401(k) plans save employers money because workers fund a portion of them. But a new analysis says 401(k)'s are an inefficient way to finance a secure retirement.
The nonprofit National Institute on Retirement Security calculated that a 62-year-old with a final salary of $50,000 would need to have $550,000 in a 401(k) to have an adequate retirement income, determined by the authors to be $26,684 a year. To achieve the same income, a traditional pension would need to have only $355,000 set aside for that worker, nearly $200,000 less.
Here are three reasons that traditional pensions need less funding than 401(k)'s.
No oversaving. In an individual 401(k) plan, you may want to save enough to last until you are 100, just in case you live that long. But traditional pensions need to contain only enough cash for the average life expectancy, and those with long and short lives pool their risk.
Allocation stays constant. 401(k) participants may want to invest more conservatively as retirement looms to protect against market volatility. But that safety produces lower returns, which can also erode retirement security. A traditional pension can always maintain an optimal asset allocation across generations.
Higher investment returns. Traditional pensions typically get higher investment returns than individual retirement accounts, thanks to professional management and lower fees. Pension returns beat 401(k) results by 1.6 percentage points in 2006 at companies with both types of plans, according to an analysis by consulting firm Watson Wyatt Worldwide. NIRS's model found that a 1 percent increase in annual investment returns results in a 26 percent cost savings over a career, compared with a 401(k) plan.