3 Reasons Pensions Need Less Funding per Worker Than 401(k)'s
401(k) plans save employers money because workers fund a portion of them. But a new analysis says 401(k)'s are an inefficient way to finance a secure retirement.
The nonprofit National Institute on Retirement Security calculated that a 62-year-old with a final salary of $50,000 would need to have $550,000 in a 401(k) to have an adequate retirement income, determined by the authors to be $26,684 a year. To achieve the same income, a traditional pension would need to have only $355,000 set aside for that worker, nearly $200,000 less.
Here are three reasons that traditional pensions need less funding than 401(k)'s.
No oversaving. In an individual 401(k) plan, you may want to save enough to last until you are 100, just in case you live that long. But traditional pensions need to contain only enough cash for the average life expectancy, and those with long and short lives pool their risk.
Allocation stays constant. 401(k) participants may want to invest more conservatively as retirement looms to protect against market volatility. But that safety produces lower returns, which can also erode retirement security. A traditional pension can always maintain an optimal asset allocation across generations.
Higher investment returns. Traditional pensions typically get higher investment returns than individual retirement accounts, thanks to professional management and lower fees. Pension returns beat 401(k) results by 1.6 percentage points in 2006 at companies with both types of plans, according to an analysis by consulting firm Watson Wyatt Worldwide. NIRS's model found that a 1 percent increase in annual investment returns results in a 26 percent cost savings over a career, compared with a 401(k) plan.
Tags: pension | retirement | stock market | 401(k)
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Reader Comments
Just wait until you see how much you will lose by buying an annuity from an insurer with your 401(k) money to convert a lump sum balance to a guaranteed lifetime income stream.
401(k) is a 1978 tax dodge savings scheme slipped in during the old days of higher tax rates. It was never intended to be a pension replacement. If so, IT WOULD HAVE BEEN GIVEN A NAME.
We refer to is as a code section, because it was enacted with no vision at all for how it would be used. Shame on us. We're stupid.
Yeah but
No oversaving: Doesn't this mean that 401(k)s are better for heirs? If I die with $100,000 left over in my 401(k), my heirs get $100,000. If I die with a pension plan, my heirs get nothing.
Allocation stays constant: 401(k) participants have to invest more conservatively when they are near retirement, but shouldn't they have been investing more aggressively when they were younger? And shouldn't their investments have been outperforming pension funds back then?
Higher investment returns: I wonder how much better the pension funds do when compared to 401(k) participants who invest in low-cost index funds, rather than to the average 401(k) participants.
To Yeah but
What will your heirs think when you live too long and run out of money? I'll bet they would rather have you remain financially secure throughout your life after retirement rather than face the prospect of subsidizing you financially and/or have you move in with them.
Ask your heirs for their thoughts on what they want for you in retirement.
If they bet on getting some of your money rather than wanting you to have a financially secure retirement, then take them out of your will and don't count on them subsidizing you financially or taking you in if you run out of money!
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