Pension Plans

Two Types of Pension Plans

Very few people working today in the private sector have the old-fashioned defined benefit pension plan. You may or, more likely, may not have noticed that over the past 25 years major corporations have gradually replaced their traditional defined benefit pension plans with a 401(k) defined contribution offering.

Defined benefit pension plans are the classic retirement pension plan that you did not give much thought to while working at a corporation because the company paid for it and you assumed you were entitled to it when you retired. The key word to remember here is benefit. Under this type of plan, at retirement, employees receive a monthly benefit check for the rest of their life. The amount of that check is based on a formula that factors in average compensation and years of service at the company. This is the type of plan people usually associate with happy, secure retirees and their spouses sitting in their rocking chairs on their front porches contentedly watching the world go by.

A defined contribution 401(k) plan on the other hand is the new savings vehicle of choice in corporate America. There is no requirement for the company to contribute to the plan, although some companies do offer to match a percentage of the employees’ 401(k) pension plan contributions. If your company does matching contributions, take advantage of it. It’s free money added to your individual account.

The shift to 401(k) accounts requires employees to make a conscious decision to save a portion of their salary, which is done on a before-tax basis (avoiding income taxes) and grows tax-free until you begin distributions. However, the 401(k) pension plan also requires you to make the investment decisions and manage the account.

So, as you can see, corporate America has shifted the burden of contributing and managing retirement savings onto the employees. Employees are now responsible for their own future. Not that they weren’t responsible for their own future before, but someone else could be blamed if the investments in the plan did not do well and the company would be responsible for those decisions. If the company’s pension plan failed, the government would take it over and make plan participants whole. So employees had safety nets that no longer exist in a 401(k) pension plan.