Why do Pension Plans Beat a 401(k)?
June 19, 2014

Why do Pension Plans Beat a 401(k)?

Pension Plans

When saving up for a secure and comfortable retirement, would you consider pension plans as opposed to a 401(k) plan? Perhaps you would, but before making the decision, you should read into the benefits and the differences between the two.

Pension plans offer a lifetime benefit – hence why they’re also known as a defined benefit (DB) plan. With a defined contribution (DC) plan, such as a 401(k), your retirement is solely dependent on you.

Pension plans are less common because corporations are not keen on the long-term liability that they create. States only utilize pension plans because they can administer them very cheaply for large numbers of public employees. A 401(k) is a more appealing option, because you receive a significant break on your income taxes.

However, what you save is only enough for the present. In the long run, a common consequence experienced with a 401(k) is that individuals outlive their savings.

Lifetime Income

The idea of having enough income to last for a lifetime is idyllic, however, there’s another reason that pension plans are more preferred: because of their performance.

A study conducted in 2011 by Towers Watson, a global human resources consultant, revealed that pension plans overcame 401(k) plans by nearly 3 percent. Pension plans made investment returns of 2.74% while defined contribution plans lost money.Towers Watson also found that pension plans outperformed defined contribution plans annually by 76 or 0.76% basis points – except in years in which stocks grew. This result is due to mutual fund fees. Nearly half of the 401(k) plans were composed of mutual funds compared to pension plans with just 14%.

Chris DeMeo, the head of Investment for the Americas at Towers Watson, inferred that as time goes on pension plans will do a better job with fewer risks.

Best Plan Possible

The trends insinuate that the best possible investment plan for most individuals would be one that combines the tax breaks of a 401(k) with the long-term and low-cost perspective of a pension plan, including a solid rebalancing strategy to reinforce it.

If a pension plan is ideal for you, one way for you to achieve one is to work for a large employer who can negotiate with plan administrators and provide access to low-cost index products. Another way is to be self-employed and manage your own plan. Either way, we can help you figure out the best pension plan for you.