Over the past 30 years, a dramatic change has taken place in the use of retirement plans to help people save for their later years. In an earlier era, many people were covered by defined benefit pension plans, which promise a fixed benefit at retirement, often based on years of service and compensation levels. In recent years, 401(k) plans have become the dominant form of plan for accumulating retirement funds. This article looks at the pluses and minuses of each.
Defined benefit plans are generally a promise made by the employer, private or public, to provide a benefit at retirement. The employee may be called upon to contribute toward the benefit, but the responsibility is on the employer to make sure the funds are there at retirement. For many years, until the enactment of the Employee Retirement Income Security Act of 1974, ERISA, funding of defined benefit plans by employers was required at only a modest level. And many of them were poorly funded. The best-known example was the retirement plan for Studebaker, which made cars, in Indiana and elsewhere, for many years. When Studebaker went out of business, there was not enough in its retirement plan to fund all of the promised benefits. Employees who got less than they had expected had little or no recourse. ERISA changed that, requiring that plans be funded on a regular schedule. Contributions to such plans are deductible by private employers, which is a tax benefit, but they also reduce the bottom line and require the transfer of cash to the plan each year. Private employers have some funding leeway, but eventually have to fulfill their obligations to the plans. Or, they could terminate the plans, and move to another type of plan, which is what most employers did.
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