Could Be Better - HumbleDollar (2024)

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Richard Quinn|Apr 19, 2024

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:

• Too many employees don’t participate, perhaps 35% of those eligible, says the Federal Reserve Bank of New York.
• When employees leave their job, too many spend their plan balance. According to Harvard Business Review, 41.4% of employees cashed out 401(k) savings on their way out the door, with 85% of these folks draining the entire balance.
• Workers who participate in 401(k) plans contribute too little. One report found that in 2022 workers contributed an average of 7.4% of their pay to their 401(k). Add in employer contributions, and the average was 11.3%. The report describes these percentages as “impressive.” I don’t think so.
• Investment choices can present problems. Sometimes, there are too few or too many, and often participants make poor investment decisions.

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@QuinnsCommentsand check out his earlierarticles.

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