401Ks are a disaster: Column

[FreeJoe]

99. They are somewhat interchangeable

If I've got a bunch of money in an IRA, I can use that money to buy an annuity. I can buy one that pays me X dollars until I die. I can buy one that includes a spousal survival benefit paying my spouse 50%, 75%, or even 100% of my benefit. There are lots of options.

My company has a pension plan. When I retire, I've got a bunch of options I can choose as to how the money gets paid out. The options are various flavors of annuities or I can just take the whole kaboodle as a lump sum and roll it into an IRA.

Yes, you need to save a LOT of money to have a good income stream. That is especially true today, because interest rates are very low. Using the retirement calculator my company provides, if my pension lump sum was $1,000,000, I could take that or a monthly income of $5,337 for the rest of my life. Which is the better deal? In general, they are worth the same. Which is better for you? It depends on how secure you think the annuity provider is, what you think will happen to inflation, how you plan to invest the lump sum, and a bunch of other factors.

It doesn't take more money to provide a comfortable retirement in a defined contribution plan compared with a defined benefit plan. The dollars saved vs dollars paid out are the same in both cases. There are differences in the risks. With the defined contribution plan, you face investment risk. With the defined benefit plan, you are exposed to solvency risk of the pension provider (somewhat mitigated by pension insurance). Both face inflation risk, although in different ways.

My main point is that they are really very similar. Where I think many people got screwed is with the transition. If a company was paying 8% of your salary into their pension program and then switched you to a 401K where they matched 4% of your contributions, you took a roughly 4% pay cut without it being obvious.