Pensions: what they are and why they have declined

In their hey day pensions were the premier benefit for gaining and keeping talent in an organization. Close to 40 years ago, around 60% of people had pension plans; now it’s an abysmally low 4%.

In the meantime, other retirement plans such as the popular 401k have risen tremendously as the preferred retirement account. Why the decline in pensions and the rise in 401ks? Furthermore, what exactly is a pension in the first place?

A pension is a defined benefit plan – one where the benefit is defined – hence the name. A 401k is a defined contribution plan – one where the contribution is defined – hence its name. In other words, a 401k recipient receives their retirement and the amount of money received is based largely upon the employees contribution whereas the pension retiree receives a set amount – a “defined amount” – based upon the employers contribution. If an employee doesn’t contribute to a 401k they could very well retire with little to no savings to live off of. The person with the pension, however, has a retirement coming from their employer who contributes and manages the retirement fund.

What is a pension

Perhaps the best real world example I can give is for us to look at social security. While there are some differences between pensions and social security the basic principle remains the same: while you work the government receives money on your behalf, manages it during your working lifetime, and when you retire you receive a check from them for the remainder of your life. There are several factors which affect what is paid in, when you can retire, and how much you will receive but the overall function is the same.

A pension, then, is a type of retirement plan where an employer contributes on the employees behalf, managing the money during their working years, and the employee upon retiring gets a steady amount of money from that retirement account for the rest of their life. During their working years a person with a pension did not have to manage their pension retirement account; the employer/company did this for them. This mainly includes the contributions but also the pension credits an employee gains during their working years and the payout upon retirement.

*Pension credits are years worked set at a specific amount of money.* 

Example: Joe works for a company with a pension plan for 30 years, receiving 30 “credits.” For simplicity sake, lets say those pension credits were $70 a year/credit. 30 x 70 = $2,100 a month for life. Best part: Joe didn’t add one cent to the pension plan; it was a benefit provided to him by the company attempting to retain quality workers.

Sounds wonderful, doesn’t it? 

It is, so long as things go well. There are many pension plans which are doing very well and continue on as if there are not pension problems in the world today – and there are. There are some solid pension plans out there and consider yourself lucky if you are not only vested in a pension plan but one that is very solvent. 

However, there are many pension plans having tremendous difficulty in these times. All one needs to do is google pension plans and the trouble on the horizon comes up for all to see. What’s more, if you have a pension you get notifications from the trustees and some are likely to be vested in a pension plan which is having difficulty.

If your pension was managed poorly, had less than stellar investments, suffers from negative cash flow (you have more retirees drawing from the pension plan than you have contributing to it), or a myriad of other things which negatively affect pension plans then you could very well have a pension plan headed for insolvency down the line.

Conversely, if you have a pension plan with good numbers then you could likely count on that pension for many years to come, at least in the way you were told. There are a lot of factors which come into play when it comes to pension plans but the stability they provide (or at least promised) are a very nice feature to have when making retirement plans.

If, as stated at the beginning of the article, employers offered pensions by the droves, why the change? Was the draw of pensions not working?

There are a myriad of answers to the above questions. Let’s start with some more obvious points and then explore some many might not know about. First up is a distinction of the three different types of pensions so as to explain problems in the last 40 years or so. They are:

1. Single Employer Pensions
2. Government Pensions
3. Multi Employer Pensions

There are distinct differences between the three different types of pensions despite their being labelled a pension. In separate posts I plan to write about each one since they indeed are different but for now a simple overview shall suffice.

Single Employer Pensions

As the name suggests, these pension plans are or were offered by single companies. Examples would include some large corporations such as Coca Cola and Exxon Mobile. Because of their structure and operating ways, companies are able to deal with issues in a more decisive manner. This results in either structural changes to pension plans shoring up this type of retirement plan or a freeze in the pension and changeover to a 401k type.

Government Pensions

These are what I believe most are familiar with; after all, if you know anyone who has retired from the military then this is your plan. Of course, there are differences between agencies and government branches but overall some form of government is responsible for a pension – whether it is federal, state, or local. Should there be trouble in paradise with these types of pensions (and there are) options exist to deal with them but the bureaucratic red tape has a way of stifling progress. In the end either raising or creating new taxes can greatly help these plans which find themselves in trouble.

Multi Employer Pensions

The third type of pension plan is one which is lesser known but affects a great number of people: the multi employer pension. This type of plan has numerous employers contributing to a pension plan allowing employees portability during their working career. This type of pension plan has not only government hurdles to clear but also trustee ones also. This is the most difficult plan to adjust as necessary and there are several plans throughout this country which are in danger of defaulting.

Now that the three different but similar types of pension plans have been defined let us look into why employers transitioned from pension plans to 401k type retirement plans.

What Happened

As stated earlier, pensions were a very nice draw for an organization trying to attract talent for the long haul. So much so it became commonplace to not even consider a job without reflecting on the pension plan offered. That decision reflected how much pension planning entered into the thought process. Things have changed, however, because companies have transitioned from pensions to 401ks and government and multi employer pensions have faced some tough times. So, what has happened?

This is a complex question but one that I hope we can delve into. In large part it depends on what type of pension plan is talked about before determination is made since it plays a major role in decision making.

By and large it is the single employer pension plans who have changed from a defined benefit to an defined contribution plan; i.e. pension to 401k. This is because they have the most flexibility to make necessary structural changes.

Below are some of the reasons which have a factor in the decline of pensions.

• Companies are not employing as many people
• Companies (and entire industries) are dying off
• Technological advances have created a more transient and portable workforce
• Companies are transferring risk to their employees
• Companies are transferring retirement admin costs to employees
• Companies are taking advantage of employee laziness
•  

Lets look at these a little more in depth.

Companies are not employing as many people

A pension plan only works if you have new people contributing to it on a continual basis; out with the old and in with the new. Older workers retire and draw those promised pension funds while younger workers work and the pension is funded by those younger workers. (Yes, I realize I said companies pay for the pension and that is true but you have to have younger workers to keep the company viable, continually investing in your pension. If they employ less people they likely invest less in the pension fund which begins its downward trend.) Without those younger workers making the company money and having the pension invested in, a plan can be in trouble.

Companies (and entire industries) are dying off

This is certainly true and an underlying reason as to why the pension system is declining. After all, it is hard to have a pension when there is no company to pay for it. This reason is directly linked to the next which is:

Technological advances have created a more transient and portable workforce

In the pension heyday, an employee worked for the same company for years; for many they spent their entire career with one single company. Ask some of the baby boomers you know about their work experience and they will likely validate this. Back then, it was the norm to try and land a job with a reputable company and stay on for the rest of your working days. This is a thing of the past. I just read an article why you should change jobs frequently (in this case, around 4 years) and while people later in their working career may choose to stay longer at a job the fact remains: those days are for most a history lesson.

With the advent of a couple different generations who valued things differently, the technological boom, an increase in technology jobs coupled with the decline of many traditional ones, the ability to telework – all have a part to play with declining pension participation.

Companies are transferring risk to their employees

With a pension, the employer has the responsibility to ensure the plan remains solvent. Money projection, maintaining adequate funding, and administering the pension plan ALL fall to the employer. This isn’t as easy as it sounds, either. There are laws governing pensions and coupled with the problems listed above and investment woes you have a recipe for pension decline.

With a 401k plan, though, investment risk falls to the employee. Sure, the company has a vested interest in their 401k but a greater amount of risk has been transferred to the employee. And if there happens to be low balances at retirement time – NOT the employers problem.

Companies are transferring retirement admin costs to employees

No matter what avenue you save for retirement, someone has to administer the plan and the funds. Someone is helping to invest the money, keeping tabs on the gains/losses; the admin stuff we normally do not think about at all.

Someone has to pay those costs, the fees associated with a managed retirement plan and during the pension era companies were the ones who paid the cost, not employees.

Not so during this 401k era. The 401k might be offered through your employer but you most certainly pay the admin fees (typically 1 – 2%). On top of that are the fees for whatever investment you choose. With pensions those fees were paid for by the company but are passed on to the employee with a 401k. The company is simply saving the cost of the admin fees by transferring them over to their employees.

*Note: If you find yourself in the unusual position of having your 401k admin costs paid for by your employer then you are working for a stellar company and you should realize that. Furthermore, IF a company did pay your admin fees they likely pay a higher match dollar for dollar, too (in an attempt to attract top talent and retain them). Either way, remember to be thankful for the benefits, work like you are grateful, and capitalize on what you can.*

Companies are taking advantage of employee laziness

Let’s be frank for a moment: most people we know are undisciplined (so are most of us if we are being honest). It certainly seems that way when it comes to financial matters. How else can you explain massive credit card debt? Or how an astonishing number of Americans have NO RETIREMENT SAVINGS AT ALL?

To be fair, most of us are undisciplined in some manner or another. Leaving the cap off the toothpaste, leaving an extra light on when it shouldn’t be, impulse buying that unneeded item, etc., but having NO RETIREMENT SAVINGS AT ALL? That goes far beyond the pale of undisciplined, venturing into laziness and recklessness. Exactly how do you want to live in retirement?

You see, during those pension years it was customary for individuals to work for a company for most of their career. Companies, then, had to entice workers at the onset or the likelihood was that person was off the market, unavailable for what was probably their whole career. A stellar potential, who was working for the competition, as it were. Companies needed to sweeten the deal.

Pensions were one of those enticements. And hey, it required nothing from the employee. After years and years of the job landscape changing, companies began to shy away from those pensions for many reasons, shifting from a defined benefit to defined contribution (401k) plans. On top of all the other reasons listed above, most employers have made out because of the financial illiteracy most suffer from, and as such they save money. How so?

By lowering their cost simply because a whole lot of people do not contribute to their 401k, which the company then doesn’t have to monitor – or match employee contributions. That doesn’t mean employers do not have expenses or keep tabs on their 401k (which is why you cannot merely contribute to one if your employer doesn’t have one). I know people today who have never saved a dime for retirement – what they have has been saved for them, and their lifestyle reflects it.

Because employees can be lazy, employers save by not having to pay out via a pension, they save by lowering their admin fees, they save by offering a 401k vs. a pension (lower retirement costs for the employer), and they save when employees are too lazy and undisciplined to save money, which means the employer doesn’t match funds not saved anyway.

From a company standpoint, it’s easy to see why pensions eventually go the way of the dodo.

There is much more at play here but an aerial view of pensions paints a picture for us to see and hopefully understand. Pension plans had their advantages and when we consider what has transpired over the past 50 years or so there is more understanding why they have fallen out of favor.

Of course, pensions have their disadvantages but I’ll save that for another post. Hey – I need to create more content anyway.

I’ve attached a link below to a fascinating study about the decline of pensions and the implementation of defined contribution (401k) in their stead. While it is a decade old, I encourage you to read it and know that when it says the average household income will be lower as a result you can bet the farm it is because people were undisciplined in saving throughout their working years. They were banking on that pension and didn’t plan for uncertainties. A much healthier approach is to save as if the money you personally save is the ONLY thing you will have during retirement; BECAUSE THEIR IS A POSSIBILITY OF THIS HAPPENING. After all, what do you make of $21 trillion in national debt? Alas, another post for another time.

Anyway, check out the article fro the SSA, which you can find here.

Here is another good article dealing with pension plans and their being underfunded. 

There is so much that could be written about pension plans, which is why I want to write separate posts about the 3 different types. Each type of plan has its own challenges and reasons for the shape they are in. Again, another post for another time.

Steady on, my friends and continue to save, save, save. Don’t let retirement happen to you, plan for it. Your future self will thank you for it.