It is one of the most well-known stories about American retirement: the decline of defined benefit pensions in the private sector. At one time, 88 percent of private sector workers who had a workplace retirement plan had a pension. That number is now 33 percent. So what happened? Where did all the private sector pensions go? While the advent of the 401(k) certainly played a role, the true cause may have more to do with a series of laws passed from the mid-1980s to the mid-2000s. These laws had the inadvertent effect of causing the decline of defined benefit pensions.
Defined benefit pensions were once the most common retirement plan in the private sector (for those employers that offered a retirement plan). Workers knew that if they worked for a company for 20 or 30 years, they would be able to retire with a reliable and secure pension. That promise is now gone for most private sector employees. There are several reasons for this. One is changes in the economy and the decline in unionization. Good-paying union jobs at manufacturing plants throughout the industrial Midwest also came with defined benefit pension plans. As manufacturing jobs have been shipped overseas, those good jobs with pensions have also left. Newer sectors like information technology, for example, are less likely to offer jobs that come with a defined benefit pension.
Changes in the economy are only part of the story though. The driving force behind the decline in private sector pensions was a series of laws beginning in the 1980s. Three laws passed during the Reagan administration did the bulk of the damage:
- The Tax Equity and Fiscal Responsibility Act (1982)
- The Retirement Equity Act (1984)
- The Tax Reform Act and Single Employer Pension Plan (1986)
By the 1990s, private sector pension plans were already becoming a thing of the past. The Pension Protection Act of 2006 further accelerated the decline of private pension plans.
What exactly did these laws do? First and foremost, they increased the volatility of the pension fund from year to year. They did this by making annual contributions to the pension plan less predictable. The Pension Protection Act specifically increased funding requirements from 90 percent to 100 percent; shortened the amortization period from 30 years to just 7; and reduced the number of years plans are allowed to use to calculate the interest rates on their assets and liabilities.
This is all very technical, but the point is this: private pension plans must now have more money on hand and have less time to get to 100 percent funded status if they suffer losses in a market downturn. The two year period to calculate interest rates, in particular, increases the volatility of the funding because two years is a short time to calculate an interest rate. When you’re calculating the interest rate on assets and liabilities, the value of your assets can change significantly from year to year, depending on the financial markets. If you only have a two year window in which to judge the value of your assets, then you are going to be more vulnerable to market swings, whether from extremely high returns or unusually low returns.
Beyond increasing the volatility of the pension fund, these laws increased the complexity and the scope of the regulatory burden facing private sector pension plans. The increased volatility of the funding levels made pension plan contributions less consistent from year to year. The less consistent contribution levels have a negative impact on a firm’s cash flow and overall balance sheet. In fact, multiple surveys have shown that private companies did not abandon their pensions due to the inherent cost of the pension itself, but rather because of the complex regulatory burden they faced.
The decline of private sector pensions has consequences. As pensions have become less common, the retirement security of employees in the private sector has decreased. One study found that when companies switched from defined benefit pensions to defined contribution plans, the amount they contributed on behalf of each employee was cut almost in half. To quote The Economist magazine: “Whatever the arguments about the merits of the new wave of [DC plans], if you put less money in, you will get less money out.” In other words, if you don’t contribute enough for a secure retirement, then you won’t have a secure retirement.
Many people now accept that defined benefit pensions in the private sector are gone and aren’t coming back. It doesn’t have to be that way though. There are changes Congress could make that would incentivize private sector companies to bring back pensions. First of all, they could lessen funding volatility by allowing for a more reasonable amortization period, such as 20 years. They could also allow longer smoothing periods for assets and liabilities, which would reduce the funds’ sensitivity to market ups and downs. Furthermore, there are other possibilities, such as allowing third-party sponsorship of defined benefit pension plans.
The laws that have caused the decline of private sector pensions do not directly affect public pensions. However, the fact that the private sector has largely abandoned pensions matters in the debate over the future of public pensions. The move away from pensions in the private sector has been bad for working families and their retirement security. The answer is not to do away with pensions for public employees, but to seek to improve retirement security for those in the private sector that don’t have access to the security of a defined benefit pension.