Variable Benefit Plan: Meaning and History

What Is a Variable Benefit Plan?

A variable-benefit plan is a retirement plan that pays out based on the performance of its investments. It is similar to a 401(k) plan.

Key Takeaways

• A variable benefit plan is a retirement account whose value fluctuates with market investments.
• 401(k) plans are a common example of variable benefit plans.
• While variable benefit plans can offer higher long-term returns, they also expose account holders to market risk.

Understanding a Variable Benefit Plan

Variable-benefit plans, also known as defined-contribution plans, allow account holders to manage their own accounts. Unlike defined-benefit plans, which provide fixed payments based on an eligibility formula, variable benefit plans rely on investment returns.

Variable-benefit plans transfer investment risk from the employer to the employee. While poor investment choices can result in lower benefits, smart investment decisions can lead to better outcomes.

History of Variable Benefit Plans

The concept of investing for retirement dates back to the early days of capitalism. In 1875, the American Express Company introduced the first private pension plan in the United States.

As life expectancy increased, the need for retirement options grew. In the 1920s, Congress made contributions to private pensions tax-deductible, encouraging their growth. By 1929, there were 397 private-sector plans in the US and Canada.

After World War Two, demand for pensions rose, leading to the prevalence of defined-benefit pensions. However, pressure from competition and shareholders pushed companies to adopt variable-benefit plans, where payouts depend on investment performance.

The Pressure of Maximum Returns

Since the 1980s, access to defined-benefit plans has declined. In 2020, only 15% of private-sector workers participated in such plans, compared to around 65% with access to defined-contribution plans.