Background
Some employers, mainly larger and mid-sized ones, offer workers access to a retirement plan. In general, employer-sponsored retirement plans can take two forms: defined-benefit (DB) plans and defined-contribution (DC) plans.
Under a DB plan, workers receive a pension benefit beginning at retirement. The amount is usually based on average salary and the number of years worked for the employer. Private DB plans, unlike public pension plans, are typically funded solely by the employer.
DC plans are tax-preferred savings accounts such as 401(k)s. With DC plans, workers can designate an amount to be set aside in a retirement account with each paycheck. They also choose how to invest it. Employers may choose to contribute as well.
Over the past several decades, the number of private-sector DB plans has declined substantially, while the number of DC plans has substantially increased. DC plans now far surpass DB plans. Despite the growth of savings in tax-preferred DC retirement accounts, the income they generate has not compensated fully for the loss of employer-provided traditional pensions.
These changes have increased retirement savings risk for DC plan participants. First, since saving in 401(k) plans is voluntary, some people may not participate for some or all of their careers. Some of their employers may not even offer such a plan. They, therefore, run the risk of not having enough saved for retirement. Second, people in 401(k)s face the risk of poor investment performance because of an economic downturn, high fees, or poor investment choices. Finally, 401(k) participants run the risk of outliving their retirement savings. People can try to address that risk by converting savings into lifetime retirement income. But doing so is complex and confusing. As a result, lump-sum cash-outs at retirement are common.