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The Decline of Pensions Leads to Greater Reliance on IRAs and 401(k)s

Over the last several decades, there’s been a gradual decline of pension plan availability in the United States. There was a time when people worked longer and collected less in overall pension benefits due to shorter life expectancies. Pension benefits paid over 5 or 10 years to a loyal employee who put in 30 years of service didn't pose a risk to the financial solvency of a corporation.

But times have changed. Today people are living well into their 80s and 90s.  Past promises of a steady retirement income have come back to haunt industries such as airlines and automobile manufacturers that struggle to fulfill pension obligations and also survive in tough economies. While pensions are still fairly widespread in the public sector, funding those future benefit payments is becoming an obstacle for federal and state employers, as well.[1] Nowadays, qualifying for pension benefits often requires more years of service and, in some instances, employee contributions. So how does this impact today's investors?

While pensions continue to be a nice luxury for some, most people are finding a need to save and invest more and more for their eventual retirements and future income needs. Social Security offers one guaranteed income source, but those payments will rarely cover the retirement expenses of people used to engaging in activities like traveling, supporting their children, and dining out. There are also questions about the long term solvency of the Social Security fund, which investors should consider when planning their future retirement income sources. The realization at this point for many investors is that they should assume responsibility for saving an adequate amount of money for their own futures.

Utilizing Savings Vehicles

If you’re an employee of a large corporation, your primary retirement savings vehicle is likely the company 401(k) plan. In many cases, your employer will match a portion of your contributions, creating a "free money" opportunity. You’ll want to make sure to contribute the necessary amount to take full advantage of the match provision if your employer offers one. Another benefit of a traditional 401(k) plan is that you can reduce your taxable income by the amount of your total annual contribution and grow those contributions on a tax-deferred basis until they are withdrawn.

For those of us who are self-employed or running small businesses, there are several retirement savings vehicles that may be available. Some of the more popular plans include the SEP IRA, Simple IRA, and Solo 401(k). Basic details about those plans can be found on the IRS website.

Perhaps the most common tax deferred savings vehicle is the traditional IRA. An IRA allows for pre-tax investment contributions, which grow on a tax-deferred basis. A penalty is applied to distributions taken prior to age 59 1/2 (unless an allowable hardship exists) but must begin after the account holder reaches the age 70 1/2. When withdrawals are eventually taken, the funds are taxed as ordinary income. Traditional IRA accounts can also be funded with rollover contributions and direct transfers from other retirement accounts.

Roth IRAs are also an option. Roth IRA accounts don't offer a tax deduction for the contribution amount but they allow your funds to grow tax-free without any timeline for when withdrawals must be taken. Withdrawing earnings or interest from a Roth account can only be done without penalty once the account has been owned for at least 5 years. There are income limits which may disqualify certain people from making Roth contributions, so you'll want to check on those to make sure you qualify.

Pensions aren't the cornerstone of retirement planning that they used to be. Retirement, regardless of whether you transition into it or just stop working completely at a specific age, will be expensive. Getting into the habit of routine, systematic investing may be the only chance most investors have to reach their savings goals and enjoy a more comfortable future.

[1] Cory Eucalitto, Promises Made, Promises Broken - The Betrayal of Pensioners and Taxpayers: September 3rd, 2013: www.statebudgetsolutions.org

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