The American Dream traditionally involved getting a job with a company for 40 years, building up a big pension and then retiring to enjoy your golden years on that pension. Sadly, this notification of the American Dream has become a fantasy for most Americans over the last 20 years. Although retiring and living comfortably is still an option, the 401k plan has surpassed the pension plan as the retirement vehicle of choice.
When most people think of pensions, they are really thinking of retirement platforms known as defined benefit plans. These plans offer a guaranteed payout amount when one retires. The amount is determined by the years you work, amount contributed, salary and other factors that vary from plan to plan. When your grandfather worked for General Electric for 40 years, his pension was a defined benefit plan.
The 401k is a more modern retirement platform and one that has become increasingly popular with companies. Ready to be surprised? 401k plans have only existed since the 1980s and they were not even intended to help the common worker when they were created. Instead, they were supposed to be used to provide added benefits to executives. Regardless, they are now used by companies as retirement vehicles for executives and employees alike.
The modern 401k plan is really a defined contribution plan. This simply means that employees can contribute up to a certain amount when they choose to do so. Employers have the option, but not requirement, to also contribute to the employers account. Over time, the employee vests in the account and takes 100 percent ownership of the money in it although they can not withdraw it until the legal retirement age unless they want to pass very high tax rates.
One of the major differences between 401ks and traditional pension plans is the issue of control. Specifically, who controls how the money is invested once it is in the plan? With the traditional pension plan, the trustees for the pension has control and tend to make very conservative investments so as to protect the pool of money. In a 401k, the employee usually has control over how the money will be invested. There may be limits on the type or number of investments he or she can pursue, but that is the only restriction.
Which Is Best?
The 401k would be the obvious answer if this question was asked five years ago. Since then, however, the Great Recession hit and a lot of employees realized that sometimes they were not so great at picking stocks after all. The idea of having a stable, conservative investment like those found in pensions has started to seem a lot more attractive to such people than it did before the economic troubles came along.
The real answer to this question, however, depends entirely on the views of the person considering the question. If one is comfortable with the investment world, than a 401k makes sense. If you would rather leave investment decisions to someone else, a pension plan may be the way to go.
Personally, I prefer the 401k plan for a couple of reasons. The first is I want control of my investments. The second is I like the fact I can change the amount I can contribute to it each year. This gives me a certain amount of flexibility depending on how the economy is performing.
Ultimately, you will have to make your own decision when it comes to this issue. Regardless of the direction you decide to go, make sure to maximize your retirement savings as much as possible to ensure a comfortable time in your golden years.