Choosing Between Pension and 401k: A Financial Guide

Rob should weigh the benefits of a 5% matched contribution against the promises of a pension to maximize his financial future.

### Choosing Between Pension and 401k: A Guide for New Graduates
* 💼 Rob, a new graduate, is faced with the choice between a **pension** and a **401k-like plan with a 5% match** at his state agency, prompting a discussion on the differences between **defined contribution** and **defined benefit plans**.
* 📊 Defined contribution plans, like the 401k, offer **no guarantees on the future value of investments**, placing the responsibility of growth on the individual, while defined benefit plans, or pensions, promise a **specific benefit based on tenure and salary**, with the employer bearing the **investment risk**.
* 💡 For young individuals like Rob who are disciplined in saving and investing, the defined contribution plan can be advantageous due to the **potential for significant growth**, especially if funds are **invested wisely over time**.
* 💰 It's essential to evaluate the value of the employer's **pension promise** against the **5% match** from the defined contribution plan, weighing the benefits of each option to determine which aligns better with **personal financial goals**.
* 🔍 Additionally, if Rob opts for the defined contribution plan, he should **maximize contributions to his HSA and IRA**, potentially creating a **diversified investment strategy** that combines both **immediate benefits and future security**.
* 📉 Before making a decision, it's crucial to investigate the funding status of the pension plan to ensure it is **not underfunded**, as this could indicate a **risk of not receiving the promised benefits** in the future.
* 🔄 Lastly, for those nearing retirement, the decision between taking a lump sum or annuitizing a pension also involves **careful mathematical calculations** to determine the **best financial outcome**, emphasizing the **importance of opportunity cost** in financial planning.

[Music] all right. This is from Rob. Rob said, I'm a new grad, and I'm just starting in my career working at a state agency. We are required - now this is interesting - I thought to choose between a pension or a 401k-like plan with a 5% match. Which one should I choose? Thank you. So, it sounds like at this agency, I can either do a defined contribution plan or I can do a defined benefit plan. Well, if I'm in Rob's situation, first, can you tell me a little bit about what's the difference between the two? And when I think about building for my wealth-building journey, how do I know which one makes the most sense for me? Yeah, this is going to be fun with math with Rob because defined contributions are plans where they don't know where your money is going or what it will be worth. There's no guarantees on that. It's up to you to kind of put the money to work, to invest it, and let it grow. So

the only thing that's defined is that they're going to contribute. They're going to give you a matching contribution, it sounds like in your case 5%. So, this could be an outstanding thing if you think about money that was invested in the 80s or 90s, like into the S&P 500, is worth like it will blow your mind if you go see what $10,000 has become if you invested in 1980, and then fast forward through a typical working career, and you're like, Wow, that's amazing that that sum of money has exploded into wealth. So, in that case, you'd be like, That's an awesome deal. I'd want to take the defined contribution. The defined benefit, which is what the pension is, means that they put limits. They're actually, they're taking your employer, taking on the responsibility of what the money will become because they're promising you the benefit upon that passage of time, meaning that they're bearing the risk of

actually what's going on in that investment. So, that means that we've got a math problem here, Bo, and there's going to be multiple variables where you have to figure out which one do I think is better for me. And there's several things. I'll give a few clues and let you kind of close it out. I think a young person, this is something when, if you know in yourself that you're going to be consistent, that you're dedicated and disciplined to saving and investing. You know, the defined contribution is tremendously valuable because you know you are the master of the domain of how you're investing and what is going to become. For those of you who struggle with that discipline and just don't think you'll put in enough money, and you need to back into what is the promise they're offering you. Because if it's something amazing where you do the math, you back into what you would have to actually make as a rate of return, and you realize, Oh my God, they're over

promising this is the best thing since sliced bread. You could take advantage of that and then go still load up your WTH and all the other things. That's what I was going to say. I'm trying to, I'm working with my girls right now on like opportunity cost. I'm trying to teach them the difference like if I choose one thing, I'm giving up another. And I'm trying to like get their head to wrap around that. What I love is when you can keep options in your corner. And what I think is great when you have this choice between a defined benefit or defined contribution plan. If you forgo the defined benefit and you do the defined contribution, yes, you're going to get this 5% match, which is amazing. But there's not really anything inside of your ecosystem that allows you to go create that pensionable benefit outside of like Social Security. It's the only other thing that exists that will allow you to do that. What I think would be really interesting, again, you have to do

the math because you have to see, okay, how valuable is the promise they're giving me versus that 5% free money that they're giving me, and I have to weigh those two. But once I've made that decision, if the opinion is interesting, I might take advantage of that because I won't be able to recreate that thing in the future. But then in addition, just like you said, I'm going to be saving like a banshee. I'm going to go max out my HSA, max out my IRA. If I do all that well, then I'm going to open up a taxable brokerage account, and I'm going to have a Best of Both Worlds. I'm going to definitely contribute to my future, but I'm also going to have a benefit that's built in for the future. I think it's possible to potentially do Best of Both Worlds, and here's a little extra bonus point just to measure twice, cut once on this. If you find out that the pension is super rich, meaning it's like over

promised, and you're like, How in the world can they do this? You do have a next step you need to do. You need to go find out how well-funded the pension is and if it's grossly underfunded. That still might not mean that you still do it, but you just need to go see how close your projected benefit is to the pension benefit guarantee corporation's protections. Yep, um, because that is one of those things where there's a lot of pensions out there where people were over-promised, and then if you get way beyond what the government is going to protect or, you know, with that benefit pension benefit guarantee corporation, um, you might be really getting a false promise. So just do that extra step. And then I want to flip this because Rob is actually a new grad. He's at the beginning, so he really does have the dilemma of trying to figure out what will become of the assets and investing. But there's a lot of you out there that will also be approaching retirement and

you'll come to us and you'll call us and you'll say, Hey um, I can either take a lump sum or I can actually annuitize my pension and turn it in. What should I do? And I think you guys think that there's just going to be a rule of thumb that you just choose this always the same way, and it's not every time. It is a math calculation where we have to calculate what are the benefits that they're offering you with the pension, what does that equate to with the lump sum, so you can kind of then, you know, handicap which is the better deal. It's back to Bose's opportunity cost or incremental decision-making, which path is actually going to be the best opportunity for you to maximize your financial future.

Pension vs. 401(k): What’s the Best Choice for New Grads?

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The Money Guy Show

Choosing Between a Pension and a 401k-like Plan

Rob, a new grad at a state agency, has to choose between a pension and a 401k-like plan with a 5% match.

Defined contribution plans, like the 401k, offer no guarantees on the money's growth and depend on the individual's investment decisions.

On the other hand, defined benefit plans, like a pension, promise a specific benefit over time and place the risk on the employer.

Navigating Investment Choices: Defined Benefit vs.

Choosing between a defined benefit and a defined contribution plan involves multiple variables and personal discipline in saving and investing.

A defined contribution plan is valuable for those who are consistent and dedicated, while the defined benefit plan may offer a promising return.

It's important to understand opportunity cost and keep options open, as the defined contribution plan can provide a 5% match but may lack other pensionable benefits.

Balancing Financial Decisions: Promises vs.

Weigh the value of promised benefits against free money offers when making financial decisions.

Maximize contributions to HSAs and IRAs, and consider opening a taxable brokerage account for a balanced approach to future savings.

It's important to assess the funding status of pensions and their alignment with government protections to avoid false promises.

Choosing Between a Lump Sum and Annuity for Your Pension

Deciding between a lump sum and annuitizing a pension is not a one-size-fits-all choice.

It requires a mathematical calculation to compare the benefits of the pension with the lump sum offered.

The decision should be based on opportunity cost and incremental decision-making to determine the best path for maximizing your financial future.