When pension funds were first started in Germany in the mid-19th century, this retirement option made sense, says Amit Mohindra, director of research at the Institute for Corporate Productivity. At the time, employees would typically stay with one employer for their entire careers. Thus, it was reasonable to expect employers to take care of their former employees once they hit the retirement age.
"The market was pretty stable back then, and companies could make promises, and stocks would return enough to let them meet their obligations," Mohindra says. "But what's happening now is people don't necessarily spend their whole career with one organization, and I sense employees have less of an expectation that when they join a company that company will continue look after them past retirement."
Instead, more employers are turning to alternatives, such as 401(k) plans. As employees tend to float from job to job, a retirement fund that easily rolls over can be a better option for some of the work force.
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"When you leave a company, you don't risk losing your pension," Mohindra says. "You basically carry over your 401(k) balance with you, and you can put it in your new employer's 401(k) or another account, so there's mobility."
But that mobility doesn't always make for the best retirement option, either, as 401(k) plans are struggling to yield sufficient returns, which, ultimately, is the key ingredient to a successful retirement plan.
"Does a 401(k) plan provide enough of a nest egg?" Mohindra says. "That's arguable because 401(k) returns have been pretty bad, so people are going to find difficultly in achieving a level of income that will allow people to retire at the right age."
Defined benefits could be the new defined contributions
Considering the uncertainties of the stock market, managing pension plans can be difficult, Mohindra says, but that's not to say pensions are necessarily a poor retirement option. By having experienced asset managers in place and funding pension plans through more than one source, which diversifies the investments, pension plans can find better success than what some employers have experienced in the past.
"Employers shouldn't put all of their money into private equity because that was delivering huge returns at one point, but then it just collapsed," Mohindra says. "At the same time, you don't want to put everything into bond funds, which would basically earn very meager returns. That wouldn't give them what they need."
According to a recent study by the Employee Benefit Research Institution, defined benefit plans have been on a steady decline since 1979 compared to its counterpart, defined contribution plans. While this decline may be true, Mohindra wouldn't be surprised to see defined benefit plans grow in popularity because they pose less individual risk.
"I think the pendulum has probably swung too far in the direction of defined contributions, so the individual is at risk now," Mohindra says. "With defined contribution plans, the employer has devolved to risk to the employee and only bares administrative costs, but companies can draw the top talent they need for the long term by offering them a better deal regarding their retirement arrangement."
For employers that offer defined benefit pensions, Mohindra advises emphasizing these plans. More baby boomers are delaying retirement because they don't have adequate funds, and a less risky option could be appealing to prospects as they consider the future.
"In the current economic environment, the proposition of joining a company that has a traditional retirement package would be very appealing," Mohindra says. "Defined benefit plans could slowly start coming back in pockets. While defined benefit plans may not be as rich as they used to be, they could at least provide some degree of guarantee, and that might be attractive to people. If I were an employer with a defined benefit pension, I would really play it up."
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