Art by Alex Eben Meyer

Some in the retirement industry look back fondly on the days when company pensions guaranteed paychecks, but experts are not convinced the nostalgia is deserved.

“There’s almost like this sort of mythical Camelot,” says Brendan Curran, head of defined contribution for the Americas at State Street Global Advisors. “It’s painted as a rosy and perfect place, initially in the story, but then by the end, you understand that it’s a little bit more multifaceted than that.”

Experts say the defined benefit world was not as ideal as it is made out to be, as wide swaths of the population were left without coverage. However, most agree there is still a lot the retirement industry can do to improve the 401(k) model, such as including a DB/retirement paycheck as an option.

Curran’s sentiment of not over-glorifying the past pension system is shared by Olivia Mitchell, a professor at The Wharton School of the University of Pennsylvania.

“I cast a skeptical eye on those who argue that DB plans represented the best that the ‘good old days’ had to offer,” Mitchell says.

The defined benefit pension model popular 40 years ago was well-suited to the labor market at the time, Mitchell says. DB plans were offered by large, usually unionized firms at which workers tended to remain their entire careers. Additionally, DB plans typically paid benefits as a lifetime income stream, which helped cover workers protect against longevity risk.

“The DB model was not well-suited to many subgroups,” Mitchell says. “[That includes] women who moved in and out of the workforce due to child-rearing, those who changed jobs, non-union workers and employees at small firms lacking the infrastructure to set up and run such complex retirement offerings. Moreover, we now know that many firms did not fully fund their DB plans, leading to drastically reduced payouts when companies went bankrupt.”

One of the primary issues that has made the DB model less effective over the years is that coverage was built around full career employees, says Melissa Kahn, a managing director and retirement policy strategist at State Street Global Advisors.

“Pensions are great for people who work at one company for 30 years or more,” says Kahn. “The reality, as we all know, is that for the majority of people, they will hold somewhere between 10 and 12 jobs in their careers. Pensions, in that situation, aren’t necessarily the best alternatives.”

Even with a more transitory job market, DB plans have evolved over time, and many plan sponsors and advisories still see great value in the way they ensure income in retirement for employee bases and organizations for whom it makes sense. In a recent PLANADVISER webinar, DB experts noted that there may even be renewed interest in starting DB plans or unfreezing them to accept new participants thanks to regulations and innovations that can help make them less volatile. Overall, however, the DC world dominates the DB one today.

Pension Plans: They Weren’t For All

When thinking about the “glory” days of pensions, however, State Street Global’s Curran says it is important to remember issues with that type of coverage. He points to 2019 testimony that Representative Andrew Biggs, R-Arizona, provided to Congress.

The testimony revealed that DB pensions peaked at 39% of workers in 1975. A 1972 study by the Senate Labor Subcommittee found that between 70% and 92% of traditional DB participants did not qualify for a benefit, which Curran believes was due to pension plans having a lengthy vesting requirement. Additionally, he says the DB model did not cover for those on the lower end of the wage scale.

“A 1980s Social Security Administration survey found that only about 9% of new retirees that were in the bottom half of the income distribution received any pension benefit, and it was closer to half when you looked at the top quartile of the income distribution,” he says.  

As pension was tied to pay, women and people of color were particularly at a disadvantage, says Kahn.  

“As we know, women, particularly minority women, make much less than white men do,” she says. “That continues today, and that obviously reflects in the kind of pensions that they’re going to get as well.”

Under the DC model, among all workers aged 26 to 64 in 2018, 67% participated in a retirement plan either directly or through a spouse, according to the Investment Company Institute. That number ranged, however, from 59% of those aged 26 to 34 to about 70% of those aged 45 to 64. Coverage also varied depending on income. For those with adjusted gross income less than $20,000 per person, only 25% participated in a plan. For those with AGI of $100,000 per person or more, 88% participated.

401(k), Social Security the Solution?

Given the problems with the pension era, might we be better off with 401(k)s and Social Security, if they are used correctly?

“The person who’s called the father of 401(k), a gentleman by the name of Ted Benna, always said that the 401(k) was never designed to be the sole source of income,” says Ray Bellucci, executive vice president and head of recordkeeping solutions at TIAA. “Just like Social Security, since its founding in the 1930s, was never designed to be the sole source of income.”

However, Bellucci believes if an individual can couple Social Security with a 401(k) or a 403(b), building into their 401(k) savings plan guaranteed income, they can bring the two vehicles together as a very effective income replacement in retirement.

“On shared accountability, TIAA believes that the magic number, so to speak, that you should be saving in a 401(k) or a 403(b) between the employer and employees is about 15% of your income,” he says. “That’s what we believe is the right number for you to target.”

Furthermore, defined contribution plans, including 401(k) and 403(b) plans, are much more portable, allowing workers to roll over their contributions and, usually, employer matches from one job to the next, according to Mitchell.

“DC plans also offer a choice of investment strategies to covered workers, which was not the case in the old DB world,” she says. “Of course, if people are not financially literate, they may not select the lowest-cost and best plan investments, and at retirement, people can still take all their retirement assets and spend them.”

Therefore, Annamaria Lusardi, a professor of economics and accountancy at the George Washington University School of Business, believes it is imperative for workers to be financially literate, as the responsibility for managing and allocating retirement totals now falls largely on the individual worker.

“From the time the worker gets to the firm, they have to decide whether and how much to contribute, how to allocate that pension and also, importantly, what to do when he or she changes jobs. Also, [workers have to decide] how to decumulate the wealth when [they are] going to get the wealth at retirement, so it’s not just the accumulation phase, but the decumulation phase,” says Lusardi. “I would say it is imperative that we not just change the pension and put individuals in charge, but that we provide the type of knowledge and support that is necessary for making those decisions.”

Overall, Mitchell believes the DC model is better suited to many workers today than was the old retirement plan approach.

“What is still in question is whether and how our policymakers will restore Social Security solvency before benefits need to be cut in about a decade,” she says.

Inspiration for Lifetime Income

It is common at retirement industry gatherings to hear talk of the “good old days” when pensions used to champion in-plan annuities as a guaranteed paycheck. To Kahn and other experts, what must be kept in mind is that, rather than trying to emulate a system that no longer works for the modern world, plans must evolve to help everyone find retirement security.

“The DC market is going to evolve, and what’s driving the innovation is this push toward retirement income solutions,” she says.

Bellucci says TIAA pays guaranteed lifetime income every month to 33,000 retirees aged 90 or older and will continue until they die.

“That sense of security I talked about earlier of not outliving your savings,” he says. “It’s a theory for somebody in their 40s and 50s. It’s a reality for somebody in their 90s, and as a society, we’re living longer.”

Curran cites a survey fielded by State Street, in which 76% of survey participants valued an employer retirement solution that provided predictable income.

“As we think about innovation and retirement income and this idea of pension nostalgia to us, it comes back to: What are participants expressing in terms of their needs?” he says. “Through their actions and their words and what we’re hearing loud and clear is the need for solutions that address the retirement income challenge.”