Guest view: Intended as a supplement, 401(k)s are now main ingredient
Over the past few decades, the type of retirement plan offered by employers has changed significantly.
In the 1980s and 1990s, traditional pension plans were still prevalent in the corporate world. Today, most employers have transitioned to defined contribution 401(k) plans.
Corporate employers have switched to 401(k) plans as the dominant vehicle for retirement savings for a few reasons. Complex government regulations, hefty annual insurance premiums, and unpredictable annual costs have frustrated employers who sponsor pension plans. 401(k) plans offer employers an escape from these aspects. They also offer today’s workforce a more portable benefit, as account balances can easily be transferred to an IRA or new employer’s 401(k) plan.
However, there certainly is another side to the story. Many people don’t realize the original creators of the 401(k) plan never intended for pension plans to be replaced. The early champions of the 401(k) saw the concept as a way for employees to supplement their company’s pension plan.
The transition away from pension plans has led to many Americans not having adequate retirement savings. In general, people don’t save nearly enough and invest too conservatively to accumulate the account balance needed to generate lifetime income. Additionally, with a 401(k) plan the investment risk and longevity risk are borne entirely by employees.
In an ideal world, workers would have access to both a pension and a 401(k). The guaranteed pension benefit combined with Social Security would be earmarked for life’s fixed expenses, while the 401(k) account balance would enable each person to invest additional savings based on their own risk tolerance.
As a generation of employees retires with inadequate retirement savings, we may eventually see the traditional pension plan make a comeback. After all, the best way to deliver any type of benefit involves the pooling of risks. This is exactly what a pension plan does. A 401(k) plan on the other hand, while it is a great retirement vehicle, does leave each person out there on their own, susceptible to market downturns and volatility.
The good news is the retirement income challenges we face in today’s 401(k) world can be overcome. Awareness is the first step. A common rule of thumb to maintain the same standard of living during retirement years says that one needs to be able to replace at least 80 percent of their pre-retirement income. For most, that means an annual retirement savings rate of at least 15 percent of earnings, combining employee and employer contributions. That number may be somewhat shocking to the individual who, for example, contributes 3 percent of their pay, receives the 3 percent employer match, and feels this is enough.
However, we can still get to where we need to be with well-designed plans and engaging employee education programs. This transformation has already begun in recent years with such features as automatically enrolling employees in 401(k) plans, and automatically increasing an employee’s contribution percentage each year. Additionally, many employers are now sponsoring in-person “financial wellness” workshops led by financial experts and benefit consultants.
For companies without a pension plan in place, financial wellness programs and automatic plan design features can help employees bridge the gap in their retirement savings.
John Jeffrey is a consulting actuary specializing in retirement plan consulting and postemployment healthcare benefits, for Conrad Siegel Actuaries, based in Susquehanna Township, Dauphin County.