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The Decline in Employer-Funded Pension Plans

October 17, 2021
in Finance
The Decline in Employer-Funded Pension Plans
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Fewer and fewer companies are offering pensions to employees to last them through their retirement. It was once possible for employees who had worked for a company for decades to retire, knowing that they would receive a steady income from pension checks even in their golden years. However, most companies today have steered away from that practice.

Companies view pensions as a thing of the past, with consulting firm Mercer’s 2020 Defined Benefit Outlook indicating that 63% of pension funds are thinking about ditching guaranteed benefits for new employees within the next five years. US pension plans, specifically, are in bad shape. Pension funds have to gain in value to provide monthly payments to retired employees. However, low-interest rates have caused funds to accumulate only 85% of what would be necessary to meet their obligations in late 2019.

The Department of Labor’s Employee Benefits Security Administration said pension plans offering defined benefits also decreased by around 73% from 1986 to 2016. That’s a significant shift, so what caused it?

The Past

Defined-benefit pensions used to be a popular retirement option offered by employers. Employees would work hard for their company, receiving everything in their paychecks while expecting to receive a certain amount of money each month after they retire. The company would depend on a formula to predict how much they would have to gather in corporate earnings to provide for their retirees once the time came. The employees would have it safe, while the employers would have to worry about settling ongoing liabilities.

The Switch

In the past few decades, companies have been making the switch to defined-contribution plans funded by employee contributions. By having employees contribute to plans like a 401(k), the companies can save more of what they earn. Private-sector companies have been freezing their pension plans to start the switch to defined-contribution plans. The problem with forcing companies to fund their employees’ pension plans entirely is that the companies may shift the obligation to the government if, for instance, they go bankrupt. The government would then have to fund their employees’ retirement plans through taxpayer money.

However, many public-sector institutions continue to offer defined-benefit pension plans, so those who work in the government need not worry about their retirement funds.

The Employee

Without defined-benefit pensions, employees must contribute to their own retirement plans and carefully consider how to invest their contributions. Employees who are terminated by their company or have their pensions terminated may receive one lump sum upon leaving, which isn’t enough to fund the rest of their retirement. To ensure financial stability throughout retirement, employees have to do their best to prepare on their own.

In principle, everyone should save enough money for retirement before they retire. Most people can’t live off of Social Security alone, so it’s worth investing in tax-advantaged retirement plans, mutual funds, and municipal bonds. It’s also important to remember that saving up may mean spending less.

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