Collapse of Traditional Pension Schemes and Their Successors Detailed
In the world of retirement planning, a significant shift has been underway for several decades. This transformation revolves around the move from Defined-Benefit (DB) plans to Defined-Contribution (DC) plans, such as 401(k)s.
The primary driver behind this change is cost and risk control. DB plans require employers to guarantee fixed retirement payments, which can be expensive, difficult to predict, and involve long-term funding commitments. In contrast, DC plans provide employers with cost certainty, simpler administration, and a shift of investment risk from employers to employees.
This shift has been facilitated by favourable tax policies, deregulation, and legislative changes. For instance, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) raised contribution limits and improved the flexibility of DC plans, making them more attractive to both employers and employees.
As a result, participation in DB plans has dramatically decreased. From about 60% coverage of private-sector workers in 1989, participation fell to around 20% by 2022, while access to DC plans grew significantly.
Additional pressures accelerating the exit from DB plans include rising premiums for pension insurance paid to the Pension Benefit Guaranty Corporation (PBGC). These premiums, especially variable ones for underfunded plans, have roughly doubled in the last decade, motivating companies to transfer pension liabilities via lump-sum buyouts and group annuities.
Employer preference for schemes with less administrative complexity and financial uncertainty also plays a significant role.
Today, 68% of private-sector nonunion employees have access to a defined-contribution plan. IBM, for example, unfroze its defined-benefit plan in January 2024, and is now making a 5% contribution per employee into a new retirement benefit account. This account is immediately vested in employees and can be taken with them if they leave the company.
For individuals without employer-sponsored plans, Individual Retirement Accounts (IRAs) offer another way to save for retirement. In 2025, the maximum allowable contribution to a traditional IRA or Roth IRA is $7,000 per year, or $8,000 if the individual is age 50 or older.
Contributing to an employer-sponsored plan, such as a 401(k), is recommended if possible. If an employer does not offer one, IRAs offer another way to save for retirement. After maxing out these options, consider investments outside of retirement accounts to help build your nest egg.
In conclusion, the shift from Defined-Benefit to Defined-Contribution plans is a trend that has been driven by cost and risk control, regulatory and tax incentives, rising PBGC premiums, market and demographic changes, and employer preference for simpler plans. Whether you're an employee or an individual planning for retirement, understanding this shift can help you make informed decisions about your retirement savings.
References:
- Aon Hewitt. (2016). The 2016 Aon Hewitt DC Pension Risk Transfer Survey.
- Congressional Budget Office. (2001). The Economic Growth and Tax Relief Reconciliation Act of 2001.
- Pension Benefit Guaranty Corporation. (2022). Premiums.
- U.S. Securities and Exchange Commission. (2021). Regulatory Flexibility Act.
- U.S. Department of the Treasury. (2022). Retirement Security.
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