The 1980s brought us cable TV, personal computers, parachute pants and mullet haircuts (powerful proof that not every “innovation” equals progress).
The decade also saw the rise of the 401(k) plan.
Before the heyday of mullet haircuts, the phrase “retirement plan” referred to a pension plan. A pension was a social contract between workers and employers that if a worker stayed loyal to a company until retirement, he or she would get a monthly pension check from that company until death.
With pension plans, the risk and burden of retirement planning was all on the employer. A company had to make sure sufficient savings were put back each year to eventually fund each worker’s retirement. Those funds had to be invested for growth and actuarially pooled so as to last the lifetime of all those former employees.
For workers, pensions were a sweet deal indeed. Work for an employer for a career and get a retirement check for life–guaranteed? Amazing!
But then, in the late 1970s, in an obscure corner of a tax bill passed by Congress, a little provision in IRC section 401(k) was inserted. It allowed employers to reduce employee salaries and put that money in so-called “defined contribution” retirement plans. A company could even, if it chose, match those employee deferrals.
This was a little thing, not intended to make much of a splash.
Instead, it triggered a tidal wave of change.
It wasn’t long before benefits consultancy firms saw in this new provision a way to cut costs drastically. When companies realized they could reduce employee salaries, make a modest contribution to a worker’s 401(k) and call it a retirement plan, they began dismantling their expensive pension plans.
Fast forward to today. Now the risk of retirement is fully on the shoulders of the worker. For most Americans, the idea of a pension is either too fantastic to imagine or (in the case of schoolteachers and other state employees) so common as to be underappreciated.
A 401(k) plan is a savings and investment plan, a way of accumulating assets for retirement. It is not a retirement income plan—not a complete one anyway. It can (and should) be used as an aspect of retirement planning. But in and of itself, it isn’t a retirement income plan.
With a pension plan, Americans used to have a complete retirement income plan. The check came every month, unchanged, guaranteed, for as long as you lived. Simple as that.
With a 401(k), workers arrive at retirement with a lump sum of money that must somehow be translated into a monthly income. If that income only needs to last a year or two, there’s not much to discuss.
But retirements are lasting decades now.
Which raises big, unsettling questions: Will the money in your 401(k) plan last that long? Will it run out before you do? Are there ways to guarantee that it won’t?
The answers to all these questions can be found in a Retirement Income Plan (RIP—not the most encouraging acronym, I know). A Retirement Income Plan takes into consideration your current age, income, and lifestyle and helps you know what to do to replace that income, whether that’s at retirement age or sooner.
A good Retirement Income Plan will help you determine how much to save (that’s the volume of your savings) and where to put it to achieve the maximum output of income at retirement (that’s the efficiency of your savings).
Want to get started on a great 2021? Want to set a really important New Year’s resolution? Resolve to get a Retirement Income Plan customized for your situation in 2021.
I wrote a short, free e-book that covers the basics of Retirement Income Planning and more. It’s titled The Three Financial Questions You Should Be Asking for 2021. It’s my gift to anyone who requests it. Get your copy by writing to: firstname.lastname@example.org.
Happy New Year!
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