Pensions or 401(k)s: Which is better?

Saving for retirement


Tess Vigeland: Retirement plans for government workers are getting a second look these days. Not just in Wisconsin but around the country. This week Los Angeles mayor Antonio Villaraigosa suggested raising the retirement age for newly-hired city workers by 10 years to 65 and to cut pension benefits to 75 percent of salary instead of 100 percent. Many states are going a step further to look at getting rid of pensions altogether and replacing them with 401(k)-style plans.

Marketplace's Adriene Hill has that story.

Adriene Hill: Lots of us who work for businesses are familiar with 401(k)-style retirement accounts. Every paycheck, I set aside a percentage of what I make. Marketplace matches it, or at least will, next month when I qualify. I tend my account, make decisions about where to invest it and, ideally, my balance sheet will grow. So that years and years and years from now, when I'm ready to kick back and spend all my time baking bread and hanging out with my future grandkids, I can. At least that's how it's supposed to work.

Alicia Munnell: Private sector employees have had a very hard time. They don't necessarily join the plan, they don't contribute as much as they should, they don't diversify their investments. They just make a host of mistakes.

Alicia Munnell heads the Center for Retirement Research at Boston College. Before the crash, she says the typical person approaching retirement age had just $78,000 in their 401(k). Again, before the market meltdown. That's not even close to enough for most people to stop working.

Munnell: People who are going to be relaying on them solely, only with Social Security in retirement are going to come up short.

As the recession proved, 401(k)-style plans aren't idiot proof -- or even smart-people proof. And, they have none of the guarantees traditional pensions offer.

Olivia Mitchell: I have to say stock market performance over the last three years hasn't been terribly reassuring.

Olivia Mitchell is the head of the Pension Research Council at the Wharton School of Business. She says 401(k) plans can work -- especially for people who might want to change jobs, but it's hard to manage them well and the risk is all with the account holder. Taxpayers are on the hook for traditional government pensions, which carry their own set of risks.

Mitchell points to research showing that those pensions, also called "defined benefit plans," are underfunded by more than $3 trillion -- with a T -- in the U.S.

Mitchell: If you have a defined benefit plan that's underfunded, for example, the city of Philadelphia is about 45 percent funded, that means it's missing a lot of the money it need to pay benefits, that's not a secure promise either.

To be clear, even if states switch to 401(k)-style accounts for new employees, it's not a fix. They're still on the hook for the promises they've made to current and past employees.

That underfunding, the $3-plus trillion pension hole that states and cities face, is enough to keep Dartmouth professor Andrew Samwick away.

Andrew Samwick: If I were given the choice, I would want the money in hand as opposed to the promise made to me by the employer. Because then I own the money and I control the money and I'm not beholden to future generations of taxpayers.

Samwick says governments just have too many competing goals. They want to keep everyone happy -- employees, taxpayers. So they make promises that they don't have the money to pay for now. Unfortunately, the "pay-for-it-a-little-later" strategy seems to have caught on with a lot of 401(k) holders as well.

I'm Adriene Hill for Marketplace Money.

About the author

Adriene Hill is a senior multimedia reporter for the Marketplace sustainability desk, with a focus on consumer issues and the individual relationship to sustainability and the environment.
Log in to post5 Comments

Zino M. driveled -- "If the pension plans cut them (Wall Street people) out of the loop and invest the money in solar,wind and biofuels you can notice at least a 6-7% return on investment which is indexed for inflation."

ROFL. Obviously Zino M doesn't believe in diversification. Ever listen to the show Zino? I mean actually listen?

Too many people in the public sector (and education sectors) expect the taxpayer to pay the ENTIRE burden for their service years when it comes time to retire. The biggest complaint I hear from friends in those areas is that they are expected to contribute to their health care costs, etc. DUH?? Everyone I know in the private sector does PLUS how many places of employment do you know of that allow vacation and sick leave to accrue without end so that some employees in the public/education sectors are walking away with not only 100% of pay pensions BUT at times several years of pay in a lump-sum settlement for those unused days. It should be use or lose ... just like the rest of us. There are too many people on the backs of too few anymore. It's no longer sustainable

I do not think the pensions are in trouble. The problem here is we need to rethink how the investments are handled. Currently the Wall Street people get anything upto 2-3% of the money manage irrespective of the results. If the pension plans cut them out of the loop and
invest the money in solar,wind and biofuels
you can notice at least a 6-7% return on investment
which is indexed for inflation. This will create
an enormous amount of jobs. This could create
projects like Hoover dam which do not rely on
tax payer money infact give back to the govt.

I am currently serving in the Air Force, where at 20 years of service we get a pension of 50% of our base pay (not including housing and food allowances). There has been talk of changing the retirement program for military members as well - everything is on the table to solve the budget crisis. I do not entirely trust that they wont make changes that reduces our retirement pension so I have been slowly increasing my contributions to the Thrift Savings Plan - similar to a 401(k) but for federal employees - to 20% of my pay. That way, when it comes time for my actual retirement, I should have a decent account balance in my TSP to fall back on if Social Security and my pension do not provide as much as I expect. And in a best-case scenario my wife and I will be able to have a very stable and secure "golden years" without having to worry about money!

Many people don't seem to be aware that in Ohio at least, public sector workers don't pay into social security so their state pension plan may be their only source of income for retirement, unless they have some private investments. I paid into SS for 19 (significant) years so I receive some SS in addition to my PERS. However, my social security earnings are offset by the amount of money I receive from PERS, reducing my SS payments by about 40 percent. Before I retired at the age of 67, I was getting much more in SS than I am now.

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