—Michael Lyles, B1Daily

One of the largest financial transfers of responsibility in modern American history happened without most workers recognizing its significance.

The company pension disappeared.

The 401(k) took its place.

And retirement fundamentally changed.

Under the traditional defined-benefit pension, workers generally received a promised retirement benefit based on factors such as salary and years of service.

The employer carried much of the responsibility.

The company had to fund the pension.

The company managed its investments.

The company faced the risk that investments wouldn’t perform as expected.

For workers fortunate enough to have strong pensions, retirement could therefore resemble another paycheck.

Then American corporations began walking away from the model.

Enter the 401(k)

The 401(k) traces its name to a provision of the Internal Revenue Code created by the Revenue Act of 1978. Regulatory changes in the early 1980s helped establish the modern salary-deferral retirement arrangement.

What initially looked like a supplementary savings mechanism became something much larger.

Companies discovered that defined-contribution plans could provide retirement benefits without leaving employers responsible for guaranteeing a specific lifetime pension.

That changed everything.

Under a 401(k), the worker decides how much to contribute.

The worker selects investments from available options.

The worker experiences market gains.

The worker experiences market losses.

And ultimately the worker risks reaching retirement without enough money.

Corporate retirement risk migrated onto the household balance sheet.

Why Companies Loved the Change

Traditional pensions can become expensive liabilities.

Employees live longer.

Investment returns fluctuate.

Interest rates change.

Companies must estimate decades of future obligations.

A 401(k) offers far greater predictability.

The employer can contribute a defined amount, perhaps through matching contributions, without promising exactly how much income the worker will receive decades later.

For corporations, uncertainty falls.

For workers, uncertainty rises.

But the 401(k) Has Real Advantages

The story isn’t entirely negative.

401(k)s are portable.

Workers changing employers don’t necessarily leave their retirement future trapped inside one company’s pension system.

Employees can accumulate substantial wealth through decades of contributions and compounding.

Employer matches can be extremely valuable.

Workers also gain ownership of financial assets that can appreciate considerably.

The problem is participation and adequacy.

A retirement system based upon individual savings works beautifully for someone who consistently contributes throughout a career.

It works considerably less well for someone living paycheck to paycheck.

The Retirement Divide

The 401(k) therefore rewards something many financially stressed households have very little of:

surplus income.

You cannot invest money you need for rent.

You cannot maximize a retirement contribution with money required for groceries.

You cannot capture decades of compound growth on contributions you were never financially capable of making.

This means America’s retirement system increasingly reflects inequalities experienced during working life.

High earners can contribute more.

Workers with generous employer matches accumulate more.

Households with financial literacy and investment experience may allocate assets more effectively.

People experiencing unemployment or financial emergencies may withdraw retirement funds early.

The pension pooled risk.

The 401(k) individualized it.

From Worker to Investor

There was also a fascinating ideological consequence.

Millions of American workers became shareholders.

Through retirement accounts, ordinary households gained financial exposure to corporate America.

A worker might simultaneously fear layoffs at their employer while owning an index fund that benefits when corporations become more profitable.

Labor and capital became intertwined inside the same household.

That transformation helped make the stock market increasingly central to American retirement.

What America Lost

The old pension system was never universal.

Many workers never had one.

Some pension plans failed.

Some companies couldn’t fulfill their promises, which is one reason the federal Pension Benefit Guaranty Corporation exists.

But defined-benefit pensions offered something psychologically and financially powerful:

predictability.

A worker could know roughly what retirement income awaited.

The 401(k) replaced certainty with possibility.

Possibly much more money.

Possibly much less.

That distinction defines modern American retirement.

The pension told workers:

“We’ll help guarantee your retirement.”

The 401(k) tells them:

“We’ll help you invest for it.”

Those sentences sound similar.

Financially, they represent two very different worlds.

—Michael Lyles, B1Daily