Broken Benefits: Why don't businesses offer pensions?
Defined-contribution plans, such as 401(k)s, put burden of saving on employees
Most companies long ago stopped offering pensions to employees.
About 80 percent of workers in the private sector rely on defined-contribution plans, such as 401(k)Snnbs, for retirement. For decades, companies have been moving away from defined-benefit plans, such as company-backed pensions that provide a guaranteed monthly payment, in favor of defined-contribution plans.
The changing job market, government regulation and costs all were factors in the shift, said Gerald Jensen, a finance professor at Northern Illinois University. Portability was another factor.
“It used to be common for someone to work at one company for their entire career,” he said. “Now it makes more sense to have a retirement plan that you can carry with you.”
Many companies discovered that paying for pension plans not only was expensive, but difficult to plan for, especially as people began living longer.
“That’s what the government is discovering,” Jensen said. “It is easy to make promises, but hard to come up with the money to pay for those promises.”
In the United States, government “is the last bastion of defined benefit,” he added.
Pensions gained popularity in the 1930s and reached a zenith in the 1960s. Companies saw it as a way to gather and keep a loyal workforce. But with people living longer than had been expected when the plans were created, some large corporations found they hadn’t set enough aside to cover obligations. Increased government regulation added to the burden.
“Corporations started to realize how expensive [pensions] were,” said Dave Hubbard, president of Exemplar Financial Network, a wealth management firm in Crystal Lake that specializes in retirement and estate planning. “And by the 1980s, many started going away from defined-benefit plans.”
It started as a trickle – with a few companies unwinding pension obligations. Now, the majority of people who have pensions work in the public sector, Hubbard said.
Defined-contribution plans, such as 401(k) and profit-sharing models, put the burden of saving for retirement on the employee, although many companies also contribute to employee plans, usually based on a matching formula.
This allowed companies to better control costs and plan for future expenses, Hubbard said.
The differences between pensions in the public sector and defined-contribution plans can be stark. Most pensions for public sector employees are guaranteed by the government and include annual increases.
Private sector workers have no such guarantees to prevent losses and no annual cost of living increases like public retirees get.
For employees with 401(k)Snnbs to reap a pension-like benefit to replace income, Hubbard said he would recommend that they contribute 10 to 15 percent of their annual salary to their 401(k), start saving early, get matching contributions from an employer, and invest aggressively.
By contrast, public employees served by the Illinois Municipal Retirement Fund contribute 4.5 percent of their annual salary to their pension fund. Teachers contribute 9.4 percent of their salaries to the Teachers Retirement System.
To meet the pension funds’ payout obligations, taxpayers have to pay a significant share of public employees’ retirement benefits.
By way of example, for each dollar paid out to retirees by IMRF, 14 cents comes from public employee contributions to their pensions. About 59 cents comes from earnings on the fund’s investments, and 27 cents is paid for by taxpayers. That 27 cents is on top of the public employee salaries also paid for by taxpayers.