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People often criticize "defined benefit plans" like pensions, where the employee is guaranteed a certain pension payment by the employer. This guarantee means t
by gred 12y ago
People often criticize "defined benefit plans" like pensions, where the employee is guaranteed a certain pension payment by the employer. This guarantee means that the employer, rather than the the employee, takes on most of the market risk. Employees (via e.g. unions) often push for pension guarantees that are likely to exceed realistic market returns, further increasing risk to the employer (as has happened in many municipalities in the US). Politicians who are here today, gone in 20 years, are sometimes incentivized to provide expanded pension guarantees (to make employees happy today) without adjusting funding (to keep taxpayers happy today).
Defined contribution plans like 401(k)s, which have become much more popular in the past 20 or 30 years, move the risk to the employee -- nobody is guaranteeing anything, and your fortunes move with the market. Obviously there are downsides, but one of the big upsides is that it keeps everyone honest by forcing employers to fund plans today as needed (e.g. 401(k) matching is not a hypothetical cost to be faced in 20 years, it's something that must be paid out today).
http://en.wikipedia.org/wiki/Defined_benefit_pension_plan http://en.wikipedia.org/wiki/Defined_benefit_pension_plan
http://en.wikipedia.org/wiki/Defined_contribution_plan http://en.wikipedia.org/wiki/Defined_contribution_plan
- jordanb 12y agoThis is a good definition of "pension" and "401k" but it doesn't explain why the former is unsustainable and the latter is sustainable. Why is it sustainable to shift all the risk of bad investment, mismanagement and unexpected longevity away from institutions and onto individual workers? Are workers in a better position to shoulder those risks than institutions are? Or are they in a better position to minimize the risks? Do they have better access to the investment market or greater ability to choose good and trustworthy managers? Are they in a better position to pool longevity risks?
- ohyes 12y agoThe difference is that the 401k the matching contributions go into the employee's fund immediately. The pension is really just a promise of funds in the future. Historically pensions have been: a) reneged on by the employer b) underfunded by the employer It is correct to say that there is no reason a reasonable pension couldn't be just as good as a 401k, but it hasn't played out. The money keeps getting spent twice. I personally think this is nothing short of criminal. Because of the way the 401k works, the money can't be double spent, and you didn't have this problem of the retirement funds 'disappearing'.