What Is a Variable Benefit Plan?
A variable-benefit plan is a type of retirement plan in which the payout changes depending on how well the plan's investments perform.
Understanding a Variable Benefit Plan
Variable-benefit plans, also called defined-contribution plans, allow the plan holder to manage his or her own account. By contrast, a defined-benefit plan provides the plan holder with predetermined payments upon retirement that do not change and which are based on an eligibility formula rather than on investment returns.
Variable-benefit plans shift investment risk from the employer to the employee. It is possible that the employee will end up with less money from a variable-benefit plan if he makes poor investment choices. However, he also has the power to make superior investment choices and end up with better benefits. Therefore, the ability of the employee to make smart investment decisions is critical in variable-benefit plans.
History of Variable Benefit Plans
People have been investing in financial markets in order to provide for their retirement for as long as the history of capitalism itself. The American Express Company first offered its employees a pension plan in 1871, establishing the first private pension plan in the United States. As Americans’ life expectancy rose throughout the late nineteenth and early twentieth centuries, the problem of how to provide for the retirement of members of the growing middle class became of increasing importance. Congress sought to encourage the growth of private pensions by making contributions to such accounts tax-deductible in the 1920s. By 1929, there were 397 private-sector plans extant in the United States and Canada.
The growth of pension plans exploded following World War Two, when unions began to strike in large numbers, demanding the provision of pensions. From the end of World War Two to about 1980, defined-benefit pensions, or a pension in which a worker is guaranteed a predetermined set of benefits until death, were a major form of retirement security for American workers. But these sorts of pensions put great pressure on American companies, which were facing increased competition from foreign rivals, and from shareholders who were demanding maximum returns. This led the private sector to rely more on variable-benefit plans, in which the contribution from the company is defined, but the actual payout depends on how the pension investments perform. From 1980 through 2008, the proportion of American workers participating in defined-benefit pension plans fell from 38 percent to 20 percent, according to the Bureau of Labor Statistics. During that same time period, the share of American workers participating in variable-benefit plans rose from 8 percent to 31 percent.