Remember your grandparents boasting about their “golden parachute” – the generous company pension plan waiting for them at retirement? Today, that picture is fading fast. The remaining recipients are government workers. Corporate America has shifted gears, leaving many wondering: where’s the safety net in this new retirement paradigm?
It’s not just you feeling the impact of the change. Companies like General Electric and IBM freezing their pension plans are stark reminders of a nationwide trend that includes even the biggest corporations. The traditional, defined-benefit pension plan, where the net worth of your employer guarantees a set monthly income after retirement, is nearly extinct.
But why the switch?
In our blog, we’ll look at some of the factors that caused this shift and how you can use the services of a Roseville retirement planning team to plan accordingly for the type of retirement you’ve envisioned for you and your spouse.
Economic Pressures: The Squeeze is On
In the early 1980s, many companies began moving away from pension plans, also known as defined benefit plans, and shifting to defined contribution plans, also known as 401(k) plans.
This shift was mainly due to the Revenue Act of 1978, which included a provision that became Internal Revenue Code (IRC) Sec. 401(k), which was effective on January 1, 1980. The provision allowed employees to avoid being taxed on deferred compensation if the benefits complied with specific requirements.
The first 401(k) plans were established in 1981. This change was attractive for companies because 401(k) plans shifted the responsibility for retirement savings from the employer to the employee, reducing their financial burden and the risks associated with company-paid benefits for life.
Following are some of the driving factors that caused companies to move away from pension plans into 401(k) plans:
- Defined benefit plans can be expensive for employers due to the guarantee of a specific retirement payout, which can fluctuate based on investment performance, the funding capabilities of companies, and employee longevity.
- The employer bears the investment and longevity risk in a defined benefit plan. Poor investment returns or increased life expectancy can significantly increase the cost of these plans.
- Defined benefit plans are subject to complex regulations and requirements, which can be burdensome for companies to manage while complying with regulations.
- The modern workforce is more mobile than in the past, leading companies to prefer retirement plans that are more portable for employees, such as defined contribution plans.
- Economic and market uncertainties made it challenging for companies to predict the long-term asset amounts necessary to fund defined benefit plans. This prompted a significant shift to plans where the employees bear the investment and longevity risks.
Watch our video on how you can redefine your retirement goals.
Workforce Wanderlust: A New Breed of Employee
Remember when working for one employer for all of your career was common? People dedicate their entire careers to one company, often motivated by a sense of loyalty and the promise of a secure, guaranteed pension amount (adjusted for inflation) when they retire.
Times have changed. Today, employees are more inclined to move between companies (average tenure of seven years), driven by various factors, including the pursuit of better opportunities, higher salaries, and more fulfilling work experiences.
One of the critical factors influencing this shift is the decline in the availability of pensions that rewarded long-term employment.
Pensions were a significant incentive for long-term employees, offering them financial security for life during their retirement years. This worked best when a typical lifespan was more like 75. Today, one or both spouses could live well into their 90s, and this number is about to rise even more.
The relationship between you and your employer has shifted and evolved, so financial security in retirement is now your responsibility, not your employer’s.
Download our eBook series: Your Financial Compass. These informational guides provide you with steps you can take today to help better protect your tomorrow.
Enter the 401(k) Plan: Freedom, with a Serious Dose of Financial Responsibility
A 401(k) plan offers several advantages for employees and employers.
For employees:
- It serves as a foundation for retirement savings, allowing you to contribute a portion of your salary pre-tax, which can reduce your taxable income and help pay for the contribution.
- The funds in the account grow tax-deferred until withdrawal, which is a major financial benefit compared to paying capital gains and income taxes on earnings inside the plan.
- Many employers also match a percentage of employee contributions, effectively providing additional free money towards their retirement savings.
For employers:
- Offering your employees a 401(k) can make it easier for you to attract and retain top talent, as a competitive retirement plan is a sought-after employee benefit.
- You may receive tax benefits for contributing to your employees’ plans and the costs associated with establishing and maintaining the plan.
- Offering a 401(k) also fosters a culture of savings and financial responsibility within the company, contributing to overall employee satisfaction and loyalty.
Tailored Retirement Planning
As experienced financial planners in Roseville, CA, our team focuses on helping successful individuals and families plan for retirement. Using a proprietary planning process, we break down complex financial situations and convert them into manageable retirement planning steps, explicitly focusing on income, investments, taxes, healthcare, and legacy planning.
To learn more about our retirement planning services, connect with us.
