Thursday, July 18, 2013

New Study Demonstrates 401(k)s Better for Higher Income Employees, Pensions for Low Income Workers

The battle over which style of investment plan is best seems to be somewhat dependent upon your income status and whether you work in the private or public sector, according to a researchers at the Employee Benefit Research Institute.

Here are some excerpts from a MSN story, “Which is better: 401(k) or a pension?” that covered the EBRI study.

But if you reduce the assumed rate of return, the traditional pension starts to look better for lower-income people, the study found.

For example, when the rate of return is decreased by 200 basis points, a 25- to 29-year old lower-income worker who is eligible for a plan for 30 to 40 years would see his income replacement rate at retirement with a 401k plan drop to 4 percentage points lower than he would have enjoyed with a pension plan, at the median.

For the next highest income group in the above scenario, their replacement rate with the 401k would be 1 percentage point less than with a traditional pension.

However, for the two highest-income groups, the 401k is still better: that plan provides a 6 percentage point and 15 percentage point replacement-rate benefit over the pension, at the median, even when a lower rate of return is assumed.

And combining the lower-return assumption with a higher-cost annuity assumption (reflecting the current low-interest-rate environment, which is substantially different from recent history), then traditional pensions look even better

The study’s author makes a point we’ve been making all along, that pension plans should be supplemented – not replaced – by 401(k)s:

In an ideal world, [Jack VanDerhei, a research director at EBRI and author of the report] said, workers would have access to both a traditional pension and a 401k or similar defined-contribution plan.
"If you have both," he said, "then obviously you have less employee investment risk, you have less employee longevity risk and you still are giving employees the upside if they choose to participate in the 401k plan."

And finally, you have to read to the bottom of the page to find out that the study really only considered private sector defined benefit plans:

Also, the data looked at private-sector pension plans. It did not include public-sector plans. Doing so would have pushed the data more in favor of pensions.

"I can promise you I would get much different results had I done a public defined-benefit as opposed to a private defined-benefit comparison," VanDerhei said.

Public pension plans -- those offered by government entities -- generally offer more generous benefits than private-sector plans, and usually include cost-of-living adjustments in retirement.

And the reason for those “generous benefits” is that throughout the employees’ working years they probably earned much less than private sector employees. -- Max Patterson