Was the 401(k) a Mistake? Pensions vs 401(k) Plans

In a recent article published by The New York Times, author Michael Steinberger explores new challenges and uncertainties associated with retirement in the U.S. — particularly challenges surrounding the shift from defined-benefit plans (pensions) to defined-contribution plans (401(k)s). The broader narrative highlights some potential pitfalls of 401(k) plans, which, though beneficial for high-net-worth individuals, could leave many without sufficient retirement savings.

The big question is: is it better to have a pension or a 401(k)? In this article, we’ll delve into the history of pensions vs 401(k) plans, how they compare, and why working with a Houston retirement planning advisor can help maximize an individual’s 401(k) investment potential and help them take advantage of the flexibility of a 401(k).

Pensions vs 401(k) plans: a brief history

Where is the safest place to put your retirement money? Although there are numerous retirement savings vehicles available, pensions and 401(k) plans stand out as two of the most ubiquitous. Each has its own complicated history and a long list of benefits and drawbacks, making the choice between them a topic of hot debate.

	Pension (Defined Benefit)	401(k) Plan (Defined Contribution)
Funding	Primarily employer-funded	Primarily employee-funded, often with employer matching
Investment Risk	Managed by the employer	Borne by the employee
Income in Retirement	Fixed, based on salary and tenure	Dependent on contributions and investment performance
Flexibility	Low; terms set by employer	High; employee controls contributions and investments
Portability	Generally low (some exceptions apply)	High; can be rolled over into another plan or IRA
Suitability for High Net Worth Individuals	Less control over investment options	Greater control, suitable for customized wealth management strategies

A brief history of pensions

The traditional pension, or defined-benefit plan, has roots going back to the 19th century but became more widespread during the post-World War II economic boom. Pensions promise a fixed monthly income after retirement, calculated based on years of service and salary earned during employment.

Under a pension plan, the employer bears the investment risk, is responsible for pension maximization and management, and ensures that all retirees receive their promised benefits.

While pensions offer the security of a guaranteed income, they are not without drawbacks. Historically, pensions have been subject to mismanagement and corruption, with funds often being invested in speculative ventures or managed in ways that benefit insiders rather than retirees. Additionally, the heavy regulation and high administrative costs required to maintain their viability can detract from their efficiency.

Read more: How does a defined-benefit plan work?

A brief history of the 401(k)

Introduced in the 1980s, 401(k) plans are a form of defined-contribution plan that shifts the responsibility of saving and investing to the employees themselves. Employees can choose to contribute a portion of their pre-tax salary into this account, which then grows tax-deferred until withdrawal during retirement.

The 401(k) has gained popularity due to its flexibility and the control it offers participants over their investment choices; however, the responsibility for making wise investment choices and saving enough to secure a stable retirement income rests solely with the individual, which can be daunting without proper financial guidance.

Was the 401(k) a mistake?

The Steiberger article offers a pointed criticism of the current retirement landscape in the U.S. by highlighting an increasing gap between the growing number of retirement-age individuals with 401(k) plans and the financial literacy needed to maximize their investment potential. In short, 401(k)s do offer more freedom, but with more freedom comes more risk:

• Inadequate savings: Many individuals do not save enough in their 401(k)s to sustain their standard of living in retirement. This issue is compounded by a lack of financial literacy and the absence of mandatory contributions, unlike traditional pension plans, where contributions are predefined and mandatory.
• Market risk: 401(k) participants bear the full brunt of market volatility. Many saw their retirement savings significantly diminish during economic downturns, such as the 2008 financial crisis. (Continue reading: How to protect your 401(k))

That said, arguing that the 401(k) was a “mistake” oversimplifies the issue. It acknowledges neither the beneficial aspects of the plan for many retirees nor the complex economic and social factors influencing retirement security. The 401(k) has been instrumental for millions in building retirement savings, especially for those who are proactive and knowledgeable about investing.

These criticisms do make clear that the 401(k) is not a one-size-fits-all solution and does not fully address the retirement needs of all Americans, particularly those at the lower end of the income spectrum.

The case for adept wealth management

Because 401(k)s are a higher-touch retirement vehicle than pensions, and given the complexities involved in creating an overall retirement plan, professional advice is invaluable for those who are looking to maximize their 401(k) savings and turn the burden of investment into a boon. 

Wealth management advisors can offer tailored investment strategies and high-net-worth retirement planning services that help maximize the growth and preservation of wealth.

Hypothetical scenario: maximizing the 401(k)

Imagine Alex, a 25-year-old with an annual income of $65,000. Keen to secure a comfortable retirement, Alex decides to save diligently, contributing 5% of his yearly income, or $3,250, to a 401(k) plan each year.

Despite their employer not offering a match, Alex remains committed to this strategy. Assuming all contributions are invested in an S&P 500 index fund with a conservative average annual return of 8%, fast forward 40 years to Alex’s retirement at age 65. His 401(k) balance has grown impressively to $841,933.69.

At this point, Alex faces a critical decision: how to convert this substantial nest egg into a steady, reliable income stream for retirement. One option is to purchase a fixed-income annuity, which currently guarantees a 6.5% payout. This choice would secure Alex approximately $5,000 per month for life, complemented by an estimated $2,000 from Social Security, assuming no adjustments for inflation. Together, this would provide Alex with a stable annual income of $84,000.

However, let’s explore another strategy that, with the help of a wealth advisor, could potentially enhance Alex’s financial outcomes. Instead of an annuity, Alex could adopt a more dynamic investment strategy, taking a 4% annual draw from the 401(k), equating to about $34,000 per year.

By allocating $561,000 of the portfolio to bonds with a 6% coupon rate — reflective of today’s interest rates — Alex could generate roughly $34,000 from bonds alone. This strategy, combined with the $24,000 annual Social Security benefit, would result in a similar annual cash flow of about $58,000.

Moreover, with the remaining $280,744.56, Alex decides to continue investing in equities, assuming an 8% return. Over the next 10 years, this equity investment would grow to approximately $653,000.

At age 75, Alex could then adjust their portfolio to a more conservative 50/50 split between stocks and bonds. The fixed income component, now amounting to $600,000, would generate about $36,000 annually, keeping another $600,000 in equities to benefit from further market growth.

Hypothetical Scenario: Maximizing the 401(k)
Strategy	Fixed Income Annuity	Investment Strategy with Advisor
Initial Investment	$841,933.69	$841,933.69
Approach	Purchase of an annuity	Strategic investment in bonds and equities
Monthly Income from Annuity/Investments	$5,000	Income from bonds: approx. $2,833/month
Annual Social Security	$24,000 (approx. $2,000/month)	$24,000 (approx. $2,000/month)
Total Annual Income	$84,000	$58,000 from investments + $24,000 from Social Security = $82,000
Investment Growth	None (annuity provides fixed payout)	Equity portion grows, potential increase in bond income
Flexibility	Low (fixed payouts, no capital access)	High (ability to adjust portfolio based on market conditions and personal needs)
Future Financial Position at Age 75	Steady income, no remaining capital	Approx. $1.2 million total assets, diversified investments
Advisory Support	Not applicable	Ongoing, with adjustments and comprehensive financial planning

In Alex’s case, the proactive, informed approach facilitated by a wealth advisor could help him safeguard his retirement funds and also potentially increase his financial legacy, all while maintaining a comfortable lifestyle in retirement.

Want to get the most out of your retirement? Talk to an Avidian wealth advisor today.

Choosing between pensions vs 401(k) plans depends heavily on individual circumstances, including income level, investment acumen, and personal financial goals. For high-net-worth individuals, the flexibility and control offered by a 401(k) make it an appealing option, particularly when guided by informed advice from wealth management professionals.

At Avidian Wealth Solutions, we tailor investment strategies to individual needs aiming to enhance returns and manage risks. Our team offers several integrated financial services, including tax and estate planning, and adjusts strategies periodically based on market or personal changes.

If you’re interested in getting the most out of your retirement in Houston, Austin, Sugar Land, or The Woodlands, schedule a conversation with one of our advisors today.

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