What Happened to Pensions?
A pension program today is like a valuable gem, rare and hard to find. Looking back 40 years, over 80% of employees at large companies were eligible for a pension upon retirement. It was the “norm.” An employee could plan to work 30 years and be guaranteed a set monthly retirement payment from their former employer. The payment formula was based on attributes like salary and years of experience. Today, pensions are rare in the private sector, and more commonly found in the public or government sector. Whatever happened to pension plans? Employers looking to reduce their investment risk and leverage a timely change in the IRS tax code shifted much of the burden of planning for retirement to the employee.
Though attractive for employees, the structure of a traditional pension presents a number of risks for companies. First, a pension squarely puts all responsibility for funding the cost of individual retirement on a company’s shoulders. Additionally, employers take on the full risk for managing the investment of these financial obligations that will not come due for years. To do this successfully, companies make estimates on a number of moving targets, including employee salaries and estimated life span of retirees. And to be clear, the best laid plans do not always work. Some companies failed to meet these obligations when the time came and claimed bankruptcy. As a result, these financial burdens were passed on to the government and taxes were increased to cover the shortage.
Then along came a change in the tax code that offered employees tax-advantaged retirement savings. The year was 1978 and Congress passed the Revenue Act of 1978, which added Section 401(k) to the Internal Revenue Code, allowing employees to defer money from their income for retirement. Many companies embraced this change and switched retirement structures, offering a matching percentage to employees who contributed to this new 401(k) account. This shifted the responsibility away from companies, further freeing up their balance sheet from a hefty liability. Instead, the onus to choose investments wisely was now placed on workers who had more skin in the game.
The popularity of pensions has decreased rapidly in the last four decades. Big companies like GE, Verizon, and Lockheed Martin stopped funding their formerly wealthy pension plans in recent years. According to the Bureau of Labor Statistics, only 17% of private-sector workers had a pension benefit in 2018. And the remaining companies with pension plans are few and far between. Companies who are looking to decrease their investment risk and share the costs of retirement with employees have moved away from pension plans, a once popular benefit offering.
Originally featured in UBA’s July 2021 HR Elements Newsletter.
