11 January 2016

From Pensions to 401(k)s - One of the Less Reported Reasons For Growing Wealth Inequality

There are two kinds of retirement plans: defined benefit and defined contribution. While not technically correct, you can think of it as the move from pensions to 401(k)s. This move from defined benefits to defined contribution is one of the least reported reasons for growing wealth inequality.

If you have a defined benefits plan, your retirement benefit is defined. "If you work 30 years, your pension will be equal to 60% of the average of your last three years of income," might be one simple formula. With a defined benefits plan, you are guaranteed a monthly income - often adjusted for cost of living - until you die. Nobody gets rich with a defined benefits plan but they are fairly safe and reliable.

By contrast, if you have a defined contributions plan, you can't be sure what amount you'll have in retirement. You define your contribution - say 10% of your pay - and your employer may match this (sometimes they'll match your contribution by 25, 50 or 100%). You know that you're putting $300 a month into your retirement account each month. What you can't know is how that investment will do. By the time you've worked 30 years, your investment may have grown to $3.1 million or be worth only $31,000. It will depend on how your investments have done.  You can get rich with a defined contribution plan but they aren't safe or reliable.

Defined benefits plans minimize differences in wealth and retirement income. Defined contribution plans exacerbate differences. As more people move (or are moved) into defined contribution plans, we would expect to see more disparity in wealth.

This graph from Employee Benefits Research Institute:

Since the late 1970s, there has been a dramatic change in the use of defined contribution and defined benefits plans. Looking just at just employees with retirement plans, the percentage with defined benefits plans has dropped from 62% to 7%. Meanwhile, the percentage with defined contribution plans has gone up from 16% to 69%.

Unsurprisingly, wealth inequality has gone up as defined benefits programs have gone down. The growth in the use of defined contributions plan is by no means the only reason for growing wealth inequality but it is a very real one.

And one of the many ways that it shows up is that even as wealth goes up, a growing number of people feel vulnerable in retirement. If you have a set income every month, you may not feel rich but you'll feel secure. By contrast, even if your investments do well and you are considered "well-to-do," you might still feel vulnerable because you know that one big market move could change your situation.

It's not clear that employees or employers will reverse the trend of the last quarter century. It is clear that the price for this change has included more wealth and income inequality and more feelings of vulnerability.

1 comment:

Anonymous said...

When I worked for a major chemical company in 1989, we were forcibly moved from a fixed-retirement plan to a 401(k). Initially they matched employee contributions dollar for dollar, but gradually, over time, this amount was reduced. They now pay 25-cents on the dollar for direct employees who have been there for five years.

This was in effect a massive pay cut for their employees with the proceeds passed along to the stockholders. Naturally, all that was reported was that their stocks skyrocketed.

I'm afraid the ultimate goal of health-care reform is the same: pass more of the burden on to the employees, pass the savings on to the shareholders, and make sure the press reports only that the stock market is up again.

Calling them "benefits" makes it sound like it's a benevolent gift from the corporations, not something the employees earned through their own hard work. That makes them easier to take away.