Traditional Pension Plans Vs 401K-Style Pension Plans – Advantages And Disadvantages

1. What Are The Advantages And Disadvantages Of Traditional (Defined Benefit) Pension Plans Versus 401K-Style (Defined Contribution) Pension Plans?

Advantages

The defined –benefit plans are cost effective since they cost nearly has of the defined-contribution plans such as 401K-style to offer the similar levels of benefits. In accordance with the National Institute on Retirement Security, these benefit plans achieve the cost savings since they are structured or organized as diversified, land, and professionally managed investment plans. Hence, they have the ability to capitalize on returns over a long period (Tcherneva pg70).

Another advantage of the defined-benefit plans is that they only require collecting enough money to pay for average retiree’s lifetime and hence taking the advantage of their capability of pooling longevity risk across all individuals in the plan. On the other hand, a person with the 401K-style pension plans needs to save the amount of money that is enough for their utmost life expectancy. Therefore, saving only sufficient funds for the mean lifetime could leave the individuals with insufficient income later in their lifetime (Ginneken pg280).

Defined benefit plans have high investment proceeds because the investment decisions are made by professional investors and hence wiser decisions are made than the ones made by just ordinary workers in the 401K-style (defined contribution) pension plans.

Disadvantages

The primary concern, for the taxpayer, with the defined-benefit plan is that the needed contribution levels can fluctuate and hence extra contributions may be needed during tough economic periods (Tcherneva pg76).

From the taxpayer’s view, the additional contributions when the money is tight are a concern since they may need higher taxes and divert funds away from other significant things. Moreover, distributed over a big number of individuals, the additional contributions may be relatively small, mainly when the employees also give the extra contributions (Ginneken pg284).  Averagely, the taxpayer contributions become less than they would be under the defined-contribution plan since the traditional pension plans are more efficient.

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