringent funding requirements to ensure that employees receive benefits.
But companies have not always fully funded plans. Too often, the money was not there when it was needed, and the government was forced to bail out the plans. This route has been taken by several airlines and a contingent of steelworkers over the years, all of which have filed for bankruptcy and transferred responsibility for their pension obligations to the U.S. government. The government, in turn, has shifted the burden to taxpayers.
Defined benefit pension plans are still quite common in the public sector, especially for those who work for the government.
Impact of switching to defined contribution plans
So what does the end of defined benefit plans mean for employees? The whole storyline is bad news. Unlike a defined benefit plan, where employees know exactly what their benefits will be upon retirement, the only certainty in a defined contribution plan is how much the employee contributes. Many employers also offer matching contributions.
Once the money has reached the account, it is up to the employee to choose how it is invested (usually from a menu of mutual funds) and the vagaries of the stock market to determine the end result. Maybe the markets will increase, and maybe not.
On the flip side, many employees who relied on their employer-funded plans were left to fend for themselves when their employers failed to fund the plans. Likewise, many employees found themselves in a bind when their employers ended defined benefit plans or downsized, offering workers a one-time lump sum payment instead of a constant stream of income.
The reality of today’s retirement: fending for yourself
When it comes to a financially secure retirement, you have to fend for yourself. For the most part, social security benefits are not enough to survive in retirement. The first thing you need to do is save money, as early and as possible.
Tax-advantaged pension plans
The first place to start is with tax-advantaged retirement plans. If you have access to an employer-sponsored plan, such as a 401 (k) plan, maximize your contributions, if possible, and take advantage of your employer’s matching contributions if offered.
You can contribute up to $ 19,500 for the year 2021 to an employer-sponsored defined contribution plan, and you can add an additional $ 6,500 if you are 50 or older. This amount increases to $ 20,500 and an additional $ 6,500 for 2022.
The number of private sector employees who have access to a defined contribution plan, according to the Bureau of Labor Statistics.
If you don’t have access to an employer-sponsored plan, you can instead contribute to an Individual Retirement Account (IRA). In 2020 and 2021, you can contribute up to $ 6,000 per year to a Traditional IRA or Roth IRA and $ 7,000 if you are 50 or older. After putting the maximum amount allowed in these retirement accounts, it is time to look at other investments.
A wide variety of investments designed to minimize tax implications, including mutual funds, municipal bonds and more, are available for review. While taxes aren’t a concern, there is no shortage of investment opportunities designed to achieve just about any investment goal imaginable.
But to get the most out of your investing decisions, you need to understand the principles of investing. You should start by educating yourself about asset allocation, as many experts agree that this is the most important factor in generating portfolio returns. You may want to consult a financial advisor if making these decisions yourself is too intimidating.
Finally, saving may not be enough if you don’t limit your spending as well. If you can learn to live below your means instead of exceeding them, you can free up more money for your retirement.
The bottom line
If you’re one of the lucky few who work for an employer that still offers a pension plan, you have an advantage when it comes to saving for retirement. If you are like everyone else, you will need to take responsibility for planning yourself.
Contribute to an employer-sponsored plan, such as a 401 (k) plan, if you can. Otherwise, IRAs offer another way to save for retirement. Once you’ve maximized these options, consider investing outside of retirement accounts to help build your nest egg.