I just read a letter to the editor in which the writer declares he will not vote for any tax increases until pensions are completely eliminated for all public employees. He also states emphatically that “defined benefit pension plans are a thing of the past”, and that “companies have decided they were just too expensive”. This opinion seems to be fairly common these days as public employees are vilified for their seemingly generous retirement benefits. While I agree that these benefits do appear generous today, the issue presents a far more important matter that we, as a society, should be debating.
In my opinion, public employee retirement benefits have not become egregiously generous so much as private employee benefits have become excessively lean! It’s true (at least locally and in the state of California) that public pension costs have risen disproportionately during the last decade. Returning benefits to the levels that they were at in the 1990′s is most likely a good idea that I would not oppose. However, when it comes to completely eliminating these plans for public employees, I am not so sure that is a route we should be taking.
First of all, let us look at a little history. Section 401(k)* was written into the tax code in 1978 and became effective on January 1, 1980**. It created the “defined contribution” retirement plan which is more commonly known as a 401(k) plan. Before that, most middle and large sized companies provided employees with a “defined benefit” retirement plan which is more commonly known as a traditional pension. The 401(k) plan is nothing more that a tax-differed savings account with no guarantees of income levels during retirement. The pension provides a guaranteed level of income for life during retirement based on the number of years of service.
More important than the difference in retirement income, is the difference in how each type of plan is funded. The traditional pension must be fully funded by the employer. The employer must set aside sufficient amounts of money each year and manage the investments so that it is able to meet the lifetime guarantee obligations of the plan. This responsibility is rather onerous, and generally companies used professional money managers to handle the investments and administer the plans. In the case of the 401(k) plan, the responsibility for funding the plan is completely shifted to the employee. The employer might make matching contribution up to a certain capped level, but they are not required to do so, and in most plans the employer can stop making matching contributions at will, such as during down times.
So while our friend the letter writer says “companies have decided they were just too expensive”, it might be more accurate to say that companies realized they had to ability to shift the burden of retirement planning onto employees. This shift allows companies to have much leaner operating costs and presumably contributes to greater profitability and efficiency.
However, that improved business performance has come at quite a great cost for the employee! Since 401(k) plans are voluntary, not everyone participates (i.e. saves for retirement). Even with automatic enrollment, most worker do not contribute enough to properly fund their retirement. The national average for the amounts saved in 401(k) accounts across all age ranges is dismally and potentially disastrously low. In addition, most employees lack investment management skills. Most, simply choose a few mutual funds and let the money just sit there. While some plans contain automatic asset re-allocation, in general the investments in 401(k) plans are not actively managed.
So while 401(k) plans may have been really good for businesses, they are actually not very good at all for the average employee. In the three decades they have been around they have almost completely replaced the traditional pension plan in the private sector. The question is rather workers are better off now then they were when a traditional pension was the norm. I would argue that they are far worse off under the 401(k) system and that the average employee would be far more secure in retirement under the old system.
So, our letter writer is probably correct when he states, “defined benefit pension plans are a thing of the past.” But, is that a good thing? We have lost a great deal of security for the sake of greater company profits. Combined with the insecure future of the Social Security program, the retirement landscape for my generation is looking far more precarious than that of the Baby Boomers or even the Greatest Generation before them.
So the next time you feel like a public employee is getting a free ride, remind yourself of what you have given up, or what has perhaps been taken from you. I don’t know how we can steer our society back to a more conservative and secure approach to retirement planning. However I do know that public employee pensions may not be such an evil luxury, as they are currently portrayed. In fact, if embraced as a model for future retirement plans, they might be our last hope.
*Section 401(k): As I understand it, the 401(k) plan was never intended to replace the traditional pension. In fact, Section 401(k) was written to allow companies to provide a supplemental system for employees to be able to save in a tax-differed account on top of their traditional pension. In fact, it was written specifically for one company, Xerox, to provide such a plan. I have not been able to confirm the company specific reference in my research on the matter, nor have I reviewed the congressional debate over this provision of the tax code. However, the obscure nature of the provision as simply Section 401(k) of the tax code leads one to understand that it was not intended to replace the traditional pension system prevalent in this country at the time.
** January 1980: It is remarkable (however unrelated) that the effective date of Section 401(k) coincides with the same month that Ronald Reagan became President of the U.S. ushering in the era of Supply Side Economics (see Republican Myth #1). It’s a incontrovertible fact that this country has had a steady contribution of wealth since that time. I can’t help but believe that the shifting of retirement savings burden from employer to employee may be yet another contributing factor in the nation’s long slide towards becoming a two tiered society. Watch for the topic of income disparity and wealth distribution in future posts.