Last week we discussed Social Security and how it was created to help ensure economic security for older citizens upon retirement. However, Social Security was never intended to offer an easy life for citizens, but rather to prevent ‘poverty-ridden old age’ by providing a very basic safety net. It was up to individuals to provide the rest through personal savings and, preferably, enrollment in a company pension plan.
Employees and employers contribute an equal share to Social Security, however, pension plans are paid for entirely by the employer, which makes them an ideal employment benefit. However, the current generation of incoming workers is unlikely to ever work at a company that offers one.
How do pensions work?
This employment benefit guarantees a monthly income after an employee retires until they pass away. The amount a retiree receives is dependent on their salary history and time with the company. Some generous pension plans will even offer partial payment to a surviving spouse – though these have become increasingly rare. In general, the longer you work for a company the larger the payoff will be, but working at a company that offers a pension plan doesn’t guarantee that an employee will receive one.
Pensions are subject to vesting schedules. A cliff vesting schedule means an employee will only receive 100% of their pension benefit if they stay at the company for a specific amount of time, say five years. If the employee leaves before that time, they receive nothing. In contrast, a graded vesting schedule means that an employee is eligible to receive an increasing portion of their pension benefit with each time milestone they hit. For example, an employee could receive 25% after they work for two years, 50% after three, 75% after four, and then 100% after reaching five years.
What happened to pension plans?
Pension plans today are mostly found in the public sector and have become rare in the private sector. According to a 2021 Congressional Research Service report, 86% of employees in the public sector have access to a pension plan while only 15% of employees in the private sector are offered the same benefit. For reference, there were nearly 118 million private sector jobs in 2020 and only 18.7 million in the public sector, meaning a vast majority of workers don’t even have the option of a pension anymore.
This wasn’t always the case. Prior to the 1980s, pension plans were the most common retirement plan for workers. The reason for the change is pretty simple: pension plans cost the employer a lot of money, while alternative retirement plans, such as a 401(k), cost the employer considerably less.
Rather than the employer bearing the full liability for managing and paying for an employee’s pension fund, these alternative plans shift the majority of the cost and risks over to the employee. Instead of the employer paying for the retirement benefits using company earnings, 401(k)s are funded by employee payroll deductions with some companies (but not all) offering matching contributions — often through vesting schedules. This leaves it up to the employee to contribute towards retirement.
What does this mean for the next generation of workers?
Only about a third of millennial workers participate in a retirement plan through their job, which is significantly less than the generations before them. Gen Z could follow a similar pattern as they enter the labor market as pension plans are becoming more elusive with each passing generation.
As Insider noted, “the main difference between a pension and a 401(k) is that 401(k)s don’t actually guarantee any retirement benefits.” Whether you will have enough for retirement is now dependent on the market and may mean losing some now (through contributions or payroll deduction) to gain something later, which many younger workers simply can’t afford to do.
It is important to keep in mind that many small businesses and start-ups are the least likely to have retirement plan options. Therefore that segment of the labor market has to find alternative ways to plan their retirement, as we know Social Security may not be an option.