The modern 401(k) practices emerged from one of these then-obscure tax codes, which I view as an unabashedly good outcome.
Then during the 1980s as corporate accounting schemes became more sophisticated preference for 401(k)'s and other defined-contribution plans exploded because of how liabilities are calculated.
In every conceivable measure pensions are theoretically better for workers and society as a whole. I say theoretically because that's predicated on employers and pension funds (if employer managed) obeying good (translation: dead simple) accounting practices rather than spending all their time and effort figuring out how to subvert them in order to cook their balance sheets to increase their yearly bonuses. Many corporate merger waves since the 1980s have been driven by schemes to drain pension funds (cost "synergies"), and of course states are notorious for failing to fully fund pensions on a YtoY basis (states, unlike corporations, aren't actually required to fully fund pensions[1]).
All of these downsides to pensions can be easily remedied. But corporate interests have succeeded in selling the narrative that pensions are unreliable and inequitable, while 401(k)'s are more reliable and equitable. In fact pensions are categorically more equitable, and any less reliability (which is a dubious claim, notwithstanding the many high profile pension failures over the years--nobody reports on someone's 401(k) fund vanishing during a recession) is a consequence of lobbyists phenomenal success in killing legislation and enforcement efforts responsive to corporate financial accounting schemes. Overall reliability of private retirement systems has fallen over the past 40 years, but the decline for pensions was more precipitous simply because they were so damned good before CFO offices became profit centers.
Life insurance markets were once dens of fraud and outright thievery, the mortgage backed securities and CDOs of the late 19th and early 20th century. Relatively simple reforms restored the market to nearly unassailable reliability. Though, I suspect the necessary legislation only succeeded after life insurance stopped being the center of growth and profit for financial markets. Legislation regarding private retirement plans likely will only ever make substantial reform once corporations have finished exploiting all opportunities for subverting employee income disparity and asset protections, finally shifting their attention elsewhere.
[1] "Fully fund" does not mean paying in the entirety of a worker's expected retirement disbursements. Rather, it means ensuring that each and every year you pay the full fractional share of expected liabilities. Basically the same thing an individual is expected to do when managing their 401(k) contributions.
Switch jobs every few years? You probably weren't going to collect much in the way of a pension.
I'm not sure how much the switch has been about "corporate interests." As people became more mobile (for good reasons and bad), the idea of your retirement savings being tied up with a specific (usually large) company became less attractive to employees as well.
[1] Not per se a horrible thing, but that ability is better preserved for infrastructure and other discretionary investments rather than retirement.
Those lobbyists must be doing a terrible job, since the Pension Protection Act of 2006 strengthened the reliability of defined benefit pensions.
The problem is defined benefit pensions are extremely risky for beneficiaries since the existence of an employer decades into the future is a huge risk, as are changes in a world where things change quickly and many people do not stay at the same job for many years.
And they are risky for employers in that expecting every employer to also function as an insurance company selling annuities and survive as long is expensive and ridiculous to execute. That is how you end up with so much corruption and money wasted because so many people have no idea what is going on (and the root cause for taxpayer funded DB pensions being a quagmire since voters have no idea what is going on).
There is zero reason an employer cannot just give the normal cost (the present value of the benefit accrued during the year) to an employee, and the employee put it in VOO rather than the employer doing the same and then having to pay actuaries and fund managers. I am happy I do not need to pay finance people who have been obviated by automation.
Pensions were already dead long before 2006, and inevitable future pension failures baked into the system years and decades earlier. And in any event the PPA heavily favored 401(k)'s, the price extracted by Republicans for creating the Pension Benefit Guaranty Corporation. And the PBGC itself also favored corporations. Nothing about the PPA directly addressed the underlying reasons pensions were failing; the PPA was about creating a soft landing.
> The problem is defined benefit pensions are extremely risky for beneficiaries since the existence of an employer decades into the future is a huge risk, as are changes in a world where things change quickly and many people do not stay at the same job for many years.
They're not risky at all. A pension is just an annuity, the corporate equivalent of employer-provided health insurance vs open market health insurance. Annuities, like life insurance, are considered some of the most reliable investments possible, precisely because of relatively strict, century-old reform legislation. See my response elsethread regarding fully funding requirements and the difference between employer vs independent management. Again, this notion that pensions are fundamentally risky is a false narrative. To the extent pensions are risky, it's only because the laws don't adequately address what in other insurance markets would be considered systemic accounting fraud.
Exactly, but DB pension funds are not regulated by insurance commissioners the way insurance companies that sell annuities are. I wonder why every taxpayer funded pension and private company pension before PPA 2006 would value an annuity at a lower price than an insurance company would…
Since they are the same as annuity, then the employer should just go out and buy people an annuity. Or better yet, give the employer cash and let the employee decide if they want to buy an annuity or not. Insurance companies make single digit profit margins, it is not like having every employer roll their own insurance company was saving anyone any money.
> the corporate equivalent of employer-provided health insurance vs open market health insurance.
It is not quite equivalent since the company is not the one deciding how to do the actuarial calculations, at least not in a way that can be tilted like having their own people on a pension board of trustees would. Most of the health insurance aspects are taken care of by managed care organizations (aka health insurance companies). It would be equivalent if employers offering DB pensions were hiring insurance companies to calculate the cost of their annuities.
But they never would, because annuities are simply very expensive. At the end of the day, compensation for most people in the US was falling or stagnant in real terms for the past few decades (and people were living longer), so offering them properly priced annuities would have made any business untenable, hence businesses jettisoning them in favor of DC plans.
Annuity return rates suck relative to pensions and especially stock market returns (ignoring potential long-term risk). But I have the impression that if you're rich or if you're part of a group effort, the returns get better, much like any other class of financial instrument. But I don't actually know if that's true; never looked into it.
Similarly, if your annuity terms are bargained by a sophisticated party on your behalf, you'll likely end up with a more optimal cash vs future benefit balance. Whereas if the decision is left up to you, you'll do what the vast majority of people do, which is favor cash. And favoring cash is something even a financially conservative, risk-averse person might do, because to laymen "conservative" means cash in hand. Just a few weeks ago my dad explained to me that he wanted to cash out his old union-provided annuity and stuff the money in a mattress because he was concerned about Biden/Pelosi policies driving higher inflation. I wanted to be like, "WTF!?"[1], but I long ago learned not to argue with cranky old men, though I'm well on my way to becoming one. (It was a tiny annuity, anyhow, started only a few years before he retired. Definitely not worth lecturing anyone over.)
[1] Because almost certainly the annuity was inflation adjusted.
Health insurance, like life insurance and annuities, is pretty efficient already with low single digit profit margins.
Average annual employer sponsored insurance is $7,675 for single PPO coverage in 2019:
https://www.kff.org/report-section/ehbs-2019-summary-of-find...
And average lowest cost monthly gold premium on healthcare.gov is $516 ($6k annual) in 2019:
https://www.kff.org/health-reform/state-indicator/average-ma...
> Annuity return rates suck relative to pensions and especially stock market returns (ignoring potential long-term risk).
Ignoring the main risk of an investment certainly makes it cheaper. That is what we have been discussing these past few comments. Once those risks are taken into account, by legislation like PPA 2006, the time shifting of costs into the future becomes more difficult and is one big reason why DB pensions are not tenable.
Although, at this point, I would argue an even bigger reason is that they simply have been obviated (same for annuities by insurance companies). Why pay an insurance company a cut of your investment returns when you can get rock bottom expense ratios on target date funds from Vanguard or buy VOO? That is what all these DB pension fund managers and insurance companies are doing anyway. Same reason why whole life insurance is a scam. All of these products have been automated and their middlemen bypassed.
What are the DIY alternatives to whole life?
For me (and I think many others), an annuity that ends at death is not my primary goal when considering how to arrange my investments.
To my mind, Social Security, pensions, 401(k)s, and the like can all play a part. My larger point about pensions specifically is that there's nothing inherently less risky in pensions from a purely accounting perspective. Actuarial tables were astonishingly precise 100 years ago, and our ability to diversify and insure risk through private markets has only grown while at the same time U.S. monetary stability has achieved undreamed of heights, even considering asset inflation. The basic dilemmas and moral hazards, meanwhile, have largely stayed the same, albeit sometimes obscured by increasing technical complexity.
The biggest part of the puzzle concerns public policy. For some reason we keep returning to tired debates about socialist vs private markets or personal freedom vs authoritarianism, like we're still picking sides in an insurgent communist revolution at the turn of the previous century. (The current debates are astonishingly similar to the ones we've had prior, such as over hourly limits, employment disability insurance, and especially Social Security.) It's ridiculous. We have a decent grasp on which basic tools work better in which contexts and why, partly because the science of economics has improved, and partly because the past century saw a large number of social experiments play out at large scales both domestically and especially globally. The immediate question isn't which singular option to chose, it's about how to mix-and-match instruments and incentives. Interactions and second-order effects are still fuzzy, and political cultures do matter, but there are so many tremendous improvements we could make before we hit that next wall.
For the recipient of an earned pension, there is substantially less volatility in future payout (as compared to defined contribution plans). There is some value in that for the individual. For people who are capable to save more than the minimum required in a personal account, an annuity is on-average worse than their own diversified portfolio of mostly equities. But for people saving/earning the minimum pension, capping downside risk has a pretty large benefit and, at least in that sense, I would say pensions are "inherently less risky".
Is the pension fund making sound investments? Will the city, state, or corporation be sound decades from now or will they be bankrupt or struggle to pay obligations made by their priors that were maybe inflated?
Private investment vehicles are independent of your employer. If they go bust your balance is sound if it wasn't in their securities, which is again ultimately the investor's choice. If I make bad investment decisions I can live with it. I can't live with promises others couldn't keep, I'm at their mercy.
I would prefer eliminating 401ks entirely and expanding IRAs. IRAs allow choice of broker and much wider investment options. If I know what I'm doing I can take more risk. Otherwise I can play it safe with mostly index funds and sensible asset allocation. If I don't know where to start I can hire an advisor or multiple of my choosing to handle it for me. It also would eliminate vesting periods which keep people in jobs they're unhappy with.
> nobody reports on someone's 401(k) fund vanishing during a recession
Recession dips are temporary. If you're well diversified and don't panic sell the balance should recover. Whatever balance you're relying on near term should not be in something volatile like the stock market.
Now that so many of us are participating in the stock market (in one way or another), we're more likely to support policies that Wall Street tells us will keep the market booming. Wall Street won by winning over Main Street.
Possibly. I can't complain personally, The shift from defined benefit to defined contribution retirement savings has probably been generally positive for those with the ability/discipline to take full advantage of 401(k)/IRA. The flipside is that relatively few people (mostly public sector) in the US now get a more or less automatic defined retirement payout from a pension.
Of course, the shift isn't just tax code changes. Traditional pensions also largely encoded long-term employment with a single organization.
That's exhibit A of what I'm talking about!
This is an article about IRAs being heavily restricted, 401k's are in the same 400-section of the tax code. IRAs are subsection 408, 401k's are subsection 401(k).
Literally just stop talking about it, stop trying to get a personal finance blog going, stop trying to get youtube views funnelled over to a personal finance discord server, just let unaware people run around like chickens with their heads cut off because when you tell them whatsup they try to get the laws changed when they fail to take advantage of it adequately
Ignorance is bliss and convenient, this is where we are. Just get the tax breaks you have because of your superior reading comprehension skills and eventually your ability to outsource and augment those skills to experienced lawyers and accountants with the same skills.
I'd rather be building something than dealing with tax, but I'm very much incentivized to do the latter (though your situation may differ).
People don't want to hear this because 401ks are silver bullets, and we are all inclined to desire silver bullets over applying rigor. Most people have no idea what part of their paycheck is invested in. Why do we let them lecture us on where to hold and grow our wealth?
That's not to say that 401ks in and of themselves are bad. Their existence doesn't mean that people shouldn't take their own risks and hold assets that keep their wealth liquid rather than locking it up. Personally, I prefer paying more in order to have liquidity. Many would disagree with that. But truth be told, no one knows any one answer that applies to all.
Everything else is a waste of time, plastic straw ban of lawmaking.
In many countries (like mine) organised labour has a wage negotiation-followed-by-industry-wide-strike season. Every year, come rain or shine.
Industry has long responded by: a) adjusting their 'final price' to accommodate the theatre b) automating whatever they can c) scheduling plant maintenance d) learning which jobs can be eliminated and doing so.
All without paying a cent in wages.
Since they seldom get all this done inside 6 weeks, its takes the labourers years to recover even a 5% increase.
Many (mining, paper, logging, hospitals) even budget for it.