New Pension Plans and Changes to Current Retirement Plans
I previously discussed my employer-sponsored pension plan where I contribute 6.45% of my paycheck and the state agency I work for matches this contribution with another 6.45%. I will be vested in this plan after five years. However, while researching for that article I found that only 31% of employees were offered a pension plan in 2010.
Defined Benefits Pension plans have taken a back seat to the 401(K) as companies started to drop the traditional pension in order to cut costs and remain competitive (specifically in the retail, manufacturing, and energy sectors). On top of this, employer-sponsored health care plan costs have increased dramatically, causing even more companies to abandon pension plans to help offset other personnel costs.
Pension plans are different from 401(K)s because pensions pay a specified monthly amount at retirement. The security offered by pension plans, coupled with the fact that Americans are notoriously bad at contributing enough to their own retirement funds, has led the government to become more involved in changing the way that companies and individuals approach retirement plans. Some of these options are in development phase, while other changes have all ready been implemented. Not every company offers these options, and employees still have the choice to opt-out in every case. All of these choices became available due to the Pension Protection Act of 2006.
New Pension-Type Plan that is in Effect
- DB(k) Retirement Plan: The DB(k) plan became available in 2010 thanks to the Pension Protection Act of 2006, and is a hybrid of the pension and the 401(K). Businesses with 500 or fewer employees can offer both a 401(k) savings plan and a small guaranteed lifetime monthly income during retirement using this plan. The guaranteed lifetime monthly income is equal to 1% of final average pay multiplied by the number of years of service, or 20% of the employee’s average pay during the five consecutive highest earning years. In both cases, it rewards employees who are loyal to companies. On top of this, the employer is required to automatically enroll workers in a 401(k) plan at 4% of their salary and to contribute a 50%, fully vested match (employees can choose to opt out of this). An employee is vested in the plan after three years.
Changes to Employer-Sponsored Retirement Plans
- Automatic Enrollment: When I first started my job at the state agency three years ago I was shocked when they said I was automatically enrolled in their non-matching 401(k) plan. I have always been diligent with my own Roth IRA contributions, and their 401(k) plan had a lot of fees, so I promptly took myself out of the plan. The Pension Protection Act of 2006 allows employers to automatically enroll employees in 401(k) and 403(b) plans.
- Auto Escalation Feature: This feature allows employers to automatically escalate the percentage of contribution an employee makes to their 401(k) each year. Typically the annual increase is 1%, until the maximum contribution amount of a 401(k) is reached. Employees can opt out of this while still participating in overall 401(k) plan.
- Auto Balancing: Many companies now offer auto balancing to their 401(k) plans to ensure that the asset allocations into stocks, bonds, etc. match the employees risk tolerance, age, and goals.
Proposed Changes to Employer-Sponsored Retirement Plans
While these are just proposals by the current administration, it is good to look at the direction the government is looking to go in light of the social security problems and the underfunding of retirement accounts by many.
- Guaranteed Retirement Accounts (GRAs): This is a government-run pension plan funded by employee contributions and is supposed to supplement Social Security (not replace it). Employees would be guaranteed a lifetime of income in retirement that is safe from inflation. Some of the ideas are a mandatory 5% contribution by employees, and a $600 annual credit from the federal government. The fixed rate of return would beat inflation by 3%.
- Automatic IRAs: The Automatic IRA would be for employees who are not offered an employer-sponsored retirement plan. Some ideas going around are that an excise tax on businesses who do not offer a plan would be levied (per person who enrolls in the automatic plan), and that people who enroll will be given a small tax credit for the first several years of the program. Employees could opt-out of this plan. There would be a default percentage amount to begin with that could be raised or lowered by the employee.