How’s your pension doing? If you answered, “great,” you probably belong to one of a few specific job sectors—or an upper age bracket. The more common answer these days is something other than “great.” Maybe your employer’s pension plan has been frozen, or has pushed early lump-sum payouts, or never existed in the first place. For most employees, pension plans are becoming as rare as the unicorn. Should you care? Yep. Because even if you’ve never had access to a pension plan, you should still understand the major ground-shift behind the phase-out of pensions. Once upon a time, the burden of saving for your retirement—and the risk of future payout—belonged to the employer. Now, even if you’re in an employer-sponsored retirement plan such as a 401(k) or SEP/SIMPLE IRA, the burden and the risk all come down to you.
A pension plan provides retired employees of a company or government agency a guaranteed payout, often in the form of a certain amount of income for life. About 30 or 40 years ago, pensions were commonplace in many industries. However, during the last few decades, they have been phased out almost everywhere except government and industries that are heavily unionized.
Ideally, the way a pension works is that as a company earns money, it puts aside some of the money it would otherwise pay the employee as a salary into a pension plan. The pension plan then invests that money so that it grows over the employee’s career. Then, when the employee retires, it pays the employee income at that time. It sounds simple, but complications add up quickly.
One difficulty is the increasing lifespan of Americans. While this is good for people, it puts extra pressure on pensions. Decades ago, most workers retired in their mid-60s, and then died in their mid-70s. A spouse might live a few years longer. As a result, a pension plan only needed to have enough money to pay the average worker for little more than 10 or so years. However, as people began to live more commonly into their 80s, pension plans needed to be able to pay workers for 15 to 20 years or more. Often enough, there hasn’t been enough money to do that.
Another issue is that employers don’t always have enough money to make the full scheduled contributions. If a company or government hits a rough patch, one of the first things it might do is reduce contributions to the company pension plan. Of course, just as it is for ordinary people, making up savings or contributions is very difficult. In order for times to be good enough to “catch up,” the company would have to earn enough to make the regular contribution plus the reduced amount. The result is that many plans end up chronically underfunded.
Market performance poses yet another risk for pension plans. Employers are expected to guarantee a payout to their retirees, but the investment markets that support pension plans provide few guarantees. Poor market returns can make it very difficult for pension plans to live up to their promise.
These issues made pension plans both very costly, and very unpredictable, two things businesses hate. The rise of the 401(k) retirement savings plan gave employers a way out. Instead of putting money into a pension plan and then managing it for employees, businesses opted to contribute matching funds to a 401(k) plan on behalf of the employee. That shifts most of the responsibility and all of the risk to the employee. Other companies have opted out altogether, and put the full onus on the employee to save for retirement.
Either way, these days, pensions are not common for most employees. That makes it more important than ever to ensure that you are properly saving for your own retirement.