Ask the grumpies: Benefit vesting and the employer-employee relationship

Bogart asks:

What are the pros and cons (from all of the employer’s, employee’s, and society’s perspective, because, hey, you are the all-knowing Grumpies) of “lumpy” benefits. By “lumpy” I basically mean something that’s a step function with a long time-horizon; for example, at 30 years of service my DH’s pension got MUCH more valuable than it had been at 29 years, 364 days; if I work where I am now until DS is a college student (and the system doesn’t get tweaked, or tweaks are grandfathered), we’ll qualify for a great tuition benefit (provided, basically, that he goes to an expensive school — it’s structured as a % of tuition with a noticeable but not huge deductible). Actually I could debate that latter from all sorts of angles (fairness, value, moral hazard on the part of the student), but for now I’m just asking about the employer/employee relationship.

Ok, so lumpy benefits are related to Lazear contracts, which we discussed here.  Lazear contracts being one type of lumpy contract that is used in situations in which employee monitoring is difficult and employers want to keep employees working hard so they don’t get fired.

Pros

Employers:  These odd benefit structures are generally used by larger companies that have a lot of firm-specific human capital building– they want employees to stay and learn things that will help them at the specific firm but won’t necessarily help them outside that firm.  Employers like knowing that they can encourage employees to stay for a full 30 years on the job, and then hopefully retire soon after that in a predictable fashion, having trained up a replacement.  That’s the idea.  Employers can also offer lower wages during the earlier period with the promise of a big lump benefit later on, and if the employee leaves before that period, then the benefit is never realized and the company has not lost as much from their investment.  And, as discussed earlier, having delayed benefits decreases the need for monitoring of employees because the loss if caught is so high for an employee who has not yet vested.

Employees:  In general, employees like deferred compensation, that is, they like having increasing income and bigger benefits later on, rather than say, having real income degrade each year because of salary compression and inflation (*cough*).  Many employees, particularly the reliable ones who don’t get bored (they’re not “scanners” in Barbara Sher’s terminology) like the ability to stay with one company, and they like being able to predict what their future income stream, expenditures, and employment are going to be.  Being in that situation in which they know how long the company wants to keep them and when their benefits are going to vest adds to that predictability.

Society:  When employees get delayed compensation, that’s a form of forced savings (in theory, they are trading in a lower salary today for a lump sum benefit later).  When people who are spendy are forced to delay their compensation, that’s good for society because that means we have to worry less about impoverished retirees or huge amounts of student debt, or whatever the delayed compensation scheme is giving out in benefits.  In addition, if folks have lower wages early on, they get used to spending less while they’re earning income, and they have more money later for things society cares about:  tuition, health care, and not eating catfood.

Cons

Employers:  Sometimes within that 30 year period things change for the employers and industry and employers find that they promised more when times were good than they can afford to pay out but are still committed to when times were bad.  This is less of a problem in private industry than in public because the government put in regulations about how much money firms have to have in their, say, pension plans so in general they have funded pension plans.  The money is there and can’t be completely raided for other things.  Ironically, there are no such regulations on government plans, which explains say, the situation in Illinois which has promised a lot more than it can give out ever.  (Ironically again, Wisconsin’s pension plans were/are mostly funded!  All that union-busting was not needed in Wisconsin.)

Employees:  Lumpy benefits can lock employees into jobs they would not otherwise keep if it were not for waiting to vest the benefit– this is termed “job lock” (job lock also refers to keeping your job for the health insurance).  My MIL finally left a job she hated 2 years before vesting her pension because she just couldn’t stand it anymore– and wished she’d made that decision at least a decade earlier.  Eventually the carrot wasn’t enough to keep her there, but it kept her longer than she should have stayed.

Current generations tend to prefer mobility to stability in terms of benefits.  They like being able to get outside salary offers and are less likely to trust firms not to reneg on their promises.  And indeed, shady employers do sometimes reneg on lumpy benefits, firing employees without cause right before a benefit is vested.

Society:  Job lock is a problem for society as well as for employees.  When employees don’t make as productive a match as they otherwise would, less stuff is made, stuff is more expensive, and everybody loses.

State governments use lumpy benefits to make promises they cannot keep. Because of short political cycles, the people making the hard decisions in the future when the bills come due will be different people than the ones giving out the deferred compensation benefits.  We’re starting to see those bills coming due now.

ERISA also makes it difficult for employees to stay with the same firm after they start drawing down a pension– this has negative implications for employers, employees, and society when the worker’s most productive match is to do part-time work for the same firm but they can’t live on a part-time salary.

Hopefully that’s enough of a discussion for the main post… there’s probably aspects I’ve missed, but it should cover many of them.  Feel free to add things for bogart in the comments!

10 Responses to “Ask the grumpies: Benefit vesting and the employer-employee relationship”

  1. bardiac Says:

    Of course the union busting wasn’t needed in Wisconsin! But the governor has convinced people that pensions aren’t deferred compensation, but an unearned bonus. And he’s trying to convince the folks who control the pension funds that he should have access to that money for other stuff.

  2. Debbie M Says:

    “Job lock”? I’ve always heard it called “golden handcuffs.” “Job lock” sounds like slavery, which it isn’t, so I don’t like that term.

    One big advantage for my employer is that if you don’t receive the pension (you quit too soon and roll over your contributions elsewhere), you lose the employer contributions (which is about the same amount). That’s great for the people who stay (my system is fairly well funded, probably partly due to that phenomenon), but not so great for people who leave.

    Besides job lock, another disadvantage for employees is that they never really know how much they can count on these future promises.

    Another oddity is that a lot of times they make changes for the worse apply only to new employees (who are not even benefiting from salary compression). The new people get the low salaries and only a mediocre pension (though I think we still have above-average benefits and above-average job stability, so long as you never need another raise in your life and are willing to do the work of more and more people). (If they applied horrible new changes to everyone, they would risk massive turnover and/or picketing and demonstrations, etc.)

    Your idea that early low wages help teach people to be frugal is interesting. A related issue: a lot of my friends are in more cyclical areas, so they make a lot more money while they’re working, but they can’t count on getting that pay indefinitely. (It still averages out to a lot more, though, but not as much as it seems like at first.) So it usually takes them longer to figure out how frugal they have to be.

    So this system is good for people who like to know exactly what’s going on and be able to have plans, which is exactly the kind of person who you normally want for a bureaucrat, so it helps with matching up the personality types for many government jobs (besides faculty).

    • nicoleandmaggie Says:

      Hm, I hadn’t thought of joblock as sounding like slavery. But I also didn’t realize until recently that Bare Naked Ladies isn’t the best name for a children’s band (though their Snacktime CD is awesome). One gets used to jargon.

      And for folks with pre-existing health conditions… it is a little bit like slavery. Not so much if you’re just going to lose some pension benefits, but if you’re sick and you can’t go on the private market you could be well and truly locked into employment that provides health insurance.

      • Debbie M Says:

        Definitely more like slavery if you have pre-existing conditions and most of the competing job possibilities have lumpy insurance benefits (like you have to wait 6 months, first).

  3. chacha1 Says:

    I’ve never worked for an employer who offered long-term pension, or other, benefits. Pretty much all my law-firm employers have had a sliding scale on the vesting of employer matching funds and profit-sharing in employees’ 401(k) plans, but the 100% vesting timeline was never more than five years from date of eligibility for the plan.

    I’m not exactly a youngster, but I wouldn’t trust a deferred-compensation plan either … I’ve worked in ten different firms in twenty-three years (counting temp jobs) and not one of them, even my current firm which I like a lot, would I trust to still be in business and honoring its contracts 20-25 years from now when I stop working.

    All this reminds me I need to nag DH again about rolling over his ancient 403(b) into an IRA.

  4. bogart Says:

    Thanks! I admit that I assumed the Lazear contracts post had already answered all my questions, but now I see it hadn’t, so much. I think this covers it, though.

  5. Comradde PhysioProffe Says:

    This shitte is way too f*cken complicated!


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