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

Adriene Hill Mar 4, 2011

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

Adriene Hill Mar 4, 2011


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.

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