Of the 100 largest companies in the U.S. only 37 continue to offer a traditional pension plan, the “defined benefit” plan that formed the bedrock for retirement in the 20th century. This according to a survey by human relations consultant Watson Wyatt Worldwide. That’s down from 89 just 20 years ago.
If you’re unsure about the difference between a defined contribution plan and a defined benefit plan, the rest of this note won’t mean much to you. Stop and read this.
Our parents’ generation enjoyed retirement secure in the knowledge that each month, for the rest of their lives, they would receive a check. They knew exactly how much they would receive, and they geared their lifestyle to the money on which they could rely. They may not have been fabulouly wealthy, and yes, they were on that much-maligned “fixed income,” but they were secure.
From the employer’s perspective there are two basic problems with defined benefit plans:
- The employer bears the investment risk. If there’s a downturn in the market, the employer must contribute more to the pension plan (or dump it in the lap of us taxpayers) even though the employees don’t enjoy any greater benefit.
- Employees don’t understand them. In my experience, it’s rare for any but the most financially sophisticated employee to understand his or her pension plan before age 45 or so. Before then, it just sounds so small and so far away that it seems irrelevant. So the pension plan fails in one of its central goals, that of motivating young, talented employees to stay and work hard to help the employer accomplish its goals.
So we can all understand why employers are moving away from pension plans. Now let’s think about what this means for society:
- In the future more employees will participate in defined contribution plans, and fewer will participate in defined benefit plans.
- By and large, we Americans are stupid when it comes to investing our wealth. Far too often, we choose safe, low-interest investments like money market and U.S. bond funds that leave our savings growing at a low rate, so low a rate that it often barely keeps up with inflation. Or worse, we become bewitched by somebody’s siren song and invest everything in our own company or in some other unsafe investment. What most of us need to be doing during our early working years is to invest in a broad diversified mix of domestic and international stocks for maximum growth.
- Therefore, in the future, unless we change our habits, more and more of us will be ill-equipped and therefore unable to retire. This may be acceptable to a 70-year-old, who is likely to be physically able to work. But an 80-year-old may not be able to continue working. What then?
Lest it sound to you as if I’m just whining, let’s take a moment and talk about what we can do. As a society, let us accept the cruel truth that more and more of us are destined to make crucial investment decisions today that will determine our financial security later in life. Let’s begin teaching our society about how investing works, starting with the startingly simple and powerful Rule of 72.
Let’s agree that every employee needs to participate in a defined contribution plan, enrollment in which happens automatically unless the employee opts out. And let’s require the employee to complete a simple web-based financial management course as a precondition to opting out.
Our society can survive and thrive in the face of this sea change in our retirement, but only if it comes to its collective senses and insists that employees properly prepare themselves for it.