It's clear that most Americans aren't saving enough for retirement, and it's easy to put the blame on the current 401(k) and IRA retirement system. After all, the good old days when a traditional pension plan was much more popular seemed wonderful: You could quit your job, sit back and still get monthly income like clockwork.
But blindly claiming that the pre-401(k) days are better is just inaccurate, because there are plenty of reasons the do-it-yourself system is better. Here are a few to consider:
Not every employer offered pensions, even when they were popular. Before the introduction of 401(k)s, roughly four out of ten people had a pension. That means most people didn't have an efficient way to save for retirement other than sticking it in taxable accounts. These days, most large employers are offering 401(k) plans, and even for those who can't get access to one, IRAs are available to everybody.
The assets in 401(k)s vest much sooner, and you own the funds. If you are one of the lucky few who still has a pension, you will likely have to stick with your employer for at least a decade before any of the pension money will benefit you. What if you get a job opportunity elsewhere that pays more? If you have a pension you will be less able to change jobs for whatever reason because you might have to give up the opportunity to get guaranteed monthly payments for life or start all over again on a new pension clock. On the other hand, your own contributions to a tax-deferred 401(k) are vested immediately and employer matches will vest much sooner than pension benefits.
You can control taxes a little better with an IRA or 401(k). The dependability of pension income can actually be a drawback as well. This is because you are forced to count every penny of that monthly pension income when you figure your taxes. With a 401(k), you can delay withdrawals, or only take out a portion of your investments in order to keep more of your money tax deferred. Play it right and you might even be able to convert some of your pre-tax income to post-tax via a Roth conversion without ever paying any taxes on that money.
If you really need it, you have access to the money. Taking money out of your retirement accounts is generally a bad move, but it could still beat the alternatives in certain emergency situations. Roth IRA contributions can be withdrawn tax free after five years, and 401(k) balances can be taken out as a loan. There is no such luck with pensions. Even worse, you might lose all your benefits if an emergency requires you to quit your job before you have qualified for any benefits.
There's a chance that your heirs will get some money. The pension system guarantees payment in your lifetime, but the income will stop after your death. With a 401(k) or IRA, prudent savers will actually be able to leave some money to their heirs.
Your 401(k) plan may have high fees, but low-cost investments are possible. Investing in low-cost funds was impossible in the good old days because none existed. The average Joe was stuck with load funds that required you to hand over as much as 5 or 6 percent of your contributions just to have the privilege of investing in funds that couldn't beat the index. Then you had to pay more to withdraw money because there were also back-end loads. It wasn't until 1976 when Vanguard introduced the first index fund for the masses that the public could actually participate in sharing market returns, and even then the index fund's expense ratio was 0.43 percent. Nowadays, a similar index fund with Vanguard costs 0.05 percent in expenses. That's more money you can keep year after year as your money compounds tax free.
The current retirement system puts the responsibility of saving for retirement on our own shoulders, which is not only appropriate but also beneficial for prudent savers willing to take some time to learn and manage their investments properly. But with more power comes more responsibility. Handle the task properly, and you can maximize your wealth.
David Ning runs MoneyNing, a personal finance site that shares money moves you can make to significantly increase your chances of having a comfortable retirement. He likes to share simple changes that anyone can make, such as picking the best online savings account and figuring out whether a 0 percent balance transfer credit card makes sense.
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