In the 1980s, the 401k, the defined contribution retirement plan named after the legislation creating it, became the standard employee retirement savings vehicle. This type of plan replaced the defined benefit plan or the traditional pension plan. It was the result of a social movement toward less government intervention in the lives of American citizens.
After the Great Depression in the 1930s and World War II in the 1940s, there was a movement in favor of government having a role in taking care of older workers. Up until the early 1980s, this led to most companies offering their employees defined benefit retirement plans or pension plans.
Defined Benefit Pension Plans
Defined benefit plans usually offer an employee who is retiring a certain monthly annuity for the rest of their life. The amount of that annuity is based on a formula using both salary and years of service. This type of plan rewards employees for loyalty and years of service and the employee’s share is paid from pre-tax dollars and usually matched in some amount by the employer.
If a company offers a defined benefit pension plan, it assumes the financial risk of the plan including preretirement inflation and investment results. The future costs of the employer for the employee are not precisely known. After a vesting period, an employee who leaves the company can take their contribution with them.
401k: A Defined Contribution Plan
During the 1980s, legislation was passed creating the 401k retirement plan. During that decade, there was a movement toward less intervention by government into the lives of citizens. The 401k is a defined contribution retirement plan. These plans are cheaper and easier for employers to administer. Employers do have the opportunity to provide matching contributions to employees’ 401ks. However, not every employee is an investment expert, and now they have to make investment decisions for themselves if they have a 401k instead of having seasoned trustees or investment analysts make the decisions, as they did with the traditional defined benefit pension plans.
The 401k is subject to the highs and lows of the stock market. Some financial experts think that they have destabilized the labor market since they keep older workers in the labor market longer as they try to recover losses in their 401k’s.
Offering a Retirement Buyout to Employees
If companies are trying to reduce their labor forces, in the case of a poor economy, or if the company has fallen on hard times, they may offer the employee early retirement with a buyout under either a pension plan or a 401k.
The days are gone when companies assumed the financial risks associated with their workers’ retirement plans and pensions. Since the 1980s, there has been a slow shift of financial risk away from the company and toward the individual. No longer do companies usually pay workers a guaranteed monthly annuity for the rest of their lives. Instead, pensions depend on how good novice investors are at choosing appropriate investments for their 401k’s in a very complex stock market.
When you are looking for a job, look hard at the retirement plan the company offers.
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