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Some Pension Plans Better Than Others at Helping Employees Retire

May 19, 2011

In the course of providing professional services to over 185 not-for-profit organizations I see a number of employer sponsored pension plans. Almost all of these are the defined-contribution type of plan where an annual contribution is made into the plan and the employee ends up with whatever that amount has accumulated to when they retire and leave the company. Most employers have also established a plan where the employee can save some of their own salary toward their retirement nest egg.

In the course of providing professional services to over 185 not-for-profit organizations I see a number of employer sponsored pension plans. Almost all of these are the defined-contribution type of plan where an annual contribution is made into the plan and the employee ends up with whatever that amount has accumulated to when they retire and leave the company. Most employers have also established a plan where the employee can save some of their own salary toward their retirement nest egg.

Employers generally provide a retirement benefit as one of the fringe benefits aimed at encouraging employee loyalty and longevity. Employers, especially my not-for-profit boards, also believe that helping an employee live in retirement is the right thing to do. The purpose of this Blog entry is to discuss how some pension plans are better than others at “helping an employee.”

First let’s review some generally held beliefs. The quality of one’s retirement will be inadequate if all they have to live on is Social Security benefits provided by the Federal government. Therefore, this benefit must be supplemented by some other retirement nest egg. In addition to Social Security it is generally held (by financial planners) that one should save approximately 11% of their annual salary in a tax-deferred retirement savings vehicle. Tax-deferred retirement plans provide for maximum savings percentages that are far in excess of this 11% because the government realizes that most people do not start saving for retirement with their first job. Thus, a person who starts saving for retirement at age 30 should be saving more than 11% of their annual salary in order to adequately provide for their retirement.

Some organizations have a pension plan where the employer contributes a certain percentage of the employees’ pay into the plan. Usually this is 6% or less due to the financial realities at not-for-profit organizations. Most allow for employees to supplement this with salary withholdings.

Some organizations provide a smaller employer percentage for every employee but then provide an employer match of a certain percentage of employee withholdings. A typical plan of this nature might contribute 2% of employee salaries into the plan and then a 50% match of employee contributions up to 6% of employee pay. So an employee who contributes 7% of their own pay will have a total pension contribution of 12% (7% of their own money, 3% of the 50% employer match of the employee’s first 6% plus the 2% that every employee received). The maximum total employer cost is 5% in this example.

I believe that if an employer truly wants to benefit an employee, they should structure their pension plan so that it is entirely an employee match type of plan. In such a plan, the employer match serves to encourage the employee to save their own money for their own retirement. Since most organizations do not have sufficient resources to provide an adequate retirement savings plan for employees with no employee participation, the goal should be to create a plan which achieves the intended result of the adequate retirement nest egg. Since that can only be achieved with employee participation, all available employer resources should be directed toward incentivizing the employee to make a large contribution toward their own retirement.

In the example above, the 2% that the employer was providing to all employees accomplishes very little. It is insufficient to provide an adequate employee retirement nest egg. And, an employee who knows they are part of a pension plan, but who has not studied the issue to know the amounts needed for an adequate retirement, may falsely believe that their employer has generously taken care of their retirement.

It is much better if the employer were to take all of their available retirement resources and craft a plan whose aim is to encourage employees to save the appropriate amount for retirement. An employer who takes steps to encourage their employees to save appropriately for retirement is being more beneficial to that employee than the employer who funds an inadequate amount on behalf of the employee.

So, for example, a pension plan whereby the employer provides a 50% match for the first 9% of an employee’s elective pension contribution will be paying maximum pension costs equal to 4.5% of employee wages (but since it will only incur a cost for those employees who contribute toward their pensions, the total cost will likely be less – perhaps allowing the organization to increase the match amount).

In this example, an employee who contributed 9% of their pay would end up with a total contribution equal to 13.5% of salary – certainly an amount that is more likely to result in an adequate retirement nest egg. The fact that the employee saves $1 and immediately has $1.50 in their retirement plan is easily understood by all employees and usually results in a very high percentage of employee participation. Isn’t this what the employer wants? Isn’t this the true objective of sponsoring a retirement plan?

Such a program results in a retirement plan in which the employee is invested – literally and figuratively. The employee values the plan and the employer’s objectives of fairness to the employee, plus increased employee loyalty and longevity are more likely achieved.

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