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Did you grow up with grandparents or older relatives that had a pension? I did, and it sure seemed like they had a good thing going!
As I understood it, all you had to do was work someplace for 30 years, and then you’d be rewarded with a nice, fat check every month for the rest of your life. What a great deal!
I was so excited when I started my first job out of college and couldn’t wait to find out what my pension plan would be like. That was until one day someone from HR laid a packet on my desk that said “401k”.
I naively asked the guy at the desk next to me if this 401k-thing was our company’s pension plan, and he just burst out laughing.
That’s when I learned a little something about pension plans.
Pension Plans Are Nearly Extinct
Since the 1980s and 90s, there’s been a big shift away from pension plans. In 2019, only 14% of Fortune 500 companies were still offering them. That’s compared to 59% of companies just 20 years ago.
It’s not impossible to find employers who still offer pensions. My wife, for instance, works as a public school teacher and will be eligible to receive a pension when she retires someday.
But I can tell that our situation is quite rare among our family and friends.
So why did so many employers stop offering pensions? And what have they been replaced with?
How Are Pensions and Other Retirement Plans Different?
A pension plan is what’s called a “defined benefit plan”. This means that the employer is in charge of the pension fund and manages:
- How much each employee must contribute with each paycheck
- How the entire pool of contributions should be invested and maintained
- How long the employee must work before they are eligible to receive benefits
- How much income the employee can receive once they are retired
Since the first private pension plan was established in 1875 by American Express, this has been the arrangement between employer and employee throughout most of the twentieth century.
In return for decades of hard work and service, the employer would continue to provide the employee with income for the rest of their foreseeable life.
As you might guess, that puts an incredibly large burden on the backs of companies.
As trade started to become global and more competitive in the 1980s and 90s, businesses were looking for any opportunity they could to reduce their overhead and cut costs.
And when it came to retirement plans, they found one: Switching to a new type of retirement plan called a 401k.
A 401k plan is what’s called a “defined contribution plan”. Originally created back in 1978, it was intended to allow employees to make tax-deferred contributions in addition to funding their pensions.
However, big corporations decided to start using them in a different way.
They began to phase out their pension plans to new employees and only offer them 401ks instead. This shifted the responsibility of saving and planning for the employer to the employee.
For some people, this was unfortunate because (to say it as nicely as possible): They have no idea what they’re doing. I’ve worked with dozens of colleagues who have:
- No clue how much they’re saving
- No clue what they’re investing in
- No clue if it will even be enough for them to retire someday
It was around this same time that IRAs (individual retirement accounts) also began to rise in popularity.
Although they had been around since 1974, with pension plans going by the wayside, people started looking to use IRAs in combination with their 401k as a way to save more for retirement.
To add to this confusion, Roth-style retirement plans were introduced to Congress in 1997 starting with IRAs. Since they were so popular, the same structure was also adopted by many 401k plans too.
Although Roth-style plans are widely praised by most financial professionals for providing tax-free retirement income, they unfortunately only added to an already complex situation for people unprepared to manage their own retirement plans.
Often, I’ll hear people complain about how “companies cheated them” by taking away pensions. But to that I say: You’re missing a golden opportunity …
Why I Like a 401ks and IRAs Better
If there’s one thing I’ve come to conclude about pensions versus traditional retirement plans, it’s that you’ll be able to have a much better retirement plan if you use a 401k and IRA.
- With a pension, you have no say in how much money you can contribute, how it will be invested, or what your retirement income will ultimately be. In my book, that’s a huge negative because I plan to build up my retirement savings not just to support myself, but also to accomplish other financial goals like starting a business and passing my wealth on to future generations.
- By contrast, because I’m in the driver’s seat with my 401k and IRA, I can save and invest any way I see fit. I can contribute as much as I want, invest in funds that agree with my risk tolerance and work towards building up my nest egg as high as it will go.
- With a pension, someone else tells you when you can retire. You might have to work 30 years or so before you’re eligible. But with a 401k or IRA, you can invest as aggressively as you want and retire as soon as you’re ready. Even if it’s before age 59-1/2, you can always use techniques like a 72t or Roth Conversion Ladder to get early access to your money.
- When you leave an employer that offers a pension, you forfeit a large portion of what you were entitled to receive if you had stayed with the company. However, with a 401k and IRA, that money is yours forever. It follows you whether you switch jobs, quit, or retire from working altogether.
- Sadly, with a pension, there’s no guarantee that you’ll ever get your money. There are many situations where companies or municipalities have only been able to pay out a fraction of the benefits they had promised to their employees. But with 401ks and IRAs, you won’t have this problem because it's your money and can manage it any way you want.
Overall, it’s your retirement. And if there’s one thing you want to be in control of, it's how your money is managed so that you can enjoy a safe and secure financial future. That’s why I happily use 401ks and IRAs.
The Bottom Line
Pension plans were once a universally accepted way for companies to take care of their employees in retirement. But all of that changed with the 1980s when big corporations started swapping them out with 401k plans.
Even though 401ks and IRAs put the burden of retirement planning on the employee rather than the employer, I see it as a golden opportunity.
Not only can you potentially save more and invest the way you want, but they can also help you to adjust your timeline according to your needs. That’s especially great news if you’re planning to retire early someday.
More importantly, 401ks and IRAs put you in control of your financial future; not your employer.
You can take the money if you change jobs, and you don’t have to worry about if the company will be able to make good on its promises in the future.
When it comes to your retirement, there’s nothing more valuable than knowing that your money is safe and will always be there waiting for you to use it whenever needed.