Generally speaking, one of the benefits of working for a large employer is the ability to participate in a 401(k) plan. This is all well and good, however, your 401(k) plan, in and of itself, probably won’t provide you with adequate retirement income to meet your financial needs in most cases.
A 401(k) plan is a defined contribution plan that has generally replaced the defined benefit plan as the retirement plan of choice in the private sector today. Unlike a defined benefit plan that provides a predetermined lifetime income stream at retirement and is generally funded solely by one’s employer, this isn’t the case with defined contribution plans.
A defined contribution plan, by its name, defines the amount of allowable contributions to a plan by employees and employers. Although many plans provide for employer matching contributions, the vast majority of 401(k) plan investments originate from employees.
Given the fact that 401(k) plans are contribution versus benefit-oriented, employers have no way of knowing whether their plan will provide individual participants with sufficient retirement income. Notwithstanding the fact that 401(k) plan investments generally aren’t income-driven, this determination is complicated by several variables. In addition to investment choices, allocation, and performance, these include length of employment, salary, percentage of salary contributed to the plan, and employer matching contributions.
While this may come as a surprise to many people, in addition to employers being unable to determine the retirement income adequacy of 401(k) plans, this isn’t a concern for most of them. In a recent survey of United Kingdom employers done by Towers Watson, a leading global human resources consulting and risk management firm, it was found that the primary purpose for providing a defined contribution plan is to ensure that the employer competes in the market.
According to the survey, only 15% of employers said their purpose for providing a defined contribution plan is to ensure that workers save for an adequate retirement income. Market competition was cited by 65% of respondents as the main reason for offering this type of plan.
What’s perhaps more striking is that employers have chosen the 401(k) plan route over defined benefit plans despite their belief in the superiority of the latter as a source of dependable retirement income as evidenced by the following additional results of the survey:
- 86% felt that defined benefit plans help retain employees
- 22% felt that defined contribution plans help retain employees
- 80% believe defined benefit plans ensure employees have adequate retirement income
- 22% believe defined contribution plans ensure employees have adequate retirement income
Given these findings, it behooves all employees, including those with defined benefit plans, to take the ball in their own hands when it comes to retirement income planning. In addition to the inability of employers to determine the retirement income adequacy of 401(k) plans for individual participants, they aren’t privy to their employees’ projected financial needs and other available financial resources.
Although a 401(k) plan can grow to become an individual’s largest investment asset with the potential to generate a substantial amount of retirement income, it’s only one piece of a retirement income plan.
As evidenced by the findings of the Towers Watson survey, you can’t, nor should you, depend on your employer for something as important as your retirement.