The rise of the 401(k) plan has spelled the end of employer-sponsored pensions for many workers. But don't count out pensions just yet.
Employers across the country have fled from traditional pension plans, which require them to set aside enough money to pay out monthly benefits for workers throughout their retired lives. By setting up defined contribution plans like 401(k)s for their employees, employers have essentially shifted the burden of adequately saving and investing onto their workers.
Recently, however, a third alternative has regained popularity in the retirement benefits world. So-called hybrid pension plans combine some of the favorable elements of 401(k) plans and traditional pensions in a way that helps employers and workers alike.
Mixing it up
Hybrid plans -- which include cash-balance and pension-equity plans -- borrow certain traits from both traditional pensions and 401(k) plans. Like pensions, hybrid plans use formulas based on salary and length of employment to determine the total benefit owed to each employee. Rather than paying a set monthly pension, however, hybrid plans typically calculate a lump-sum amount that the worker will receive at retirement. If the worker wants guaranteed monthly income, converting to an annuity is often an option.
From the employer's perspective, hybrid plans work much like regular pension plans during an employee's career -- the employer sets aside certain amounts of money to cover the expected lump-sum benefit. However, making one payment, rather than a monthly allotment for life, makes the hybrid plan's cash flow much more predictable for the employer. Also, the lump-sum calculation eliminates longevity risk for the employer; it's up to employees to manage their money so that they won't run out early.
Converting and age discrimination
During the 1990s, many employers converted their traditional pension plans to hybrid-type plans. Here are just a few:
|
Company |
Year Converted |
|---|---|
|
Aetna |
1999 |
|
American Express |
1995 |
|
AT&T |
1998 |
|
Citigroup |
1996 |
|
Goodyear |
1998 |
Source: Christian Science Monitor, Center for Retirement Research.
Because these conversions reduced the pension benefits of many workers -- especially older workers -- some companies faced age-discrimination lawsuits alleging illegal benefit cuts.
Now, however, employers like IBM
Pros and cons
From an employee standpoint, hybrid plans have several attractive features. Perhaps most importantly, contributions to hybrid plans are made entirely by employers, so they represent free money for employees. Although many hybrid plans have vesting requirements similar to 401(k) plans, they don't require employee participation. If an employer also offers a 401(k), hybrid plans can give employees an extra benefit toward their retirement.
In addition, hybrid plans are somewhat more portable than traditional pensions. Many traditional pensions skewed benefits toward longtime workers, making it more difficult for those who changed jobs during their careers to keep up. Hybrid plans typically allow a departing worker to roll over accrued benefits into an IRA.
Unfortunately for employees, whether a company offers a traditional pension or uses a hybrid plan, your lack of control over that money makes it difficult to incorporate it into your financial plan for retirement. In contrast, the complete control you have over your 401(k) account balance makes planning much simpler.
If hybrid plans do become more popular among employers, a new generation of workers may enjoy some supplemental income beyond what they set aside on their own. Yet with all the uncertainty over retirement payouts, both from Social Security and private employers, you're still better off treating a company pension as an unexpected bonus, rather than relying on it for your necessities.
For more on retirement, read about:
- Why you need to prepare for a gruesome retirement.
- Avoiding the worst retirement investments we've ever seen.
- What you should do to retire rich.
