Where Did Pensions Go? Carmichael Hill

Before 1978, most retirement plans were set up as pensions. Although the term “pension” can colloquially be referred to as any kind of retirement account, usually what is meant by “pension” is a defined-benefit plan.[1] These types of plans provide a known and defined outcome, such as a guaranteed monthly income benefit in retirement. Formulas based on how long you worked at the company, your age, and your salary are used to determine the size of that monthly check.[2]

What makes these plans unique is the way that they manage risk. Employers carry 100% of the risks in a defined benefit plan. It doesn’t matter how much the underlying investments supporting the plan earn or whether the longevity assumptions for the plan’s beneficiaries are correct![3] The employer is still responsible for guaranteeing those payments. Cash from current operations must be used to pay out retirees if there is any kind of shortfall in the plan, and that can make it difficult to sustain a business.

So, what changed in the late 70s? Congress passed the Revenue Act of 1978. This act added a provision to the Internal Revenue Code that allowed a new way to save on a tax-advantaged basis. Under the new section 401 subsection K (i.e. 401(k)), employees would be allowed to defer some or all of their paychecks into a pre-tax account built specifically for retirement. Employers could add money to their employees’ accounts as well, but it would be optional.[4] Many major companies began offering the new 401(k) plans and in just a few short years it was one of the most popular retirement plans in the country.[4]

So, what’s different with a 401(k)? A 401(k) is what’s called a defined-contribution plan.[6] Employees contribute known amounts up front but there is no promise or guarantee of any kind of benefit in the future. It’s solely up to the employee to make those funds last.

The appeal to employers is obvious – the full burden of retirement planning and all investment risks are shifted to employees. Companies administer the plans, provide general education to employees, and pre-screen a list of funds to choose from, but that’s the limit of employer obligation. The advent of the 401(k) plan significantly cut costs and reduced liabilities on corporate balance sheets. It’s no surprise that pension plans have all but disappeared from private employment. The few employers still willing to take them on are almost exclusively governmental entities backed with the unlimited taxing power of the state.

Regardless of what kind of accounts you have, it’s not always clear how best to use them to maximize your income in retirement. If you’re curious about what a financial planner can do for you, reach out to us today for a complimentary review and second opinion on your retirement planning.

 

REGULATORY DISCLOSURE

Carmichael Hill & Associates, Inc. is a U.S. Securities and Exchange Commission Registered Investment Advisory firm. Registration does not imply that the SEC has endorsed or approved the qualifications of Carmichael Hill or its respective representatives to provide any advisory services. Advisor does not render or offer to render personalized investment advice or financial planning advice through this medium. Advice can only be given after:

  1. Delivery of a disclosure statement by advisor to client.
  2. Execution of our Investment Advisory Agreement between the client and the advisor.
  3. Initial payment of the planning fee or investment advisory fee by the client to the advisor.
  4. Advisor will not solicit or accept business in any state in which she or he is not properly registered or otherwise qualified to conduct business by virtue of a state “de minimis” exemption.
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The information in this web site is based on data gathered from what the Advisor believes are reliable sources. It is not guaranteed as to accuracy, and does not purport to be complete and is not intended as the primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. The identification of specific funds and model portfolios is being made on the assumption that the investor would participate in that investment or portfolio on a long-term basis and only after consulting with their investment advisor to determine their needs and tolerance for risk. With respect to any such identification, there can be no assurance that the fund or model portfolio will in fact perform in the manner suggested.

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All references that might be made to an investment or portfolio’s performance are based on historical data and one should not assume that this performance will continue in the future.

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