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Pensions vs. 401(k)s: Which is better for retirement income?

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It’s almost a gospel among American workers: Having a traditional pension is preferable to a 401(k) in terms of providing a reliable stream of income in retirement. But a new study from the Employee Benefit Research Institute (EBRI) found that depending upon many fluctuating factors, there is no clear-cut winner.

Using its proprietary simulation models and plugging in various combinations of key factors, EBRI compared the average final payout from a defined benefit (DB) plan versus an annuitized voluntary-enrollment 401(k) account and IRA rollover balance for workers now between the ages of 25 and 29.

What the nonpartisan organization found was that the median accrual rates that the final average DB pensions needed in order to provide retirement income equal to voluntary 401(k)s would range from just under 1 percent to 3 percent of final compensation per year of participation, using baseline assumptions. Those rates would drop between 0.6 percent and 1.6 percent per year if investment returns fell and annuity prices increased.

To calculate the retirement income at age 65, EBRI applied a final average DB accrual of 1.5 percent of final compensation per year of participation across a range of tenures and incomes. It then compared those outcomes with the projected sum of 401(k) and IRA rollover balances, translated into the value an annuity each benefit would produce. That gave researchers a reference point to evaluate the two plan designs.

Yet the study’s author, Jack VanDerhei, EBRI’s research director, emphasized that a strict apples-to-apples comparison between the two plans is difficult to establish because of several factors, including a lack of comparable data.

Also, traditional DB plans and 401(k) have major structural differences and function quite differently from each other. For instance, the retirement income potential of 401(k)s are generally based on the current account balance. Meanwhile, a DB outcome is often viewed at face value, meaning the amount the plan design provides, assuming that full service and vesting requirements are fulfilled.

Then there are “extreme variations” among American workers in terms of employment tenure. Lastly, each alternative can be impacted by a variety of dynamics, such as investment market returns and annuity purchase prices.

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