What is the Better Retirement Option: A Pension, or 401k?

On the subject of retirement, I strongly advise my clients to operate based on the assumption that someday Social Security will not be a viable income source at age 65. The other options out there are long-term investments in tax-sheltered accounts, or pensions offered by employers.

Over the past decade or so, there has been a lot of bemoaning about the gradual demise of the pension plan in American society. In the middle of the 20th century, many companies and levels of American government created pension plans for their employees when they retired from the labor force.

While the idea of a pension is certainly great in theory, it practically has not performed as well or sustainably as other retirement options we have at our disposal. Between the pension and the 401k/IRA, I strongly prefer the latter over the former.

My issue with the pension lies not in the idea of it, but in the performance and projections.

One of the biggest failures of a company with a pension system was Enron in 2001. For years, the company cooked the books and hid from their shareholders and employees the true nature of the company’s financial situation. At the same time, its retirement and pension plans were greatly tied into the company’s stock value.

When the company when bankrupt, nearly $2 billion of pension value was lost. Top executives went to prison for fraud, and former employees spent years fighting in court to gain even a small fraction of their pension’s value back. Many of these former Enron employees had to find other jobs to pay their bills during the years they planned to be retired.

Some state governments and local municipalities are dealing with probable failures in the future, as well. The state of Illinois, now famous for its “Pension Crisis” is dramatically underfunded for its existing pension liabilities. The state has about $214 billion in pension obligations, but only has about $85 billion available to pay retirees.

Other states like New Jersey and Kentucky also have very large unfunded pension liabilities, with their credit rating spiraling every downward each year. California has had to make cuts to its pension payouts over the years to keep the California Public Employees’ Retirement System somewhat afloat.

Even for pension plans that are not facing such dramatic shortfalls, the returns for the retirees are well below that of market mutual funds. The assumed rate of return for the CalPERS plan is about 7% (and that’s down from 8% in 2001), though the actual annualized ROR has been more like 5.7%.

For comparison’s sake, the S&P 500 index, since 1928, has had an average rate of return of 9.8%. There are periods within those many decades where the compound rate of return was 18%, as was the case in 1985-1999.

In the beginning of July 2009, the S&P 500 was at 898. In the last week of June 2019, the index was at 2941, a tripled value in 10 years.

Many actively-managed mutual funds have outperformed this rate of return as well, going up to 11 or 12%, some even more.

Whereas pension plans are often in a state of crisis and are under-performing the market in many ways, the 401k and IRA plans offer individuals a greater variety of solid investments to choose from, and even low-expense, passively-managed funds that track the indexes offer much better rates of returns than pension plans typically do.

One of the best aspects of the 401k and IRA plans, in my assessment, is that fact that you the employee have full control over the money. The pension plan is held by the company or the government, and your pension’s value hinges on that particular company or government’s ability to properly manage it.

When you take control of your money, it empowers you to make better decisions for yourself long-term, and you are able to protect yourself from individual companies or governments going bankrupt. There are dips in the market, but you controlling your money is always preferable to someone else doing so.

No one can manage your money as well as you can; not your employer’s human resources department, nor the government. For me, it’s the IRA and 401k all the way!

Nearly 80% of American millionaires used their company-sponsored 401k plans and IRAs to achieve that status. With all the opportunity available in these investment accounts, to me it’s the obvious answer to the decline of the pension plan!

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