With the introduction of 401(k) plans in 1980, the responsibility for retirement contributions shifted from the employer to the employee. Unfortunately, the employee had no way of gauging what those contributions should be, or how the contributions should be invested. Thirty-six years later, little has changed.
As we near the first wave of retirement for those whose retirement will be funded largely through 401(k) contribution plans, it’s useful to ask: How did we get here? and What can improve the situation?
Mid-Century Workers and Pension Plans
Pension plans, more precisely called defined benefit plans, were very effective for employees because they did exactly that: They defined the benefit. The employer was responsible for funding the future obligation of providing a stated benefit, or pension, to retired employees. The funding obligation was based on actuarial assumptions and expected investment returns. Lower expected investment returns meant that employers needed to make larger contributions to meet the benefit obligation. Of course, higher investment returns reduced the employer’s funding obligation.
Employers certainly had an incentive to reduce their contribution cost. Aggressive employers utilized an aggressive investment strategy, resulting in wide fluctuations of investment returns. Those fluctuations meant less stability in long-term funding expectations.
In a complex, competitive business environment, the challenge of meeting future obligations with the addition of each new employee meant less short-term flexibility—in other words, available cash—to quickly adapt an ever-changing business climate.
Profit-sharing plans were the first step for employers to alleviate the funding obligation of defined benefit plans. Instead of defining the benefit, employers could define the contribution as a fixed cost, regardless of investment returns.
Initially the employer’s contribution was similar to that of the defined benefit plan. The primary difference was the unfunded liability, created either by market fluctuations or failed aggressive investment strategies.
401(k): Employees Take the Reins
Under a 401(k) plan, the employee is tasked with defining their income needs in retirement, determining the inputs (inflation, expected market returns, etc.), calculating the necessary contribution, and periodically recalculating and adjusting based on ever-changing assumptions. Even for the most financially astute employee-investor, this can be a daunting task that can quickly break down, leaving the retiree in a precarious situation. Unfortunately, this is where most employees have ended up.
Maintaining the status-quo will continue to produce failed outcomes. Progressive employers who realize and appreciate the value of their employees will take action to clearly define a path to retirement, and alleviate the planning burden employees face. Transitioning a 401(k) plan to a defined benefit-styled plan can
- simplify the retirement planning process,
- produce sustainable retirement outcomes, and
- empower employees to make the decisions that are right for them.
This approach focuses on what’s needed to achieve retirement readiness, and less on the employer’s match. flexComp provides a framework and management platform that benefits employers, advisers, and employees. Using flexComp, employers can make more informed decisions for the betterment of their workforce. flexComp helps advisers effectively manage investment portfolios that focus on outcomes. Employees using flexComp can be empowered to make lifestyle decisions on their terms, instead of forced decisions at retirement.
Better outcomes require better solutions.