A recent article in the Wall Street Journal, Is America's Favorite Retirement Plan Broken, describes the current state of 401(k) plans. The article provides evidence that these plans may need to be fixed for them to create successful retirement outcomes for the millions of Americans that participate in these retirement investment vehicles. While the main point of the article is to point out plans of policymakers to make the 401(k) more equitable in respect to the way taxation is handled, other points made in the article piqued my interest.
WHAT IS A 401(K)?
A 401(K) is an account-based investment program created in the early 1970's as a way for highly paid executives to save some money on taxes by deferring a portion of their paychecks into this retirement savings account. Over time however, employers in the private sector have opened these plans up for all employees to participate. Employees may opt into the plan, defer some money into it with each paycheck, and the employer may also contribute on the employees' behalf. The money is invested in the markets by the employee, and the account balance grows over time until the employee is ready to retire and begin drawing from their account. This sounds great, and it can be, but the evidence shows these plans work best for higher earners and the financially savvy.
IS LAGERS A 401(K)?
No. LAGERS is a defined benefit public pension plan available only to employees of Missouri's local governments. Benefits from LAGERS are not based on employee-directed investments nor an account balance, but rather, a simple formula based on salary and length of service.
LAGERS members eligible to receive benefits will be paid a monthly benefit for their lifetime. The amount of this benefit is known ahead of time because of the simple formula used to determine the amount. The money contributed to LAGERS from employees and employers is invested in the markets by professionals who are experts at navigating the financial landscape. Returns from these investments are used to help pay for the benefits. Defined benefit plans, like LAGERS, are the most common type of retirement plan for state and local government employees with around 75% of government workers participating in these plans. Defined benefit plans have been in existence long before the 401(k) and continue to be a stable, equitable, and sustainable source of retirement income for millions of Americans.
THE NUMBER OF AMERICANS PARTICIPATING IN RETIREMENT PLANS CONTINUES TO DECLINE
As a LAGERS member you have access to some of the best retirement benefits available. If you work long enough in a LAGERS-covered job, your monthly lifetime benefits from LAGERS will probably be your largest source of income during retirement. LAGERS combined with social security, your own personal savings and some planning should set you up for a financially secure retirement. This is not the case for everyone. Though most state and local government employees participate in a defined benefit plan (and those that don't participate in a 401(k)-like plan), less than half of employees in the private sector participate in a retirement plan. Is this because their employer doesn't offer one? Maybe. But even if they do have access to a plan through their employer, many employees simply choose not to participate. Even those that do likely aren't saving enough and probably will need help to navigate the markets to maximize their benefits.
"Defined benefit plans have been in existence long before the 401(k) and continue to be a stable, equitable, and sustainable source of retirement income for millions of Americans."
THE VALUE OF YOUR LAGERS RETIREMENT PLAN
Though the monthly benefit you receive from LAGERS will seem modest, the total value you will receive may be quite significant. For example, a LAGERS member who retires after 25 years of service with the 1.5% (L-7) benefit program and an annual salary of $50,000 will receive about $469,000 from LAGERS during retirement if they live for 25 years. This amount doesn't even include LAGERS' cost of living adjustments that adjust benefits based on inflation in order to maintain your purchasing power. In order to save the same amount in a do-it-yourself 401(k), this same employee would have to save 19% of their salary every month for 25 years and achieve a 7% annual investment return. This is pretty daunting for the average person. Having access to LAGERS' secure monthly income takes some of the guesswork out of retirement planning and reduces the amount you need to save on your own.
A do-it-yourself retirement plan, such as a 401(k), can produce successful retirement outcomes with exceptional planning and saving. However, these plans work best for high earners who can afford to save more and those who are more comfortable with the investment markets. State and local government workers have access to defined benefit plans that provide stable income during their retirement years. These plans, like LAGERS, have been providing retirement security for millions of Americans for decades and continue to be a sustainable solution for retirement success.