Determining Your Marginal Tax Rate

From Mike Piper & The Oblivious Investor we read the following Question & Answer:
“I’m a recent grad, with my first real job and am learning about taxes for the first time. I understand that knowing my ‘marginal tax rate’ is very important for many decisions. But from what you’ve written recently, it sounds like there’s a lot more to it than just tax brackets, correct? And do you have any tips for determining what my actual marginal tax rate is other than just looking at my tax bracket?”

You’re right that there are many factors that can cause your marginal tax rate to be something other than just the tax bracket you’re in. For example (and, to be clear, this is not an exhaustive list):

• Once your adjusted gross income exceeds (for 2013) $29,500 if single or $59,000 if married filing jointly, you lose eligibility for the Retirement Savings Contribution Credit,
• Once your “household income” exceeds 400% of the federal poverty level, you lose eligibility for the Affordable Care Act subsidies (tax credits) for people purchasing health insurance via one of the new exchanges,
• Once your adjusted gross income exceeds (for 2013) $250,000 if single or $300,000 if married filing jointly, the personal exemption phaseout and limitation on itemized deductions come into play,
• Once your “combined income” exceeds $25,000 ($32,000 if married filing jointly), Social Security benefits begin to be (partially) taxable,
• Qualified dividends and long-term capital gains go from being untaxed to being taxed at 15% once they fall into the 25% (or greater) tax bracket, and they’re taxed at 20% if they fall into the new 39.6% tax bracket, and
• Once your modified adjusted gross income exceeds $200,000 if single or $250,000 if married filing jointly, the 3.8% tax on net investment income comes into play.

In other words, there are a number of taxes that appear and tax credits/deductions that disappear as your income crosses various thresholds or travels through certain ranges, thereby causing your marginal tax rate to be higher than just your tax bracket as your income travels through those ranges or across those thresholds.

Unfortunately, this is not the sort of thing that lends itself to fast and easy modeling in a spreadsheet, given that these various calculations aren’t all based on the same measurement of income. That is, some are based on taxable income. Some are based on adjusted gross income. Some are based on varying definitions of modified adjusted gross income. One is based on “combined income.” And one is based on “household income.”

One of the best methods for figuring out your marginal tax rate is to plug your information into your favorite tax prep software and try fiddling with the numbers a bit. For example, try bumping your income up or down in increments of $500 or $1,000 and see if your total tax changes by something other than just your tax bracket multiplied by the change in income.

Unfortunately, even this isn’t perfect, because tax laws change from year to year. For example, plugging your current information into a 2012 edition of a tax preparation product will not necessarily give you your correct marginal tax rate for 2013, given that the software doesn’t apply the various new rules that have come into effect in 2013 (e.g., the 3.8% net investment income tax). So to be really sure about your analysis, you need to keep abreast of tax law changes each year so that, if necessary, you can make manual adjustments to what the software is telling you.

Business and Independent Contractor Tax Deductions Grow in Importance as Obamacare Looms

From Firmology we read: or small businesses and independent contractors, taking full advantage of allowable tax deductions is becoming increasingly important.  This week, the US Court of Appeals for the Fourth Circuit in Virginia upheld Obamacare’s employer mandate as constitutional. 

Although businesses won’t be required to provide health insurance for their employees until 2015 (the Obama administration chose to delay this key provision), critics argue that the White House’s move is illegal: Congress passed the healthcare law stating that the employer mandate must begin in 2014.

Under this new requirement, businesses with more than 50 employees must offer their workers affordable health insurance or pay a penalty to the Internal Revenue Service (IRS).  However, many small businesses are expected to circumvent Obamacare by simply laying off full-time employees and assigning many of the same individuals part-time work in order to stay under the magic number of 50.

Temp Workers

Staffing agencies across the nation are seeing high growth in business because of Obamacare.  Companies are planning to hire more part-time workers, such as temps or seasonal employees, and independent contractors in order to avoid higher healthcare costs and to avoid paying Obamacare-related fines to the IRS.

As millions of taxpayers transition from being full-time employees to independent contractors, they’ll need to familiarize themselves with the IRS’ filing requirements, especially with the 1099-MISC form.

Filing a 1099-MISC is required if a freelancer, small business, or independent contractor earns more than $600 in a calendar year.  More individuals will need to understand what expenses are tax-deductible on their Schedule Cs.

Items such as the home office deduction, office supplies, fuel expenses, cellphone bills, work equipment, subscriptions, and utilities could be tax deductible expenses if they are necessary business expenses.  Failure to keep receipts and list such expenses would result in higher tax bills for millions of Americans, including those who shift to part-time work as contractors or freelancers.

Contractors and Tax Filing

More than 80% of taxpayers file electronically.  If a small business files a 1099 and has filed more than 250 records per year, the IRS requires you to file the tax returns over the Internet.

“[By e-filing], you import in all your data from Excel, [then] review and create the file for transmission,” says Erich Ruth of 1099fire.com, a tax software firm based in Arizona. “[Alternatively], when you mail in the red-ink forms, there is a certain hope that [the IRS] received the forms and everything is okay.”

Administrative and regulatory requirements should also become much more expensive for many taxpayers as Obamacare gets implemented.  Assessment and collection of the fines will be managed by the IRS.

“With a 1099 form, you have to print and mail Copy B to the recipients by the end of January. That is a lot of work and expensive,” says Ruth.  “Stamps cost money along with envelopes, paper, folding, stuffing, sealing and mailing. A really good question is: ‘Will the IRS ever make it possible to distribute these forms in a way other than mailing because mail is expensive?’  They are just starting to consider emailing options if the recipient signs off that they will accept files this way.”

Some who have snail mailed their tax-information get letters from the IRS stating that their returns are incomplete.  This costs time and money.  Taxpayers who e-file their 1099s often use software that have built-in tools advising the user what information are needed.

LivePlan Integrates with QuickBooks in the Cloud

Michael Cohn for Accounting Today writes: Palo Alto Software has launched a service to integrate QuickBooks data with the company’s LivePlan software to allow accountants to remotely monitor the performance of a client's business.

The service provides access to QuickBooks data in the cloud so accountants can monitor their business clients’ financial performance, as well as help them with budgeting and forecasting. Users can sync their QuickBooks account to LivePlan to get real-time access to key accounting data at any time from a mobile device, allowing them to track sales and expenses against a business plan and make business decisions.

The LivePlan Scoreboard feature enables accountants and their clients to leverage profit centers within a business, identify and correct loss centers, and monitor payables and receivables in order to improve the business’s overall financial performance.

Accountants and their clients can collaborate online to build a budget and sales forecast, and then automatically bring in actual financial results by syncing with their QuickBooks data. Accountants can also advise their clients by posting comments in LivePlan to help them focus on their key performance indicators.

From GetApp we read Rakesh Sharma take on LivePlan:

Most small businesses start with an idea. Business plans add contours and a concrete road map to the idea. Writing a business plan, however, is easier said than done. The task is both arduous and confusing.  This week, we will look at a solution that simplifies this task.
We will review LivePlan – a SaaS solution that simplifies business plan writing for small businesses and startups. We will look at its features, interface, and see how it can be of use to you.

Planning Your Business With LivePlan

The key to working with LivePlan is to understand its approach to business plans. LivePlan deconstructs business plans into constituent parts and enables you to think about your business from the ground up. This approach can be extremely useful for individuals interested in starting a small business as it helps clarify their thought process and focus on the really important elements of your idea.

LivePlan breaks down your business plan into four elements. These elements are reflected in the individual tabs on the interface. They are as follows:

• Pitch: This module enables you to craft custom pitches for investors. It provides a snapshot of your company to investors, including a high-level view of your finances. Each pitch is further broken down into elements such as business model being used, target market, competitive landscape and team.
• Plan: This module delves into the details of your plan. It provides an executive summary of your company and provides additional color regarding metrics. For example, this section details your sales forecasts and projected revenue. In addition, you can also add appendix information (not otherwise covered in standard business plans or in the plan template) in this plan.
• Schedule: This module helps you on track with your stated goals. Thus, you can add milestones, notes, and reminders to yourself using this tool. In addition, you can send emails to yourself and others using this tool.
• Scoreboard: This module takes care of all budgeting and forecasting and tracks your actual performance vis-à-vis your stated plans. It also integrates with third-party solutions such as QuickBooks and displays them into simple easy-to-use formats.

Within each module, LivePlan asks users a set of questions designed to find out more about your plan through entered text and numbers. Then, the solution extrapolates these responses (and numbers) into essential figures that an investor expects to see in a business plan. I especially like the fact that it enables you to do this without complicated spreadsheet formulae. For example, you can generate sales forecasts or projected cash flow statements using LivePlan merely by entering specific information and numbers. 

  In case you are still confused or unable to answer questions relating to your business idea, LivePlan incorporates examples in its feature list. I thought this was one of the most useful features of the solution. Simply, you can embed examples from previous users for inspiration into your business plan. LivePlan also bundles XpertAccess, a module that provides access to experienced entrepreneurs, and a free eBook by small business expert Tim Berry along with its pricing.

Why LivePlan Works For Entrepreneurs

There are several reasons to like the tool. Prime among them is its focus on simplifying a complex and time-consuming task. Reducing a business plan to a simple set of instructions helps you think strategically about your business. Added to these benefits are the pluses of cloud technology that enable collaboration regardless of geography or system.
You can do several things using the solution, including simplify complicated math, visualize your finances, and also, perform lean project management using the Schedule feature. Expert access and freebies such as eBooks only make a further case for LivePlan. Another site www.bplans.com provides free guidance, content and advice from their stable of entrepreneurs. They also have a regularly-scheduled Webinar series that helps first-time entrepreneurs gain a better understanding of risks involved in entrepreneurship.

Is It For You?

As someone who is very interested in entrepreneurship, I think LivePlan is an excellent solution. It provides users with a crash course in business planning. What I liked most about the solution is that it implements focus and rigor to your idea so that it can withstand scrutiny from investors.

How to Reduce Your Tax Liability in 2013

Ellen Chang for MainSt. writes:  Single taxpayers have several options to reduce their tax liability each year, enabling them to save more money. If purchasing a house is not in your immediate plans, tax professionals recommend various methods to lower the amount you pay to the IRS annually.

Investors should take advantage of their employee retirement plans, which are commonly known as 401(k)s or 403(b)s, said Michelle Mullen, a CPA with Briggs & Veselka Co., based in Houston, Tex. The money invested into a 401(k) or 403(b) is tax deferred, which means you do not have to pay taxes on the amount until you reach retirement age and make a withdrawal. The 2013 limit for contributions is $17,500.

Even allocating as little as 3% of your salary into a 401(k) plan adds up quickly, but Mullen suggests stashing away 15% of your salary.

"I recommend that investors save absolutely as much as they can afford," she said. "If you form a savings habit early when you are not making that much money, you won't miss it. Start now. Every little bit counts. If you are already established in your career, it's never too late to start saving and tax planning."

Some companies encourage you to save more money by matching your contributions, which maximizes your savings.

"The first rule is to take advantage of your employer retirement plan," Mullen said. "If you are single without any dependents, you are likely to be in the 25% tax bracket. It is absolutely crazy to pass it up, especially if an employer matches your contributions, which is free money."

Some companies offer a Roth 401(k). Although you don't get a deduction for your contributions, the funds you withdraw when you reach retirement age will be tax free, said Ed Gardner, a CPA and CFP at Edward M. Gardner PC, based in Houston.

Some companies offer both options to put funds into a 401(k) or a Roth 401(k). If you feel that you will be in a higher tax bracket when you retire, a Roth 401(k) contribution might be a good choice.

Another priority is to take advantage of your company's health savings account (HSA). These accounts allow you to allocate a portion of your salary that has not been taxed for medical purposes such as your co-payment during a doctor's visit or for prescription drugs. In order to qualify for a HSA, you must be covered by a high-deductible health plan.

If your medical or prescription bill tallies up to $100, it will cost you only $75, because you would have received a $25 tax benefit, assuming a 25% tax bracket, from contributing the $100 to HSA, said Mullen. The maximum a single person can contribute to a HSA for 2013 is $3,250 which includes employer contributions.

While some investors are "nervous about saving too much," the HSA is a "portable" investment vehicle, she said. This allows you to move the account to your next employer.

While receiving a tax credit for buying a hybrid vehicle is no longer an option because the automakers reached the limit set by the U.S. government, there are credits for those buying a plug-in electric car that can be as high as $7,500 depending on the model and your tax liability, Mullen said.

Single taxpayers have an advantage by choosing where they want to work and live. Relocating to one of the seven states that do not collect an individual state income tax can be an added bonus. If you get a job offer from Texas, Alaska, Florida, Nevada, South Dakota, Washington or Wyoming, it might be worth considering a move to one of those states. You can also deduct the costs of your move, such as hotels, gasoline, mileage and paying for tolls, said Corinne Hillman Vahalik, an attorney at Vahalik & Vahalik, P.C., which based in Brookshire.

If you are not living in one of those seven states, you can lower your tax bill by investing in tax free bonds in your retirement accounts or other tax-free income investments, said Vahalik.

"This option will typically generate a lower rate of income than more aggressive investments, but the investor does not have the tax liability on the earnings," she said.

Some employees who work for multi-national corporations have the opportunity to work abroad. You may be eligible to exclude up to $97,600 of your income and avoid paying federal tax on that portion of your earnings, said Mullen. Some countries abroad do not collect income tax. Another added benefit is that your company may pay all or a portion of your living expenses.

"Don't move for purely for that reason, but it is a good factor to consider," she said.

If you are still paying off student loans, you can deduct the interest you are paying of up to $2,500 per year, depending on your income level, said Vahalik.

Another option is to see if your company offers the educational assistance tax program. If you are taking courses, companies can give their employees up to $5,250 for free each year, said Gardner. Since this amount does not appear as part of your salary, you are not taxed for it.

Educators can deduct what they spend for supplies and other materials for the classroom. Even if you don't itemize, you can deduct up to $250 for those expenses, said Vahalik.

If you are dabbling in a side business, any net earnings over $400 are taxed, she said.

"While all income should be evaluated if you are self-employed, the very small side businesses may not generate self-employment tax," Vahalik said.

If you are searching for a job, any of costs incurred in the hunt can also be deducted.

Before next year rolls around and it is time to file your taxes again, examine whether your tax refund is too high, said Gardner. Instead, adjust your withholdings so you "increase your take home pay so you are not giving extra money to the government. Use the money to pay off credit cards or save it in a tax-free account."

If you are planning on making contributions to your favorite non-profit, consider doubling your donation this year instead of splitting it into the next two years, he said.

Donating stock to a non-profit is another option to lower your tax liability because you can deduct the value of the stock and any gains it has received, Gardner said. Otherwise, when you sell the stock, you incur a capital gains tax and are "giving up money," he said.

Homeowners who are making upgrades have several options. If you purchase alternative energy equipment such as solar hot water heaters, geothermal heat pumps or wind turbines can receive a 30% credit on the cost of equipment, Gardner said.

If you are purchasing double-paned windows, installation or energy efficient doors or an air conditioner, the energy credits have been extended through 2013 for a maximum lifetime credit of $500, he said.

The middle of the year is a good time to look at your return from last year and examine your deductions, Gardner said. Or talk to a tax advisor who can make recommendations on how to lower your tax liability since all contributions, donations and purchases must be made by the end of December.

"Get into a positive habit of gathering tax information on a regular basis, so you can find more deductions with better records," he said. "It all adds up and you can easily save $100 on your taxes. If you want to save on taxes, keep better records."

Midyear Tax Planning: Drum Up More Business

 Ken Berry for AccountingWeb writes:  The summer doldrums have set in. Aside from the occasional "emergency," your office is quiet, as most clients pursue outdoor activities and tend to personal business. Tax planning is probably the last thing on their minds. 

But it doesn't have to be that way. You can give your tax practice a needed shot of adrenalin – and boost the bottom line in the process – by reaching out to clients via a timely notice. What will start the juices flowing? Alert your clients to the need for midyear tax planning. For instance, you can send e-mails, postcards, or other communications to your client database, pointing out various tax planning strategies that may be beneficial during the summer months. Most likely, your clients will appreciate the information and might contact you for more details. 

Why should you focus on midyear planning? All too often, tax planning is relegated to the end of the year. By then, it may be too late to take meaningful action, while certain tax breaks are geared toward summertime activities. In that vein, here are several worthwhile ideas to pitch to individual and business clients at this time.

Midyear Ideas for Individuals

Harvest capital losses. Don't get "boxed in" at the end of the year. Reap tax benefits early by realizing capital losses to offset capital gains plus up to $3,000 of highly taxed ordinary income. On the flip side, capital gains realized now may be absorbed by prior losses. Under the new American Taxpayer Relief Act (ATRA), the maximum tax rate on net long-term capital gain remains 15 percent in 2013 but increases to 20 percent for certain upper-income taxpayers.

Rake in charitable deductions. Are you cleaning out the basement, attic, or garage this summer? Whether its gardening tools or used clothing or furniture, you can write off the cost of items donated to a qualified charity as long as they're in good condition. The deduction is based on the property's current fair market value. Many organizations, including the Salvation Army, provide guidelines to follow.

Generate an energy credit. ATRA revived the residential energy credit and extended it through 2013. The credit, which is generally equal to 10 percent of the cost, is available for a wide variety of energy-saving improvements. However, be aware that certain restrictions apply, including a lifetime maximum cap of $500.

Dodge the "wash sale" rule. Under the wash sale rule, you can't deduct a loss from the sale of securities if you reacquire "substantially identical" securities within thirty days of the sale. To avert this result, you might (1) wait at least thirty-one days to buy back comparable securities, or (2) acquire the comparable securities first and wait at least thirty-one days to sell the original shares. Making this decision at midyear should give you ample time to secure a loss for 2013.

Minimize personal use of vacation homes. If you rent out a vacation home, you can generally use expenses to offset taxable income from the rental. However, you can't claim a loss from the activity if your personal use of the home exceeds the greater of fourteen days or 10 percent of the time the home is rented out. Watch out for this limit if you plan on taking an end-of-summer vacation at your home.

Midyear Ideas for Businesses

Load up on new equipment. Thanks to extensions by ATRA, there are two key tax incentives for acquiring qualified business property before 2014. Under Section 179 of the tax code, a business may currently deduct up to $500,000 of qualified business property placed in service this year (subject to a phase-out threshold of $2 million). In addition to the Section 179 deduction, 50 percent bonus depreciation is available for qualified property. Remember that property must be placed in service in 2013, so give yourself enough time.

Take off business travel expenses. When you travel away from home, you may deduct your travel expenses – including airfare or other transportation costs, lodging, and 50 percent of your meals – as long as the "primary purpose" of the trip is business related. Naturally, you might have some downtime relaxing, but spending more time on business activities is critical. Note that the cost of personal pursuits is nondeductible.

Employ special hiring credits. ATRA also revived the Work Opportunity Tax Credit (WOTC), available for hiring workers from several "target groups," and extended it through 2013. The maximum WOTC is generally $2,400 per qualified worker. Furthermore, a business may qualify for a credit for hiring disadvantaged teens in the summer, up to a maximum of $750 per worker.

Score summer entertainment deductions. If you treat a client to a round of golf at the local club or course, you may deduct qualified expenses – such as greens fees, club rentals, and 50 percent of your meals and drinks at the nineteenth hole – as long as you hold a "substantial business meeting" with the client before or after the golf outing. The discussion may take place the day before or after the entertainment if the client is from out of state.

Of course, every situation is different, so you might decide to tailor your communications to the specific needs of your clients. This "extra touch" will show those clients how much you care and with further strengthen existing relationships. At the very least, don't just sit back and wait for more business to come to you – be proactive!

A Beginner’s Guide to Picking 401k Funds / Most plans offer differently named funds, but the flavors are similar

Jeff Reeves, Editor of InvestorPlace.com  writes: 401k investing is the most common way for young investors to get involved with retirement savings. But the problem with 401ks is that every employer has its own plan, with its own list of mutual funds to pick from.
That makes it very difficult for young investors to know what to pick, because similar funds can look very different depending on how they are named or the jargon used in your benefits kit.

So here’s a simple primer on five major flavors of funds you’ll have to pick from:

Stock Funds

These cover a host of stock types — there are funds that focus on smaller stocks, funds that focus on large and established stocks, funds that focus on international stocks — so they can be confusing. But take the time to explore the various stock funds in your 401k because young investors should place the lion’s share of their retirement funds here.
A general rule of thumb for the average investor is to take 100, then subtract your age — that’s your stock allocation for your portfolio. So if you’re a young investor around 30, you should be 70% in stocks and 30% in bonds, typically. If you’re more aggressive, you might want even less than that in bonds to grow your money faster.

How to allocate that money around the stock universe is simple: Stick with large, U.S.-based stocks to play it safe or dabble in smaller stocks or international picks depending on how aggressive you are. Most 401ks only offer a handful of stock funds to choose from, so selecting funds in this category shouldn’t be hard — just look at expenses (lower is better) and long-term returns (higher is better) to find the best fit.

Target-Date Funds

A no-fuss way to invest, target-date 401k funds tend to have a year in them — say, 2030 or 2045 — and this is theoretically the “target date” for your retirement. These funds are simple and adjust your asset allocation over time, so there’s no need to rebalance on your own — making them a maintenance-free way to invest. However, sometimes expenses and fees can be higher than the alternatives, so watch out for costs.

And remember: These target funds are one-size-fits-all — so if you want to take a little less risk or be a little more aggressive, these vehicles are inflexible and might not be for you. But hey, something is better than nothing.

Blended-Fund Investments

This is like a target-date fund in that it blends stocks and bonds. But unlike a target date fund, these investments have a set ratio of stocks (more risky with higher returns) and bonds (less risky and lower returns).

Going back to the age rule discussed above, if you’re a young investor around 30, it is likely a bad idea to put your cash in a blended fund that is split 50/50 between stocks and bonds. Based on your age and the amount of money you need to have by retirement, that strategy is too conservative and won’t grow your money fast enough. Pay close attention to the blending ratio to see if these sound right for you — as well as the expenses that come with managing a portfolio mixed between stocks and bonds.

Bonds/Managed Income

These are typically “capital preservation” instruments, meant to safeguard money rather than grow it. If you’re older than 50 and have a decent nest egg, managed-income funds are a good way to grow your money a little bit and protect it from losses. But if you’re younger and are a long way from your retirement savings goal, you can’t afford to only make a few percentage points per year, or you’ll never have enough to retire.
Remember this — because parents frequently recommend their kids allocate a decent amount to bonds in their first 401k because that’s where they are in their retirement planning. Your finances and goals are much different, and if you’re under 40, it’s unlikely bonds and managed income should play a large role in your portfolio.

Money Market Funds

A money market fund is essentially a glorified CD, and an alternative to cash. The only circumstances where it makes sense to your money here is if you have achieved your retirement goals and simply are looking for a safe place to park your cash — because there is zero growth here. Returns of about 1% a year mean that money market funds barely keep up with inflation — so if you want to grow your money instead of just socking it away, avoid money market funds.

Which is better: 401k or a pension? / Managed correctly and over a sufficiently long haul, 401k's can produce more money at retirement than traditional private-sector pension plans, new research suggests, though the risks are obviously higher.

Andrea Coombs for MarketWatch writes:    Most people bemoan the loss of the traditional pension plan, and they cite its disappearance -- and the rise of the save-it-yourself 401k -- as key factors in the retirement crisis facing American workers. But new research suggests the new kid on the block is not to blame.

In fact, workers with 401k's in some cases are likelier to end up with more money at retirement than they would with a traditional private-sector pension plan, according to a study by the Employee Benefit Research Institute, a nonpartisan think tank in Washington.

Some people "have termed 401k's a failed experiment," said Jack VanDerhei, a research director at EBRI and author of the report.

"But it's just not what the evidence is suggesting," he said.

For example, lower-income workers who are now aged 25 to 29 and who remain eligible for their retirement plan for 30 to 40 years end up with a 15 percentage point higher income-replacement rate at retirement with a 401k than with a traditional pension plan, according to the study's median finding for that scenario.

"Replacement rate" means the percentage of annual income they'd be able to create from their account balance at retirement. (As an example, unrelated to the study, 80% of income is replaced versus 65%.)

A 401k is even more valuable for higher-income workers, the study shows.

Under the same scenario as above, but looking at workers who earn more, the difference in income replacement rates at retirement rises to 21 and 30 percentage points more for 401k's over pension plans, at the median, for people at the next two income quartiles.

Pension Money Mistake

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The study found a hefty 44 percentage-point gain in favor of 401k's for workers at the highest income level, according to the median finding for the above scenario.

In the above scenarios, the EBRI study assumed historical rates of return on an equities and bond portfolio, and historical annuity costs. (In order to compare 401k's to traditional pension payouts, the research assumes that retirees purchase annuities at age 65.)

The report is based on data for more than 2 million plan participants, and accounts for the fact that not all people who have a 401k choose to save money in it.

If the study focused only on those who save, VanDerhei said, "that would clearly alter this and 401k plans would always do much better, especially for low-income workers."

Devilish details

But if you reduce the assumed rate of return, the traditional pension starts to look better for lower-income people, the study found.

For example, when the rate of return is decreased by 200 basis points, a 25- to 29-year old lower-income worker who is eligible for a plan for 30 to 40 years would see his income replacement rate at retirement with a 401k plan drop to 4 percentage points lower than he would have enjoyed with a pension plan, at the median.

For the next highest income group in the above scenario, their replacement rate with the 401k would be 1 percentage point less than with a traditional pension.

However, for the two highest-income groups, the 401k is still better: that plan provides a 6 percentage point and 15 percentage point replacement-rate benefit over the pension, at the median, even when a lower rate of return is assumed.

And combining the lower-return assumption with a higher-cost annuity assumption (reflecting the current low-interest-rate environment, which is substantially different from recent history), then traditional pensions look even better.

Who's paying?

Also worth noting: Workers, of course, contribute to their 401k out of their own pocket, unlike the traditional pension plan, which is fully funded by the employer.

"There are different financing streams going on here, I admit that," VanDerhei said.
His focus was, he said, "from a retirement-income adequacy standpoint, which of these two [types of plans] seems to be providing larger retirement account balances?"
than he would have enjoyed with a pension plan, at the median.

He added: "The sole objective was to look at: 'Is Plan A or Plan B providing a larger source of retirement funds at age 65, not adjusting for how those are financed?"
In an ideal world, VanDerhei said, workers would have access to both a traditional pension and a 401k or similar defined-contribution plan.

Pension Money Mistake

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"If you have both," he said, "then obviously you have less employee investment risk, you have less employee longevity risk and you still are giving employees the upside if they choose to participate in the 401k plan."

In his study, VanDerhei points to previous research that came to a similar conclusion: In many cases, retirement savers ended up with more money under a 401k than they did with a traditional pension plan. See the full EBRI report.

What was left out

The study is based on a robust sample of more than 2 million people. "I know what they're doing in their 401k plan. I know their salaries," VanDerhei said.

"Given the specific set of job changes and wage paths that I assumed for them under the 401k, I did the exactly same person, exactly same assumptions, and said: 'What would you end up with if you had a [traditional pension] plan?'" he said. "If you really do want to have a direct comparison of Plan A versus Plan B, I think it's helpful to actually track the same person under the two plans, and do the person by person comparison."

This study does not include workers who are automatically enrolled into their 401k by employers, though he said that would likely push the results even more in favor of such plans.
Also, the data looked at private-sector pension plans. It did not include public-sector plans. Doing so would have pushed the data more in favor of pensions.

"I can promise you I would get much different results had I done a public defined-benefit as opposed to a private defined-benefit comparison," VanDerhei said.

Public pension plans -- those offered by government entities -- generally offer more generous benefits than private-sector plans, and usually include cost-of-living adjustments in retirement.