5 Major Advantages 401k Plans Have Over Pension Plans

5 Major Advantages 401k Plans Have Over Pension Plans

March 25, 2024

Please read my contribution to an article published in Fiduciary News...

5 Major Advantages 401k Plans Have Over Pension Plans
by Christopher Carosa March 26, 2024

Let’s cut right to the quick. There’s been an inordinate amount of negative news lately about 401k plans. It seems like this comes in waves. It’s not that anything changes. No one expected the 401k plan to serve as the “be all and end all” retirement plan. Heck, if you know a little of the history behind it, no one expected the 401k plan at all. It was just an unforeseen loophole applied to a variation on a theme that turned into a viral sensation.

And, like democracy, it’s the worst idea except for all the others.

“While sponsorship of defined contribution plans, such as 401k plans, also requires compliance with ERISA and applicable law, and imposes administrative burdens and costs on employers, they can be easier to fund with employer contributions which are not even required depending on plan design,” says Michelle Capezza, of counsel at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. in New York City. “Defined contribution plan design features can provide workers with more control over their retirement savings. Yet, it is crucial for workers to have competitive wages to be able to adequately save on their own in such plans, as well as to have access to educational resources about their plans and retirement savings, as well as investment advice.”

For all the rose-colored eyes that have a created a legend flawless certitude concerning memories of a time that never existed, pension plans simply can’t measure up to 401k plans. In very rare instances they work as advertised. Overall, however, the bark of their promise was bigger than the bite of their reality.

Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California, says, “401k plans offer several advantages over traditional defined benefit (DB) pension plans.”

Here are five of them:

1. Loans
“You can borrow against it in times of financial hardship,” says Nevin E. Adams, JD, retirement geek, Maryville, Tennessee. Now, truth be told, some consider this more of a bug than a feature. But, if done right, taking a loan (a true loan, i.e., one you have to pay back with interest) from your retirement savings offers a benefit unobtainable from anything in the DB world.

2. Transparency
“The participants can understand an actual account balance and the annual changes in that value over time,” says Lawrence (Larry) Starr, executive vice president at Cornerstone Retirement/QPC Inc. in West Springfield, Massachusetts.

How does this compare with DB plans? “You can figure out how much you have without having to hire an actuary,” says Adams.

3. Control
“401k plans offer participants personal control over their investment choices within the options provided by the plan,” says Bavetz. “Employees can decide how to allocate their contributions among various investment options based on their risk tolerance, investment goals, and time horizon. This control allows individuals to tailor their investment strategy to their specific needs, potentially optimizing their returns and managing risk according to their comfort level.”

Now imagine what happens in the DB world. “In contrast,” continues Bavetz, “traditional pension plans do not offer this level of individual control. In a pension plan, the employer or the plan’s fund managers make all investment decisions, and the employee has no say in how the funds are invested. This can be a disadvantage for employees who prefer a more hands-on approach to managing their retirement savings.”

4. Higher Return Potential
“The early accumulation of account contributions is allowed to grow over time and it is tied to the actual dollar allocations to the participant’s account,” says Starr.

“In a 401k plan, there is a potential for higher returns on retirement savings due to the ability to invest in a broad range of assets, including stocks, bonds, and mutual funds,” says Bavetz. “While higher returns are accompanied by higher risks, especially with equity investments, participants who are knowledgeable about investing or who seek professional advice can significantly benefit from the growth potential of these markets over the long term.”

“Pension plans, on the other hand, provide a fixed benefit, which is determined by formulas involving years of service and salary, among other factors,” adds Bavetz. “The benefit does not directly correlate with the underlying investment performance of the pension fund, limiting the upside potential for participants even in times of strong market performance.”

Of course, with this benefit comes a certain amount of accountability. “While 401(k) plans offer these advantages, it’s essential for participants to actively manage their accounts and make informed investment decisions,” says Bavetz. “The responsibility for ensuring adequate retirement savings rests with the individual, unlike in a pension plan where the employer bears the investment risk and guarantees a specific benefit.”

This leads us to perhaps the greatest advantage of them all.

5. Portability
“They’re portable,” says Adams, “to another 401k or to an IRA (pensions have to be converted to a lump sum).”

Why is this so significant? One of the drawbacks of pensions is that employees never worked long enough at the same company to qualify for even a lump sum. With 401k plans, “Changes in career employment do not result in reductions of ultimate benefits,” says Starr.

“Unlike pension plans, which are typically tied to a single employer and can be challenging to transfer if you change jobs, 401k funds can easily move with an employee from one employer to another,” says Bavetz. “This feature is particularly beneficial in today’s dynamic job market, where individuals often change jobs multiple times over their careers. Participants can roll over their savings into a new employer’s 401k plan or an Individual Retirement Account (IRA) without tax penalties, maintaining their retirement savings’ continuity and growth. Pension benefits are generally less portable. While some pension plans may offer a lump-sum payout option upon leaving an employer, many do not, and the value of the pension benefit can be significantly reduced if an employee does not stay with the employer until retirement age.”

Portability, then, stands out as what gives the 401k plan its greatest advantage over the pension plan. It’s what allows the employee to accumulate retirement savings over an entire career. But it’s just one of the many advantages of the 401k plan.

“They are much more portable if someone changes companies, they are significantly less expensive than pension plans and they are much more flexible when it comes to the funding,” says Jason Grantz, managing director at Integrated Pension Services in Highland Park, New Jersey. “For example, an individual can change companies and roll their balance from their previous plan, start deferring into the new plan pre-tax for a portion, and if the plan allows, use ROTH for another portion and potentially be incentivized to do so by their employer essentially giving that employee an immediate return on investment in the form of a match OR if that employer is particularly generous, may simply make a contribution for them whether they participate or not. Because of these reasons, coverage, participation rates and retirement income security is exponentially greater now than it was pre-ERISA.”

So the next time you read a story about the “failure” of 401k plans, send the reporter a link to this article.

Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA.