My clients, Remington and Kimberly, are in their late 30s, with one child and a second on the way. They both have excellent jobs and salaries substantially above minimum wage. As modern workers, however, their employers do not offer them a retirement plan sufficient to support their lifestyle in retirement.
This now-common situation is the result of a significant shift in the landscape of retirement planning since the late 1980s.
When I joined the workforce, a typical private company offered a defined benefit pension plan. This once-prevalent plan is now a rarity, particularly in the private sector, marking a significant change in the retirement planning paradigm .
We have moved from a defined benefit plan to a defined contribution plan , which means the onus for saving and investing has transferred from employers to employees like Rem and Kim.
Defined benefit plans
From the 1940s until 1987, the number of workers covered by a pension increased from 4 million to 40 million .
These defined benefit plans specifically outlined the amount of income workers would receive from their employer, the eligibility requirements and the length of time they would receive benefits once they retired.
Companies providing pensions had whole departments and staff to understand money and investments, what they needed to do, how much they needed to save and how best to invest it to provide their employees with the agreed-upon pension.
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Defined contribution plans
In 1978, Congress enacted the Internal Revenue Code 401(k) as part of the Revenue Act of 1978 , introducing the concept of a defined contribution plan. These plans outline how much of their salary the employee can contribute to an employer-sponsored retirement plan and what, if any, match the employer will provide. They also outline the calculations used to determine when you can contribute and how much, as well as when you are eligible to take distributions from these plans.
Now, employers could provide a tax-deferred retirement savings account that gives employees fund options. Employees could defer a certain percentage of their income (dependent on many variables), and many employers match a small portion of what the employee defers. Then, the employee can choose how to invest the deferred income from the funds the employer offers. The employer must follow strict guidelines in setting up and overseeing the available investments.
A new paradigm
Setting up and running an employer-sponsored defined benefit plan is expensive and work-intensive for an employer. While a 401(k) still requires effort to manage, it is generally not nearly as costly to run as a defined benefit program.
The decline in traditional pensions in favor of defined contributions means the employee bears the burden of choosing their investments from those provided by the employer and bears the risk of market volatility. There are no requirements, or at best, minimal requirements, to defer income, and even those employers that set up guidelines are clear that without some professional help, there shouldn’t be any expectation of any guaranteed income after retirement.
This underscores the importance of why high-salaried employees like my clients Remington and Kimberly need to seek professional guidance in self-directed retirement planning. There is so much noise out there, determining what information applies to you, what is relevant in your situation and which options are in your best interest is challenging at best and almost impossible at worst.
When it comes to planning for retirement, it is now in the hands of the employee and requires due diligence, financial literacy and awareness of the professional landscapes out there. If you do not have the time or interest in going that route, working with a fee-only fiduciary financial advisor is your best option. Remington and Kimberly chose that direction, and it will pay off for them and their family.
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