The reliable pension plan was once a staple retirement benefit in corporate America.

American Express offered the first private sector pension plan in the U.S. way back in 1875, and popularity of this benefit peaked sometime in the 1970s when nearly 50 percent of private sector employees in the U.S. had access to a pension. In 2019, only 16 percent of private industry workers had access to such a benefit, according to the Bureau of Labor Statistics.

Pensions, or defined benefit plans, are valued for their steady income and baked-in guarantees. In short, an employer agrees to pay its workers a steady income — based on total years of service — for the rest of their lives in retirement. In that way, employees are rewarded for sticking with the company for the long-term. Today, only 16 percent of private industry workers have access to such a benefit.

But are pensions better than a 401(k)? Is salt better than pepper? Or left better than right? It's hard to say which is better because they’re just different. Instead, it makes more sense to focus on their unique attributes and the role they can serve in a financial plan. A pension and 401(k) are both financial tools, but neither is an entire retirement plan.

401(k) VS. PENSION

Pensions are a pretty hands-off, straightforward benefit. After putting in so many years of service, you’re rewarded with a pension in retirement. The company cuts you a monthly check for the rest of your life, or you can take a lump-sum payment upon retirement. Some programs even allow your spouse to continue receiving money after your death. And, unlike a 401(k), you often don't manage a pension in any way.

A pension provides level, steady income that you can depend on. In fact, many pensions are insured by the government (up to a certain amount), which means you’re protected if the company goes under or is acquired by someone else.

A 401(k) is technically considered a defined contribution plan, and, unlike a pension, it’s funded using pre-tax dollars from your income rather than by your employer. Often, however, your employer will match a defined percentage of your contributions.

A 401(k) allows you to tap into the potential of markets and enjoy tax-advantaged growth while funds are held in the account. This allows you to benefit from being invested in the stock market, which has historically returned 7 percent annually after accounting for inflation. But markets don’t always go up, which means your retirement savings may be exposed to risk, and there’s no lifetime income guarantees.

GUARANTEED VS VARIABLE INCOME

The big difference between a pension and 401(k) that’s invested in the stock market is that the former provides a guaranteed income stream, while the latter will provide an income stream but from a balance that varies with the market. In retirement it’s good to have a mix of both to help manage different risks.

Income streams exposed to markets increases risk but allows you to potentially capture upside and collect dividends to temper inflation risks. Guaranteed income streams, like a pension, are steady and will last a lifetime. Guaranteed income reduces exposure to market volatility and longevity risk (outliving your savings in retirement) in a financial plan.

GUARANTEED RETIREMENT INCOME WITHOUT A PENSION

Although pensions are in decline, there are still several ways to add guaranteed income to your retirement plan. For starters, you can begin receiving Social Security benefits as early as 62 (the benefit grows the longer you wait). Social Security will pay you for life, but it probably won’t cover all your needs in retirement. But you have options.

An annuity, which can provide guaranteed, lifetime income, is another product that’s a good substitute for a pension. There are several types you can choose from, tailored for your life stage. Lastly, the cash value of permanent life insurance can also serve as a source of safe income.

People may bemoan the decline of the pension, but that doesn’t mean a 401(k) is an inferior substitute for long-term financial health. Today, there are many financial options that can replicate the steady, reliable attributes of a pension.

The primary purpose of permanent life insurance is to provide a death benefit. Using permanent life insurance accumulated value to supplement retirement income will reduce the death benefit and may affect other aspects of the policy.

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