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EVERY TIME I READ about the decline in traditional defined-benefit pension plans, and the rise and supposed failure of 401(k) plans, I get annoyed.
You’d think all Americans once had good pensions that provided a secure retirement. That isn’t—and never was—true. Barely half of American workers ever had a pension and many of those received little value from them because their job tenure was too short. Job tenure has long averaged some four years or so.
A defined-benefit pension accrues value based on earnings and years of service with the plan sponsor. An employer might require five to seven years of service for an employee to be fully vested in the pension. Let’s do the math: average four years working for an employer, typically five years to vest, so what pension?
You might have heard folks say the birth of the 401(k) caused the decline of defined-benefit pensions. That’s not accurate. The demise of the defined-benefit pension began long ago and—except for the public sector—it’s now nearly complete. The causes are many, but a major impetus was the Employee Retirement Income Security Act (ERISA) of 1974, and the hundreds of rules and regulations that followed.
This and other laws, along with changes in accounting rules by the Financial Accounting Standards Board, hurt reported corporate earnings and doomed the private sector pension plan. Meanwhile, 93% of public sector workers have both a defined contribution plan and a pension plan—because such plans don’t have to deal with the same rules.
To be sure, the emergence of 401(k) plans in the 1980s allowed employers to offer an alternative retirement plan, accelerating the termination of traditional pension plans or prompting the closure of these plans to new hires. One benefit of 401(k) plans: For an employer, there are no long-term employer liabilities, as there are with a defined-benefit pension plan.
Does any of this make the 401(k) a bad deal? Compared to what, no retirement plan at all?
According to Fidelity Investments, 85% of 401(k) plans have some employer contribution. In my opinion, if there’s one valid criticism of 401(k)s, it’s the requirement that an employee needs to contribute to receive the employer’s contribution. Employers that provided a pension typically spent about 8% of payroll to do so, along with the considerable cost of administration. With 401(k)s, the cost to the employer is far less.
I think it would be reasonable for an employer to contribute at least 4% of pay, regardless of what employees did. In 2023, the average employer match was $4,600. Stick with just that and earn 8% a year, and you’d have some $360,000 after 25 years.
The 2023 UAW contracts with the big three automakers included a significant boost in the automatic employer contribution to 401(k) plans, with no required employee contribution. For those union members not covered by a pension plan, the automakers will contribute 10% of base pay.
For retirement plans, there are two key issues: portability and the stream of income they can produce. A 401(k) provides portability, while a pension plan offers an income stream. The answer seems obvious: combine them.
To that end, the UAW contract includes use of an organization to construct low-cost annuities as part of the enhanced 401(k). Linking annuities to 401(k) plans is an important step in providing retired workers with a guaranteed income stream. The annuity option needs to be included in all 401(k) plans, perhaps mandated or made more appealing with special incentives.
No doubt about it, 401(k) plans have their challenges. But they all relate to financial literacy—in other words, people issues, not plan issues:
Clearly, the 401(k) places more responsibility on the worker. But in my opinion, it also creates a responsibility for employers to educate and advise workers. It’s in the employer’s best interest to have a viable retirement system to help attract and retain workers, while also ensuring that employees are financially able to leave the workforce when the time is right.
Would I trade my pension for a 401(k)? No, I wouldn’t trade it for five times the balance in my 401(k). But that’s not the issue. There’s no point dwelling on what many Americans never had. Instead, our focus should be on making sure today’s 401(k) works better than it currently does.
Richard Quinn blogs at QuinnsCommentary.net. Before retiring, Dick was a compensation and benefits executive. Follow him on Twitter @QuinnsComments and check out his earlier articles.
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A corporate pension is better than a 401(k) (or 403(b))?
What about corporations that go bankrupt or decide to change the plans on the fly? (An example of this I remember was IBM. Was Enron another?)
What about diversification?
What about the ability to roll 401(k)s (in many cases) into IRAs?
Aren’t there tales of governments or companies clawing back pensions because they accuse individuals of past misconduct? Most us us don’t need to fear this, or maybe we do in the current political climate. Funds in trust in an independent financial firm are more insulated.from this.
The fees may be no higher in 401k(s) than pensions too. Yes, there are good 401(k)s and bad ones. I started in a high fee one with limited investment choices, but now I’m in a very low fee one with index funds.
I doubt many people with a pension would give it up especially after living on it in retirement.
A plan sponsor can’t take back a pension that was vested even for misconduct. It can stop future accruals, but all participants are treated the same..
Pension funds are in trusts as least partially insured by a federal agency.
Enron? That was probably the worst 401k disaster there has been as workers were heavily invested in the ENRON stock.
HOWEVER, as I said, the downside of a pension is the need for long service with an employer.
The tax deferred retirement plans like 401K, 403B, 457’s etc. have also been a great way to shelter income from taxes. I see that the government has decided too much sheltering was taking place, first passing the SECURE act which forces many retirement plan beneficiaries into taking the entire inherited amount out in 10 years, sometimes with nasty tax consequences. And in 2026, savers aged 50+ making more than $145K/year in wages will no longer be able to make catch-up contributions to pre-tax accounts and will have to put the catch-up contribution in a ROTH account, losing the tax deduction.
Every high school in the nation should be required to teach a personal finance class to every student. And a component of that class needs to be a lesson on the 401k. It is the simplest plan to wealth in our society….it just takes understanding and discipline.
I agree. I have asked many high school students if they have such classes. They all day yes, but when i ask what they learned i get a blank look.
“… it also creates a responsibility for employers to educate and advise workers. It’s in the employer’s best interest to have a viable retirement system to help attract and retain workers, while also ensuring that employees are financially able to leave the workforce when the time is right. …”
No. Benefits are not a motivator, they are a satisfier, “table stakes”. As you confirm, median tenure of American workers has been less than five years for the past five decades. Retirement preparation isn’t a priority for most workers, and most workers will leave your organization long before retirement, many before fully vesting in the employer contribution.
So, if you are an employer/plan sponsor, the last thing you want to do is attract workers based on what they think they might get after they leave the organization. That may work in the public sector …
Lots of Human Resources folks will tell you that ‘… we need to offer top quality, top value benefits at low cost to workers in order to attract, retain and engage top talent. …’ There is no study that shows benefits are an engagement lever, one that differentiates “top” from “not so top” talent. Further, because tax preferred benefits come with various eligibility, vesting, and non-discrimination rules, almost by definition they can’t differentiate talent.
Finally, as an individual with 31 years in employer/plan sponsor roles, my largest challenge in preparing workers so that they can leave the workforce and retire when they want was finding solutions for everyday financial decisions, failure to save and leakage that workers had made long before they joined my organization – items I had no control over.
Oftentimes, those weren’t mistakes, but decisions made out of necessity to forego participation, to take a withdrawal, etc. In many cases, it was a failure of their employer’s plan design that either didn’t encourage participation or failed to provide the right kind of liquidity, or both.
There are a few benefit provisions that can be added to a 401k and HSA, and Human Resources policies and programs which have a remedial effect … … but most times, workers lack the financial resilience to take advantage of those opportunities.
The 401k plan design solution? Adopt automatic enrollment, escalation and investment features while eliminating the “wrong” kinds of liquidity, and making available the “right” kinds of liquidity – “liquidity without leakage, designed to ensure repayment, along the way to and throughout retirement”.
I would add having a range of low fee investment solutions. What I too often see are a laundry list of proprietary funds with high fees that suck the life of a participant’s returns over time.
I think the auto industry may disagree on some of those points Jack, especially regarding retirement. Motivator, perhaps not, but still an employment necessity if you compete for workers which seems like where we will be more so in the future.
“It’s in the employer’s best interest to have a viable retirement system to help attract and retain workers.” This is not at all my real world experience. It’s in the employer’s best interest to cut costs and increase shareholder value. That often means offering the minimum viable option for all benefits, including the retirement plan. Prospective employees don’t receive full benefit plan details until after they are hired, and that means there is no chance to compare apples to apples. In American we love to say how capitalist we are, all the while creating barriers to actual competition. Medical and 401k plans are acute examples of this false competition in action.
Not in the long run it isn’t, sooner or later employers need to attract workers and retain them to some extent. I predict more generous benefits will gradually return if competition for workers heats up.
A worker should ask for benefit details, but in many cases at least for larger employers you can see plans via an internet search. I have done it many times.
In my many years in employee benefits and hiring I found workers show little interest in benefits at hire, cash is king – because they were thinking short term, not career.
I don’t know if that’s true. I bet many employees are afraid to ask about benefits when interviewing, for fear of appearing more interested in benefits than the job
Your last sentence captured my thinking as I read through the article and the comments. Most (not all) new hires focus on their compensation and opportunity for advancement. Only those who have experience (i.e. older workers) realize how much the benefits package really matter in the long run. And that is where we all agree, the short term, instant gratification mindset is what might doom this generation of workers. They generally do not want to trade short term gratification for an easier life down the road. I am glad that I saved early and often when I started my career and credit a subscription to Kiplinger’s Simply Money for providing an education that many do not get early enough in life.
Nice article. I continue to say that the 401k is the #1 vehicle for Americans to build wealth and ensure a good retirement. That it is so routinely vilified is at least a bit perplexing.
401k is the ONLY retirement vehicle, thanks to the demise of the pension. They are vilified probably because the average balance in a 401k (Fidelity says) is about $118k. Is $4-5k a year going to have a lasting impact.
This is backward thinking. It’s #1 simply because the contribution limits are much higher than IRAs. 33% of Americans don’t even have a 401k option, and the remaining 67% often have plans with high fees and high administrative expenses. I’ve read enough plan documents from family and friends to know that vilification is often justified. If you want the free market to work, you can’t lock retirement plans behind the walled garden of employer selected options.
That may be true for small employers with plans, but not for the larger plans who have negotiating power and are mindful of fiduciary liabilities.
But you are right that there should be one retirement vehicle available to everyone with one set of rules employer based or not.
My view would be 401k with Roth option and with an annuity payout option built in the plan so that over the years an annuity could gradually be built with a portion of savings.
Almost 50% of Americans work for small businesses.
I agree with Kevin, I believe corporate greed played a part in the shift from defined benefit plans in the private sector. It certainly saved them money. My father also worked for “Ma Bell” and had a nice pension when he retired. Many jobs in the private and government sectors offered these pensions. But when the defined benefit plans were replaced by the defined contribution plans in the private sector, there was no outcry. Politicians have found it convenient to blame the economic problems of cities and states on those evil government workers who are collecting defined benefit pensions. If you are willing to stay in a government job for 30 years, you may collect a nice pension. But how many people do that now? That was something my father’s generation did. The average state or local defined benefit pension for 2022 was $24,980 and for federal workers $26,380.
Income from Pensions – Pension Rights Center
You need to look at public employees in the total context of all compensation. If you look at BLS data you will see the total compensation package is higher than the private sector.
The amount of a pension as above needs to be considered in light of the pay as well, that is what percentage of pay for what length of service? Some state plans have quite generous early retirement as well especially for first responders.
Many workers in the business world make the same or less than public workers, whether police, or fireman, and they retire with small 401k’s and average SS benefits. Public employees with the same income get very high retirement benefits. Years ago one chose the business world because it paid more and had better benefits. Not anymore. Someone said it was greed. Laws passed that made it bad for pensions were done by politicians for their business buddies that financially supported them. Lobbyists
Most government employees take those jobs for the pension and benefits, not the pay. Teachers have a hard time finding housing they can afford. As for first responders, I don’t begrudge their generous early retirements. That kind of work is very stressful and demanding. I certainly wouldn’t want to do police work or firefighting into my 60s or 70s.
Teacher compensation is one o my favorite topics. Teachers are not underpaid on a total income/hours worked basis. Their pay reflects to ability of their community to pay through proportion taxes mostly. Teachers in the south have low relative pay, but where I live experienced teachers make $80,000 to $100,000 a year.
Richard: I will defer to your wisdom on the stated facts of your post, but nothing you or anyone can say will ever convince me that corporate greed did not play a part in the demise of the defined benefit plans.
That aside, I agree on your thoughts regarding human behavior and the average person not being disciplined enough to manage their own retirement. Back in the mid 1980’s I left a company and “spent” my then existing 401k balance. It was around $12,000, if I remember correctly. What I do not remember is what I spent it on. I shudder to think what it would have grown to over the next 40 years until my retirement in 2024.
On another point, my last employer had a 2% non contributory amount for all employees, implemented when it froze the defined benefit plan it had in place, around 2000. I joined the college in 2009, and for 15 years I enjoyed the 2% as well as a 403b plan with a 6% match, which I always maxed out.
I retired in January 2024 and because of proper planning, with the exception of the stupidity demonstrated when I spent the aforementioned $12,000, my stay at home wife and I will enjoy a nice retirement. I retired at 73, waited until 70 to file for my SS benefits, and we are able to cover 1.11% of our expenses with our joint SS. We are debt free, mortgage payment free, car payment free, and in pretty decent health as well. And, both of our kids are college grads, without student loan debt, independent, tax paying citizens.
It’s not the lack of defined benefit plans that are the problem in the US today, it is the fact that people simply will not delay gratification and refuse to spend less than they make.
I “bought my own pension,” in the form of FIAs with income riders, in anticipation of retiring this year. Three were funded with Roth Dollars and one with IRA dollars. I plan to delay them for 5-7 years before I “turn them on,” and in the meantime, their growth accounts are growing by a guaranteed 8.25% annually.
Meanwhile, we have 3 years of cash in MMF at Vanguard and the balance of our portfolio in VTI and VXUS.
I am thankful for the 401k/403b accounts I had during my working career… they worked for me.
Great Article.
As one of those who froze a pension plan for new hires, I think the change was more adapting then greed in most cases. The defined benefit pension funding and accounting rules created earnings volatility. Many times the changes were taken in conjunction with the cost of total compensation packages driven in part by high health care costs and in some cases industry competition. In addition, many large employers had added a 401k in addition to a pension plan.
In some cases employers did not adapt until there was a crisis as in the auto industry and several Taft Hartley union plans and workers and retiees were harmed.
I’ve often thought about the advantages of streamlining our retirement savings into a singular, tax-advantaged vehicle that encompasses the 401(k), IRA, 529, and HSA. Imagine the convenience of employer contributions seamlessly flowing into this unified account, naturally encouraging individuals to save more effectively.
By establishing consistent withdrawal guidelines, the government could demystify the intricate web of financial rules, making it more accessible for everyone. Automatic investments in an age-based target date fund would introduce simplicity, guiding investors away from the complexities of hands-on portfolio management.
Moreover, this consolidation might catalyze innovation within the financial services sector. With a focus on managing a singular, substantial account, industry players could develop more useful tools and services.
The account already exists, it’s the current IRA. The problem is the government doesn’t trust you to save into it, so contributions are limited. Imagine if the 401k, IRA, and HSA limits were combined to apply to the IRA. No more employer based plans with their highly limited options. No more employer match into company stock or high fee garbage funds, just give people that money as part of their paycheck. No more time out of the market while 401k money rolls over to the new employer or IRA. But the government, like the citizens that elect them, love mental accounting. Pointless, overly complicated, mental accounting.
Indeed, we need one plan, one set of rules. the complexity is mind boggling and unnecessary. On the other hand, what can we expect since it is all driven by the IRC.
I once heard someone (can’t remember who unfortunately) write about creating the USA (Universal Savings Account) along the lines you propose. I think it would be awesome.
Dick, where my son works (not the government), he gets a 2.5% contribution immediately and then a 2 for 1 match on the first 4% he contributes. Total 10.5% employer contribution. About as good as a traditional pension, and much better if he doesn’t hang around for 30 years.
Probably better in most cases.
Dick: I think you make some great points. 401K’s have been around over 40 years and the numbers clearly indicate that a large segment of the working population simply, for whatever reason, can’t use them effectively. I think it speaks to behavioral patterns in humans rather than faults in the plan itself. That said, since changing the 401K in recognition of persistent human patterns is much more feasible than getting people to change, I hope we start moving in that direction to make 401K’s more effective for society at large. I’m a bit surprised at my position on this as I tend more libertarian in nature, but the numbers are hard to deny and maybe as a society we need to mandate a bit more to ensure a more reasonable retirement foundation for the significant percentage of our fellow citizens who have demonstrated they will not. Because in the end some portion of their deficit will still need to be paid by the rest of us.
So, you criticize the public for not using something “for whatever reason” without bothering to learn some of the reasons? Well here’s one, my wife had a 401k with fund expenses and administration fees so high that it made no sense to save there. She didn’t realize this until she changed jobs and left the old 401k behind. After several years of receiving statements after she left, she asked why the account balance was always about the same when using their target date fund. That’s when I went over the plan and found the most egregious fees and expenses imaginable. Their “safe” cash equivalent was especially absurd, with a return of around 0.1% but an expense ratio of 0.5%, and administration fees on top of that. Without contributions into the 401k, it became obvious that the fees and expenses were eating up the majority of gains. People still working there didn’t realize this because of their own ongoing contributions. It’s disgusting that we allow employers to set up retirement plans, when many of them don’t care about their employees. The cost of the plan has to go somewhere, and many employers will select the plan that costs the company the least, ultimately forcing their employees to pay the price.
“I think it speaks to behavioral patterns in humans rather than faults in the plan itself.” Congratulations on blaming the victim here. This fact may blow your mind: These plans were made for humans. If they fail at working for humans, it’s clearly a problem with the plan, not the human.
No doubt there’s some pretty expensive 401K plans out there. But if your argument is that the population of people that don’t avail themselves of the 401K available to them, or cash it out upon leaving employment is due to them being highly informed on it’s costs and choosing not to participate, then I suggest you’re rationalizing on a grand scale. The data tells a quite different story.
My wife had a 401K with a nursing home company. They pooled her matching funds throughout the calendar year but did not credit it to her account until the following April, rather than at each paycheck. I felt the company did this was so they could collect interest in the interim, and the would be able to keep the money if the employee left in the interim.
Us old guys think alike. Individual responsibility and actions sound good in theory, not so much in practice spread over a diverse population mostly focused on the present. Some additional guaranteed saving for the future seems necessary.
Interesting – two comments on two different posts on the same day about my Dad. He worked for AT&T for over 40 years. He started at 17 as a machinist and retired as a manger in the late 70’s. His pension resulted from AT&T’s commitment (at that time) to maintain a professional personnel retirement program that mirrored that of the Communication Workers of America, which covered all their manufacturing employees. He drew retirement pay for 30+ years. I began my career as an engineer around the same time he retired, and he drew more in retirement than I received as salary. I’m happy to say that I reversed that after a few years.
Sounds a bit like my career – start at the bottom, stay with employer for decades and enjoy a good pension income. The – almost – good old days.
Not all employer’s have such a requirement. One of my employers contributed 3.5% with no contribution by the employee. They would then match the employee contribution dollar for dollar for the first 3.5% that the employee contributed and then 50 cents on the dollar for the next 3.5% the employee contributed.
Another interesting setup they had was that a new employee’s default contribution rate was 3.5% with an automatic annual growth in that contribution rate until the employee’s contribution reached 7%.
Auto enrollment and escalation has help participation. However, without the escalation employees tend to stay at initial level and in the conservative investments the plan selects.
Thoughts on IBM’s pseudo-revival of its pension plan?
It is notable that IBM did this after cutting existing pensioners loose by buying them annuities instead of continuing to pay their pensions itself. They also chose not to use some of the excess funds to provide cost of living increases to existing pensioners.
My company just “cut loose” 2000 retirees by buying annuities. It’s an accounting strategy and has no ill effect on the retirees,
When I was managing the pension plan we gave seven ad how COLAs over the years. Then came the 401k with match and we concluded that in the future the 401k contribution was sufficient to serve as the COLA for future retirees.
The ill effect is that the annuities are covered by a state guarantee which is less than that provided by the Pension Benefit Guaranty Corporation. I have been retired for over 20 years and have never received a COLA.
I did some research on that issue when the change was made. The number of failures of possible concern was tiny and none from any insurance company that we ever heard of. But you are right the guarantee can be less than the PBGC.
Thanks Richard. What are your thoughts about a plan like Australia’s superannuation? To late for us but maybe our grandchildren.
https://en.wikipedia.org/wiki/Superannuation_in_Australia
Over the years my thought on this have changed. The idea that people can be responsible and prudent with money and look to the future has faded.
Eventually we will have some enhanced form of Social Security, perhaps including an investment component and greater employer involvement on a required basis.
I was a Teamster union member for 33 years. In that time I had 4 different employers, all contributing to the same pension fund. The last company I worked at for 22 years. It was a small family owned company that had been around for 114 years. It closed in 2021. By then I had been collecting my pension for 10 years. Because of the Union, I’m still getting my pension to this day. It isn’t overly generous, no COLA, and amounts to 40% of my pay at the time. Between that and SS, we more than cover our expenses and live comfortably without having to tap into our investments.
Our stories seem vary similar. I was a Teamster for 33 years working for Hostess Cake. I retired one year before their bankruptcy. I have the same percentage of payout at the time of my retirement.
What is also like to mention, , is that the Central States Pension Funds was going to be insolvent by the end of this year. Though I like the government to stay out of my business the government stepped in to guarantee funding for forty years. And for that I will always be thankful.
Unfortunately, as you know not all those Taft Hartley plans worked out so well.
As I have said and written many times, a guaranteed, steady income stream is the key to a secure retirement.
The fact is the vast majority of Americans are not able to handle the planning, investing and withdrawal issues discussed on HD and others – sad but true.
Interesting article Dick. In preparing tax returns for lower income clients, I frequently see they do not contribute to their employer’s retirement plan. I think a minimum employer contribution makes sense. It could be limited to the first $50K of income, or some value. Just getting employees engaged in the process would be valuable.
Your point about employee education extends beyond retirement savings. I did a tax return for a woman inherited 50s. Her husband was disabled and could not work. She was working 2 jobs to see them afloat. Her W-2 showed $1,300 of FSA savings for 2023. We asked if she used all the money for QME and she had no idea what it was , or that she had been saving $1,300 for the past 2 years. Unfortunately, she waited to the end of tax season and it was likely too late to use the money. It was sad.
With the existence of HSA’s, are FSA’s even necessary any longer?
FSA’s a useful tool for those who don’t have a high deductible medical insurance plan that would qualify for an HSA.
The plans have very different requirements. HSAs require a HDHP health insurance plan. Not all employers offer one. Your employer can offer an FSA, even if the employee is not enrolled in their health insurance.
LOL Rick, I guess I had a HDHP plan for so long before age 65 that i forgot some people still had reasonable deductibles.
It’s about time somebody pointed out how the corporate pension system actually worked in practice. My grandfather worked for 40 years at the same company, and retired in 1965 with a nice pension, but he was a rara avis indeed.
In certain industries they worked well for decades. My pension is from a plan started in 1911. Interestingly, it wasn’t even funded until 1967 – just a promise kept even during the Great Depression with a temporary 10% cut later returned to normal.