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Started By
Message
Comparing Defined Benefit versus 401(k) Retirements
Posted on 7/27/18 at 11:00 am
Posted on 7/27/18 at 11:00 am
Can anyone recommend a simplistic way of comparing the pros and cons of these two different retirement plans.
Background on the Defined Benefit Plan:
Upon vesting (minimum of 10 years of employment), the calculation is:
Benefit $ Amount=AVG of 3 Highest Years of Annual Salary X .025 for each year spent in the system
In other words:
10 years of employment=25% of the AVG of the 3 highest years of salary within the 10 years.
Is there an online tool I can find or use to determine what the payout would be on a 401(k) plan that is trustworthy and factors in normal market fluctuations over the long term?
I'm trying to figure out how to evaluate staying within the Defined Benefit Plan versus entering into the 401(k). I can extrapolate the DCP over time to determine what I can estimate as the payout. But for the 401(k) I'm honestly uninformed and would like a point in the right direction.
TIA
Background on the Defined Benefit Plan:
Upon vesting (minimum of 10 years of employment), the calculation is:
Benefit $ Amount=AVG of 3 Highest Years of Annual Salary X .025 for each year spent in the system
In other words:
10 years of employment=25% of the AVG of the 3 highest years of salary within the 10 years.
Is there an online tool I can find or use to determine what the payout would be on a 401(k) plan that is trustworthy and factors in normal market fluctuations over the long term?
I'm trying to figure out how to evaluate staying within the Defined Benefit Plan versus entering into the 401(k). I can extrapolate the DCP over time to determine what I can estimate as the payout. But for the 401(k) I'm honestly uninformed and would like a point in the right direction.
TIA
This post was edited on 7/28/18 at 10:41 am
5
Posted on 7/27/18 at 11:28 am to GFunk
You're describing a defined-benefit plan, not a defined-contribution plan. The benefit is a fixed amount regardless of the ups and downs of the various investments. The defined-benefit plan is almost always going to be more advantageous to you.
This post was edited on 7/27/18 at 11:29 am
Posted on 7/27/18 at 1:37 pm to Layabout
You're totally right. Mistake on my part. Edited.
ETA: I understand that its far more advantages in terms of its fixed or guaranteed income aspect.
I also know the salary & employer match figures for the 401(k). I'd like to find a tool to input these figures and use really conservative rates of return or growth to compare over the course of time to that of what I already know the DBP would be.
ETA: I understand that its far more advantages in terms of its fixed or guaranteed income aspect.
I also know the salary & employer match figures for the 401(k). I'd like to find a tool to input these figures and use really conservative rates of return or growth to compare over the course of time to that of what I already know the DBP would be.
This post was edited on 7/27/18 at 1:40 pm
Posted on 7/27/18 at 1:39 pm to GFunk
Are you changing jobs or are they getting rid of the defined benefit plan for newcomers (and allowing people to switch?).
Curious why you can't do both.
Curious why you can't do both.
Posted on 7/27/18 at 1:44 pm to Teddy Ruxpin
quote:
Teddy Ruxpin
quote:
Are you changing jobs or are they getting rid of the defined benefit plan for newcomers (and allowing people to switch?).
Curious why you can't do both.
I'm considering changing jobs but I'm just trying to find a balanced way to compare the risks and rewards. I understand the Defined Benefit aspect's safety and security, but I'd like to get a feel for how much I can grow a 401(k) plan.
The potential salary growth from one to the other may make the change negligible from a retirement income standpoint when I compare staying where I am at a smaller salary in the Defined Benefit vs a potential job change's increased salary and how that can grow a 401(k) over a similar tenure.
If that's the case then I can draw a line through that aspect of any pro/con I'm working up to help me make decisions and use other comparison points.
Posted on 7/27/18 at 1:57 pm to GFunk
Can you calculate your DB and then work backwards from there?
If you know your DB will give you X amount per year, you can find out what amount of money is needed at Y% per year to generate X.
Then you just calculate what you'll have to save each year earning whatever variable interest rate you want to use that will get you to that number that will generate X income per year.
Of course taking into account what you have to put into it of your own money.
Maybe I'm thinking about it wrong.
ETA: don't forget that the "employer contribution" part of a DB is forfeited upon death. So if you retire and die two years later that's all gone and your spouse or whatever will get whatever you put in (unless you choose one of those survivor options).
In a 401k defined contribution plan, the money is always yours from the employer once deposited.
Google "Benefit Equivalent Calculator" and see if you can get it to work. Kept frozing on my PC but might be helpful
If you know your DB will give you X amount per year, you can find out what amount of money is needed at Y% per year to generate X.
Then you just calculate what you'll have to save each year earning whatever variable interest rate you want to use that will get you to that number that will generate X income per year.
Of course taking into account what you have to put into it of your own money.
Maybe I'm thinking about it wrong.
ETA: don't forget that the "employer contribution" part of a DB is forfeited upon death. So if you retire and die two years later that's all gone and your spouse or whatever will get whatever you put in (unless you choose one of those survivor options).
In a 401k defined contribution plan, the money is always yours from the employer once deposited.
Google "Benefit Equivalent Calculator" and see if you can get it to work. Kept frozing on my PC but might be helpful
This post was edited on 7/27/18 at 2:22 pm
Posted on 7/27/18 at 3:11 pm to Teddy Ruxpin
quote:
Teddy Ruxpin
quote:
Can you calculate your DB and then work backwards from there?
If you know your DB will give you X amount per year, you can find out what amount of money is needed at Y% per year to generate X.
Then you just calculate what you'll have to save each year earning whatever variable interest rate you want to use that will get you to that number that will generate X income per year.
Of course taking into account what you have to put into it of your own money.
Maybe I'm thinking about it wrong.
ETA: don't forget that the "employer contribution" part of a DB is forfeited upon death. So if you retire and die two years later that's all gone and your spouse or whatever will get whatever you put in (unless you choose one of those survivor options).
In a 401k defined contribution plan, the money is always yours from the employer once deposited.
Google "Benefit Equivalent Calculator" and see if you can get it to work. Kept frozing on my PC but might be helpful
To be honest, this potential situation came up more than a month ago. When it did, I did exactly as you mentioned and ran calculations conservatively and aggressively in my current spot and then found a basic 401(k) calculator online and used the smoke signals I got re: potential pay to plug into it.
I'm within <$100/month when I compare conservative defined benefit vs. conservative 401(k) at the end of the day using similar retirement dates. I have a side hustle-which I will easily be able to continue to do moving forward-that I will be doing well after I retire which essentially negates that many times over.
In a sense I feel like I know the answer but being unfamiliar with 401(k)'s as a retirement investment tool I'm wanting to make sure that I'm not underthinking anything as a part of my decision-making process. Which means I run the risk of overthinking it at the same time LOL.
This post was edited on 7/27/18 at 3:12 pm
Posted on 7/27/18 at 4:33 pm to GFunk
The reason why DBPs aka pensions are going away is they are very expensive for the employer.
I understand you say the monthly amount is near the same, but your defined benefit is a "guaranteed" amount. Normally when we try to relate the value of a pension, we can compare it to a conservative bond yield. For example...Let's say you have a pension of $100K. How large of a conservative bond portfolio would you need to have to produce this income? Let's assume for round numbers that treasuries are paying 3%. You would need a bond portfolio of just over $3.3 million.
Assuming you still are eligible for SS, the argument could be made that with so much of your cash flow in retirement from guaranteed sources would allow you to be very aggressive with your outside investments. Having a high equity exposure in your other investments would also better allow you to hedge for inflation over time.
I understand you say the monthly amount is near the same, but your defined benefit is a "guaranteed" amount. Normally when we try to relate the value of a pension, we can compare it to a conservative bond yield. For example...Let's say you have a pension of $100K. How large of a conservative bond portfolio would you need to have to produce this income? Let's assume for round numbers that treasuries are paying 3%. You would need a bond portfolio of just over $3.3 million.
Assuming you still are eligible for SS, the argument could be made that with so much of your cash flow in retirement from guaranteed sources would allow you to be very aggressive with your outside investments. Having a high equity exposure in your other investments would also better allow you to hedge for inflation over time.
Posted on 7/27/18 at 5:50 pm to juice4lsu
Maybe related but I look at my pension contributions as the cash part of my overall allocation until at least I vest. Because before the if I separate I'd have to pull all that out in cash, so I shouldn't then hold another stack of cash in my private accounts.
Also, it is essentially an emergency fund in itself as again, I imagine the emergency would be from job loss again giving me access to that money.
In any event, after a certain amount of wealth accumulation I don't think a cash emergency fund makes any sense, but that threshold is specific to every individual/situation. Personally, I chose if I lost 50% of my accessible funds would I still have 6 months as the point I didn't think the cash drag was worth it.
Also, it is essentially an emergency fund in itself as again, I imagine the emergency would be from job loss again giving me access to that money.
In any event, after a certain amount of wealth accumulation I don't think a cash emergency fund makes any sense, but that threshold is specific to every individual/situation. Personally, I chose if I lost 50% of my accessible funds would I still have 6 months as the point I didn't think the cash drag was worth it.
Posted on 7/27/18 at 11:15 pm to GFunk
how many years do you have in the DBP?
Posted on 7/28/18 at 10:43 am to KillTheGophers
August makes 11 years. So 27.5% of the AVG of my 3 Highest Years of Earnings.
Posted on 7/28/18 at 10:46 am to GFunk
There’s a lot of variables at play here. Depending on how close to retirement you are, those can make a huge difference in the calculations.
How long do you plan to live? Retirement age? Penalties for pension withdrawal? What’s your average raise? Is there a ceiling for you salary?
401k employer match? Salary? How much can you afford to put in? How aggressive is the portfolio?
I’ve done a similar comparison when I switched jobs in Excel. Just set up a year over year value of each account. Mine was a bit complicated as both employers had a 401k and a Pension, each with vastly different structures.
I’d set up a simple year to year calculation based on various variables (retirement age, raise %, pension, etc.). Just make sure to compare Apples to Apples. Salary can be important for the 401k (if you can’t do both) since there are contribution limits (pre-tax).
How long do you plan to live? Retirement age? Penalties for pension withdrawal? What’s your average raise? Is there a ceiling for you salary?
401k employer match? Salary? How much can you afford to put in? How aggressive is the portfolio?
I’ve done a similar comparison when I switched jobs in Excel. Just set up a year over year value of each account. Mine was a bit complicated as both employers had a 401k and a Pension, each with vastly different structures.
I’d set up a simple year to year calculation based on various variables (retirement age, raise %, pension, etc.). Just make sure to compare Apples to Apples. Salary can be important for the 401k (if you can’t do both) since there are contribution limits (pre-tax).
Posted on 7/28/18 at 10:57 am to GFunk
When can you start collecting on the DBP, after 20 years service (which would be 9 more for you) or at a certain age 55/60/65? That would be a major factor in the equation.
Posted on 7/28/18 at 3:55 pm to LSUtigerME
I am at least 20+ years from retirement. My average raise is indeterminate. Over the last 12 months it was 13%. But 6% of that is far from guaranteed so its not something I can count on. In my current position I can only foresee an additional 7% which is at least a year away. After that I would need to promote or depend on extremely intermittent merit-related annual increases. Over the past decade we’ve received this 40% of the time due to organizational and leadership decisions.
I would be seeing an approximate 25% salary increase. This does not include quarterly/annual bonus and other ancillary benefits. The 401(k) is a 4% employee match.
With the raise I can take advantage of the full match and then some if it is worth it.
My retirement age is going to be at least 61 but I enjoy working, have no kids and can easily see working now into my mid-60’s.
I would be seeing an approximate 25% salary increase. This does not include quarterly/annual bonus and other ancillary benefits. The 401(k) is a 4% employee match.
With the raise I can take advantage of the full match and then some if it is worth it.
My retirement age is going to be at least 61 but I enjoy working, have no kids and can easily see working now into my mid-60’s.
This post was edited on 7/28/18 at 3:59 pm
Posted on 7/28/18 at 7:52 pm to GFunk
If your two monthly income projections are within less than $100 20 years from now then it seems to me the two are equal. Cause that’s a rounding error.
I’ll be the devil’s advocate regarding your pension. While it is probably safe some companies do not adequately fund their plans and they fail. That’s why the Pension Benefits Guaranty Corporation exist.
Even some government entries go bankrupt or have trouble meeting their obligations. Just be aware.
With the 401K, you control it once vested. But that can have downside also if you do stupid stuff such as cashing out early. It is harder to do stupid things w/ the pension.
The 401K is an excellent way to save for retirement and in my case it produced much more income at retirement than my pension. Over about 35 years I would invest the amount needed to get the full company match; as best that I can remember that would be ~ 8% to get a 5% match.
I’ll be the devil’s advocate regarding your pension. While it is probably safe some companies do not adequately fund their plans and they fail. That’s why the Pension Benefits Guaranty Corporation exist.
Even some government entries go bankrupt or have trouble meeting their obligations. Just be aware.
With the 401K, you control it once vested. But that can have downside also if you do stupid stuff such as cashing out early. It is harder to do stupid things w/ the pension.
The 401K is an excellent way to save for retirement and in my case it produced much more income at retirement than my pension. Over about 35 years I would invest the amount needed to get the full company match; as best that I can remember that would be ~ 8% to get a 5% match.
Posted on 7/28/18 at 8:13 pm to nctiger71
quote:
I’ll be the devil’s advocate regarding your pension. While it is probably safe some companies do not adequately fund their plans and they fail. That’s why the Pension Benefits Guaranty Corporation exist.
This is exactly why you should stay with the pension plan, but also fully fund your Roth IRA and 401b. Now that we hear you don't have children, there is every reason to follow a twin-tiered retirement funding. Plus, you want to retire at 61.
Posted on 7/28/18 at 9:06 pm to SurfOrYak
Good point. I was thinking about a worse case situation such as 2008 when I believe the PBGC was stressed due to higher than normal claims.
Plus, I think the current maximum pension amount is $60k/year so there could be risk there, albeit small. I don’t know of any private sector retirees that get a $60k pension; but I live in a low cost of living area.
For me the 401K worked out better than the pension but for anyone it depends on how much the employer contributes vs the 401K match and probably some other details. And I liked having more control over my retirement that comes w/ the 401 vs the pension. It is not right or wrong, just my perspective.
Plus, I think the current maximum pension amount is $60k/year so there could be risk there, albeit small. I don’t know of any private sector retirees that get a $60k pension; but I live in a low cost of living area.
For me the 401K worked out better than the pension but for anyone it depends on how much the employer contributes vs the 401K match and probably some other details. And I liked having more control over my retirement that comes w/ the 401 vs the pension. It is not right or wrong, just my perspective.
Posted on 8/3/18 at 9:11 pm to GFunk
You'd have to grow a 401k with Miracle-Gro to match what a defined-benefit plan would provide. It would take a million dollars in your 401k to provide you with an income of $40k annually, assuming a conservative withdrawal rate of 4% beginning at age 65.
Posted on 8/3/18 at 9:30 pm to Layabout
but you would still have 1 million dollars to leave to your heirs
Posted on 8/3/18 at 9:41 pm to simonizer
quote:
but you would still have 1 million dollars to leave to your heirs
Provided you had the discipline to amass a million bucks. Sadly the average IRA balance for 65-year olds is just slightly more than $200,000 leaving you a princely sum of $8000 a year to live on unless you draw down your principal and leave your heirs diddly squat.
Privatizing retirement is a cruel hoax designed to pick the pockets of the vast majority of retirees.
This post was edited on 8/3/18 at 9:44 pm
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