A tight labor market demands careful attention to employee benefits. Employer-sponsored retirement plans are central to these packages. Retirement plans include pensions, 401(k)s, stock bonus plans and numerous others. Plan designs vary, but all serve similar purposes. Retirement plans attract and retain top talent. A suitable plan also fulfills an entity’s financial goals.
Retirement preparation has always been important. Prolonged life expectancies and surging health care costs now render it a necessity. Data reveals the full extent of both trends. Mortality tables indicate that today’s 65-year-olds have a 50% chance of living to age 90 — there is nearly a 20% probability they will live to age 100.
Life expectancy leaps are partly attributable to health care advancements. Medical interventions repel fatal diseases and life-sustaining treatments keep our ill alive longer.
These innovations, however, come at a cost. Experts estimate that an average couple may incur roughly $315,000 in retirement health care expenses. Longer and more expensive retirement periods require substantial savings.
Retirement costs are widely recognized.
As such, many workers embrace and even expect employer-sponsored retirement plans. Research ranks retirement plans as a top-three priority for prospective workers. Moreover, three-quarters of employees say they would switch jobs for better financial benefits. Businesses are responding to these concerns.
The entity’s business model, staff composition and liability preferences are key. Also, plan complexity varies greatly. Some organizations are better equipped to handle administrative burdens and liability concerns than others.
The choices might be vast, but a plan exists for every business. It behooves businesses to choose wisely.
Plan types
Retirement plans fall into three broad categories: defined contribution plans, defined benefit plans and nonqualified plans. Each type caters to particular goals and circumstances.
Most are familiar with defined contribution plans. These include standard 401(k) plans where the employee makes a defined contribution each pay cycle. Contributions can be pre-tax or post-tax. Some 401(k)s also offer employer-matching contributions or yearend, profit-sharing distributions. Employees make investment selections and market returns determine future account balances.
Other defined contribution plans include Money-Purchase Plans, Target Benefit Plans and Stock Bonus Plans.
Defined benefit plans guarantee fixed retirement benefits to employees. Sponsoring companies fund large reserve accounts to support this promise. Defined benefit plans, also known as pension plans, have fallen out of favor in recent decades.
The third category is non-qualified plans.
These plans avoid federal eligibility, vesting and contribution requirements. However, employers typically forfeit certain tax advantages in exchange. Non-qualified plans are sometimes referred to as “Top Hat Plans.” They are useful tools that lure top talent and retain key executives.
Plan options will continue to expand with changing laws and preferences.
A transformed landscape
The retirement landscape has changed considerably in recent decades. While past generations received guaranteed pensions, today’s workers are largely responsible for funding their own retirement. This reflects decades of evolution in retirement plan design. Nowadays, traditional pension plans are only utilized in limited circumstances.
Pensions extend guarantees in an uncertain world. The plan structure requires frequent, predetermined payments to retirees regardless of market performance. This places tremendous investment risk with the employer, as a pension reserve’s returns are neither predictable nor guaranteed. Decades of low interest rates and stock market volatility led many pension plans to be underfunded.
Pension designs have inherent risks for employers, and societal changes exacerbated them. Longer life spans extended the duration of each recipient’s pension benefits.
Persistent inflation introduced an additional variable. Few plans offered cost-of-living adjustments, and many pensions failed to keep pace with rising costs in the 1960s and 1970s. Congress eventually sought to restore faith in the retirement system.
Today’s retirement landscape can be traced largely to the Employee Retirement Income Security Act (ERISA) of 1974. Although Congress had long flirted with retirement reform, the collapse of several prominent pension funds compelled meaningful action. Among other provisions, ERISA guaranteed pension payments for distressed plans and established minimum participation standards. The bill also charged the Department of Labor with overseeing plans and enforcing ERISA requirements. Pension plans became more transparent, accountable and secure nearly overnight.
The 1970s then gave birth to a less publicized but equally impactful innovation: the 401(k). Prior to ERISA, some companies allowed employees to defer income to a retirement account on a pre-tax basis. These accounts, called Cash or Deferred Arrangements (CODAs), attracted both employer intrigue and regulatory scrutiny. Growing curiosity finally forced Congress and the IRS to act. The Revenue Act of 1978 included a provision that formally permitted employees to defer income on a pre-tax basis. The IRS promptly codified the provision as Section 401(k) in the Internal Revenue Code. Suddenly, a cheaper, less binding and more flexible option became available to employers.
Plan selection
No two entities are alike. This is not surprising given the sheer volume of companies nationwide. Behind each of these businesses lies a unique passion, vision and management philosophy. Plan selection requires a comprehensive review of the business’s circumstances and priorities. Personalized guidance supports specific goals.
While businesses differ, one common theme prevails. Business owners crave more time — a resource as finite as it is valuable. Administrative obligations leave little time for strategic planning. As a result, entities have ill-fitting retirement plans or no plan at all.
Professional guidance is invaluable. An experienced team can identify the appropriate plan for each organization. This leaves more time for owners to do what they do best: lead, create and grow.
Bryce Schuler is a financial advisor at Baldwin-Clarke in Bedford, and is a certified financial planner specializing in business retirement plans.
