Visualizing California’s retirement problem

February 7, 2012

By Natalie Jones, with reporting by Callie Shanafelt, California Health Report

More than 45 percent of workers aged 24-64 are at risk of serious economic hardship in retirement, according to a study by the UC Berkeley Center for Labor Research and Education.

The growing risk of poverty in retirement can be attributed in part to the shift away from pensions, or defined benefits, and towards 401(k)s or defined contributions. Employer-provided pensions represent one leg in the three-legged stool that has supported many workers in retirement. The other two legs are private savings and social security benefits. Only half of all employers in California offer a retirement plan of any kind to their employees.

Defined benefit pensions guarantee a worker a set amount of monthly income throughout retirement until death. Both workers and employers pay into pension funds, and the amount of the benefit is determined by factors such as age at retirement. Typically, an employee must work three to five years at a company before becoming “vested,” or earning the right to any pension. After that, an employee who quits or is fired might get a small lump sum payment rather than the full defined benefit for which they would be eligible if they worked at one company for their entire career.

Employers began moving away from defined benefits in the 1980s, as accounting rules started to require pension funds to account for the liabilities of the money they would have to pay to retirees on their balance sheets. This made pension funds risky to a company’s bottom line, triggering many firms to switch from defined benefit pension plans to 401(k) type plans for new employees.

These retirement plans are called a defined contribution. Employers sometimes match the contributions of employees. Defined contributions promise neither a set amount of monthly income nor that retirement funds will last the length of a worker’s lifetime. The amount of a worker’s retirement income depends on how much the employee invested and how well the stock market performed during their lifetime. On the other hand, a worker owns his or her defined contribution plan and can take it with him or her from job to job, building a nest egg along the way.

As of 2009, most workers in California with a retirement plan had a defined contribution, rather than a defined benefit, as their retirement plan, according to the UC Berkeley study. However, many workers either do not contribute to their plans, contribute too little to build an ample retirement fund, or withdraw some of their money before retirement.

Pension retirement plans once cushioned lower-income workers by pooling risk and requiring payments into a retirement plan. Today, both low-income and middle-income workers have a significant chance of retiring in poverty.

A significant majority of workers under age 44 have a defined contribution, or 401(k) style retirement plan.

The effects of this shift away from defined benefits won’t be fully known until younger workers begin to retire, say the authors of the Berkeley study. But, they add, “market volatility is a serious threat to retirement security, and coping with it is left almost entirely to 401(k) holders.”

Natalie Jones and Callie Shanafelt are correspondents for the California Health Report at www.healthycal.org

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