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You Should Prefer 401(k)s To Pensions

Author: Vale

nest eggPensions are still around, but the dominant retirement vehicle that has been coming into play over the last few decades has been the 401(k). 401(k)s give the account holder choice, access and portability, which are all valuable options. While reading an article about states switching to the 401(k) model instead of the pension system (a good thing for both employees and taxpayers), I came across nasty comments that really demonstrate some people's misunderstanding of retirement plans. One commentator opined: 

“I imagine that anyone who went through the recession with a 401(k) and saw the stock market nosedive wished they had a pension plan instead of a 401(k)”

One could reply that those who had pension plans during the 1981-1999 great bull run probably wished they had a 401(k). There are ups and downs and pros and cons with both types of systems. The difference is that with a 401(k) plan, YOU get to chose 1) how much to save 2) how aggressive you want your investments to be. And you get to take the money with you when you change jobs or retire; it's not some future promise that will have to be renegotiated. Most pensions are underfunded which almost guarantees that future benefits will have to be curtailed. If the company later collapses, then the government has to take it over and pick up the tab. What would you prefer, empty promises or real money in the account? You are also sticking your head in the sand if you prefer a pension because you think that you can just not concern yourself with the details behind the scenes and just hope that everything works out. You may be led to believe you're covered after hearing promises, but that does not mean that you really are, and the time it is likely to bite is the time when you are ready for a payout. Furthermore, the pension model assumes that they can fund it and manage it better for every individual in the plan. What is the pension doing behind the scenes? Investing in asset classes. You don't need a pension committee to do this on your behalf. And even if you are still not convinced, you can mimic a pension plan by buying an annuity with money from a 401(k). The difference is that 401(k)s are not the one-size-fits all situation that pensions are. Options are good - options are valuable. 

“Many workers don’t know how to invest, many don’t contribute enough to their 401(k)s, and many cash out much of what’s in their 401(k) long before they retire....”

Firstly, there are target date retirement funds that take the guesswork out of what to invest in for the targeted retirement date (although more people should really take a greater interest in their own retirement planning and educate themselves a little bit). Secondly, it is their own bad choice if they decide to cash out retirement assets to use on anything other than retirement. But should everyone be limited to what they can do with their own money because a few people will make bad decisions? And thirdly, many pension plans also offer a cash out option, so what do you say to them?

It is just an unfortunate part of life that some people will go to great lengths to hate any idea that does not involve hand holding and intervention, even if that attitude removes choices for other people. And some people will attempt to resist forward change at all crossings just for the sake of preventing change.


Comments   

 
+3 # Frov 2013-09-16 13:48
I get into this argument a lot with my union buddy (not that I'm in a union, but he is and he's my buddy). My wife is also a teacher and she's in the union. She initially was in favor of the whole load of BS the union spouts, but during this last round of negociations, she's seeing just how much the officers don't care about the actual union members, what those members want, and how much the officers will lie in their communications to the members.

Anyways, she gets mailed the pension newsletters and gives them to me, because I read them. What her and so many other teachers don't bother to do, is actually research any of this stuff. Right now, the teachers contribute 11.75% of their pay and the district contributes 12.75% of each teacher salary. This goes up 1% more for each next year. This % has gone up for the last 5 years or so, and the wording in the legislature went from "until the fund is 80% funded" to the "until 100% funded" that it is now. The fund will NEVER be 100% funded.

Pensions must pay out, even in down years or recessions. People say this recent recession, they know someone who "lost everything in their 401k". Bullshit. There's only 3 ways your 401k balance goes to zero (provided you're not an idea and have it all riding in just company stock, that would be the 4th way). 1) You take it to zero and cash it out, either early (which is the STUPIDEST thing you can do) or because you draw it to zero or you invest it in other vehicles. 2) The stock market goes to zero, and I mean ZERO. Then you won't care about your 401k, but rather, how much ammo and canned food you have. 3) The company you invested with goes bankrupt, but even then it's probably insured.

A pension can and will go to zero without bailouts. People are living longer and are drawing longer on pensions. Companies can go bankrupt. The pension has to pay out even in down years. The pension my wife is forced into has more teachers working than retired, hires more teachers than enter retirement, and will still lose funding unless it gets 7% annual return every year. They are paying out more than they are taking in, and they only have more teachers retiring and living longer and drawing bigger retirements.

When you die, your pension dies, unless you're married and have suvivor benefits. If you have a 401k, that goes, the entire thing, to your spouse or your estate/heirs when you die.

Basically, when you look at pensions, it's a pyramid scheme. If the US gov does it, it's called Social Security, if a union does it, it's called a pension, and if I do it, I get to go to prison with Madoff.
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# PS 2013-10-08 00:17
You both clearly misunderstand the advantages of a pension scheme. In a 401k all of the risk is bore by the individual whereas in a pension scheme the risk primarily lies with the sponsoring company. When I speak of risk here, I am talking about financial risk. Companies are switching to 401k plans because they can get away with contributing less money which ultimately means less money for the individual. Its simple math, but hey let's not go do anything crazy here.
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# Vale 2013-10-23 19:54
No, I understand what you are saying, but just because that risk is behind the scenes, it doesn't mean that risk isn't there. Companies go under all the time and can no longer fund the promises that they made years prior. The Enron, Tyco, Worldcom or twinkie pensions, for example. With a 401(k), you own the assets and take them with you whenever you change jobs. And it's real money in the 'bank,' not a future uncertain promise.

You are trading a fixed benefit up front for market risk. Sure it works when the market goes sideways for ten years like it did in the 2000s, but if we get another 1990s run, there will be some regret there.
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# PS 2013-10-23 20:57
You generally don't lose your pension if the company you work for goes bankrupt. I believe with Enron, all of the employees still received any pension they had while any stock was of course worthless. Qualified pensions are guaranteed by the government even if the company goes bankrupt. I would say that equates to minimal risk for the individual as future payment is all but guaranteed no matter what the source is.

Even with a strong equity run, what happens when a 2008 like event occurs as you are near retirement? In a pension scheme you are secure but not necessarily with a 401k. The fact is that you bear a considerable amount of risk in a 401k. If that's your preference that's fine but its not for everyone and certainly doesn't mean its a more optimal retirement scheme.
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# Vale 2013-10-25 19:49
Well if you were near retirement around 2008, you would have presumably had 60-70% of your assets in fixed income instruments that would have been safe from the equity downturn. And that is my point, people get to choose their own level of risk that they are willing to bear. The pension is the 1-size-fits-all option.

And yes, I mentioned that the government takes over the plan in the event of a collapse. However, this only happens if a firm goes to bankruptcy and there aren't likely to be any assets left over to fund an underfunded portion. They clearly state that your benefits "may also depend on plan assets and on how much PBGC recovers from employers for plan underfunding." pbgc.gov/.../... So in other words, expect less.

Also, no matter what, your benefits are capped if the government takes over. If you started taking benefits after the government took it over, your limit is 4,789.77 per month, which is not a high threshold to jump over for those employees that have had a moderate level of benefits and worked at the firm for decades. And "the maximum guarantee is lower if you begin receiving payments from PBGC before age 65 or if your pension includes benefits for a surviving spouse or other beneficiary. "
There is "no cost-of-living adjustment under the law," if your pension had guaranteed this.

And finally, not surprisingly for a government run organization, their own assets are underfunded by 23%! It's not looking good. washingtonpost.com/.../...
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# PS 2013-10-26 01:51
Your presumption about the asset allocation of a retiree in 2008 is part of the issue with 401k plans. You are assuming everyone has adequate knowledge about investing, which is clearly false. How does one choose the "level of risk" if they don't understand the risks. At best, they are taking someone else's advice....

Regarding PBGC benefits, thanks for the education but I did not need a refresher. If you spent a little more time doing the math instead of regurgitating PBGC guarantees, you would have found that a basic 401k plan that is comparable to what most companies offer, will not come close to the benefit levels most pension plans provide unless you assume very generous investment returns. The comment around 4,789.77/month not being very high again demonstrates a lack of fundamental understanding of pension plans. That is a considerable amount of money from a single source for retirement... Yes, it will not replace what a pension plan for someone making $200,000 may have had under the plan but that's not the goal of the PBGC.

Again, great research on funded status, are people still receiving their pensions? Going to have to say yes on this.
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# Vale 2013-10-26 10:34
Well there are target date funds that most plans have that remove a lot of the guesswork out of it (admittedly, those have been refined since the 2008 event), but also many 401(k)s do offer services that attempt to educate people about the choices they make. But I have never been a fan of your approach of thinking that people are too stupid to make their own choices or can't do any research for their financial picture. Also, not a fan of limiting the options of those who do take an interest in managing their own finances.
And yes, pension funds are going the way of the dodo bird and are not offering benefits like they did 30 years ago. I'm aware of what the average benefit is today, just calling out the fact that for someone who was successful it is going to be cut short.
You seem to be missing the point that in order for a Pension fund to offer such returns they have to go into the market place to generate that return. How do you think they do that? Sure, there may be some missing pieces such as private equity or hedge funds (which hasn't fared very well as an asset class for 5+ years), but most of the return is generated by equity historically anyway. Pension funds are realizing that they assumed market returns too high in the past and are stuck shelling out more than they are taking in. Whoops, I guess they weren't generating those returns after all. Being underfunded is not a great recipe for future financial success.
Are people still receiving their pensions? Sure. And Ponzi schemes can last for a long time before they collapse abysmally. Just ask Madoff.
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# PS 2013-10-26 14:25
I never said people are too stupid to make their own choices, simply not educated. Nearly all companies offer a 401k even if they have a pension plan. So if you choose to defer your own money and invest it, that's your choice and is not the point of contention here. My issue is with the argument that 401ks are superior to pension plans when considering what the employer is providing. At the most basic level, 401k plans (employer provided portion) do not provide as rich of a benefit as pension plans. From a benefit adequacy point of view, dollars are better spent in a pension scheme. I challenge you to find something that rebuts that.

And pension funds do not generally "offer" returns as most are formulaic. I'm not sure what the argument is here. Again, at a fundamental level, pension plans are considered superior to 401ks because of pooling of assets and professional management which isn't to say they are all managed well but on average far superior to the average individual with a 401k.

And you must be joking about pension funds being a Ponzi scheme. This clearly demonstrates ignorance. The only way you could argue this is if you assume managers will stop putting funds into the trust and let the current funds run go to zero which will not happen for a qualified plan (IRS regs will prevent that due to funding rules and how the plans are valued) except in a rare case of bankruptcy. This kind of view is pessimistic and not rational. If that's the point of view you have, simple to bash pension plans, then this entire argument is pointless. I could sit here all day and think of the most negative hypothetical situations that fit any given view but that does not mean they are valid.
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# Vale 2013-10-27 19:53
Yes, if an employer is going to provide you with free money, then that is superior. Pensions funds have historically used market return assumptions way above normal, which means that they end up eating the cost for your benefit. However, if the profits for the firm dry up, they will not be able to fund these empty promises and your benefit will be greatly reduced. My point is 401(k)s may give you market risk, but they remove credit risk. I'd rather know today what I own and can take with me, rather than 30 years from now what I might own and can't take with me.
My point was that even the most fraudulent scam can last a long time undetected until it collapses. Prefer "House of Cards" as a description?
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