Why do employers seem to favor a 401(k)/ 403(b) over the older pension plans?
October 1, 2023 | View PDF
In 1978, Congress passed a new tax code which included a new provision in the Internal Revenue Code, being section 401(k). The 401(k) provision is used by employers in the private for-profit sector. The 403(b) provisions are very similar but used by non-profits. Since the 1980’s the 401(k) and 403(b) section retirement plans have become generally favored over pension plans. Pension plans were entirely driven by the employer. Pension plans make the employer consider the length of service of the employee, the highest salary and the potential number of years that the employee may have in retirement.
One of my grandfathers, due to an single blinding eye disease in his youth could not serve in the armed forces during World War II. He eventually became a vice-President in an insulation firm that insulated many of the ships manufactured during World War II. He and my grandmother lived a good life as they went into retirement. While the occurrence was when I was a teen, I was told by my parents that the insulation firm went bankrupt when my grandfather was in his seventies and I was told that my grandfather lost his pension. He panicked because he lost one of the three parts of his retirement and I recall that he was applying to work at a gas station pumping gas. The 401(k) places the individual in a position to take on the risk and to contribute most of the retirement funds. Generally, the worker can contribute pre-tax at a time when their taxes are highest to a standard plan and if desired they can contribute post tax to a Roth plan. The worker may have the flexibility to have their individual plan managed by the investment company based on their risk tolerance and age or to even manage their investments themselves which requires time and educating oneself on best investments.
While a smaller risk is placed on the employer for a sponsored plan, it is not entirely without legal exposure. I do not include securities and investments representation in my law practice, but I have been able to learn some about the process of an employer sponsored plan. Hiring an investment firm that will meet the retirement goals and flexibility is one part to consider. Additionally, employers should also hire professionals to work with their oversight committee to consider the plan direction with less chance of the employer being negligent in their fiduciary duty.
Another part are the investment goals. Two goals have arisen in recent years; whether following indices of performance or industrials or a newer goal found principally among a few of the investment firms are funds that invest in companies that promote ESG (environmental, social and governance) consciousness. While investing in ESG promoting companies may give some investors a feel good about social consciousness, when intertwined with index funds there may be a conflict of interest and can result in misrepresentation by investment firms. Some of my recent reads have included comparison of ESG funds versus funds not committed to ESG values, showing the ESG funds being out performed. The reader should not take to heart this generalization in ESG investing and must do their own research or consider the research of professionals.
After the discussion about pensions and 401(k)/ 403(b) comparisons, one issue I wanted to bring to light is the recent lawsuit against Bed, Bath and Beyond by its former employees following its bankruptcy and closure of its brick and mortar stores. According to the lawsuit, it is asserted by the plaintiffs that Bed, Bath and Beyond knew a few years before filing bankruptcy that their business model was not working. In that context, the committee overseeing the employee 401(k) plan should have been aware that a particular account could lose if interest rates rose. Looking forward, Bed, Bath and Beyond breached their fiduciary duty by not moving the at risk funds to a more stable account and should have known that in case of bankruptcy and the closing of the 401(k) plan that otherwise avoidable losses could be incurred. The plaintiffs assert that is what happened and that their plans lost about ten percent of their value which totaled about five million dollars for all employees in the plan. The outcome of that case is yet to be determined.
This article is informative only and not meant to be all inclusive. Additionally this article does not serve as legal advice to the reader and does not constitute an attorney- client relationship. The reader should seek counsel from their attorney should any questions exist.
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