Pension vs. 401(k) Plans: What’s The Difference?

Key Takeaways


The best tip when planning a successful retirement is to start saving as early as possible. In many cases, this means taking advantage of an employer-sponsored retirement plan early on in your career. Most companies will offer only one type of account, but with younger generations switching jobs more frequently than ever before it is a good idea to familiarize yourself with what else is out there.

A pension and 401(k) are among the most common types of retirement accounts you may encounter. While they both aim to provide financial stability in retirement, there are pros and cons associated with each type. Keep reading to learn more about a pension vs 401(k) and find out which might be better for you.

What Is A Pension Plan?

A pension plan is an employer-provided retirement income that is typically provided once employees work for a set number of years. The amount offered in a pension is calculated by looking at an employee’s salary and number of years in the organization. Pensions are 100 percent employer-funded, meaning employees do not have to contribute to the account to receive the income in retirement. Employers who offer pensions will typically set aside a set amount of funds during the time the employee is working — once they reach retirement age the funds become accessible through a monthly income (or in certain cases, a lump sum payment).

Pensions are most commonly offered to government employees and public servants, such as teachers, police offers, members of the military, and utility workers. They are unfortunately less widespread among private companies today than they were in previous decades. This is due to the high costs associated with supporting a worker through retirement. Though, some employers do still offer pensions as a way to increase employee retention within a company. According to US News, about 17 percent of private companies currently offer pensions.


[ Do you control your finances or are your finances controlling you? Register to attend our FREE online real estate class and find out how real estate investing can put you on the path toward financial independence. ]


401k vs pension

What Is A 401(k)?

A 401(k) is an account that allows employees to contribute their pre-taxed income to a future retirement fund. In some cases, employers will match employee contributions up to a certain amount. This amount is determined as a percentage of an employee’s annual salary. Employees are often encouraged to reach the max contribution amount each year so they can increase their retirement funds as much as possible. 401(k) plans typically come with a few different investment options, allowing the money to grow within the account. These options will vary from employer to employer, but most commonly include mutual funds.

The biggest benefit of a 401(k) is thought to be the tax-deferred status of contributions. Once an employee opens an account, they set the amount they want to add directly from each paycheck. These contributions are made before taxes are applied, thus reducing their overall taxable income. The funds in a 401(k) are then taxed once you reach retirement age — at which point you will most likely be in a lower tax bracket than before. Funds from a 401(k) can be withdrawn as soon as you turn 55.

Pension vs. 401(k): Key Differences

A pension and 401(k) are two of the most well-known retirement accounts available today. While they both offer the benefit of securing retirement income, there are several key differences to keep in mind. Read through the following list to get a better look at a pension plan vs 401(k):

  • Contributions: A pension plan is completely funded by employers, while 401(k) plans rely heavily on employee contributions. For this reason, pensions are thought to be highly desirable, despite requiring a minimum number of years at the job.

  • Account Control: Account holders can choose how to invest and withdraw the funds of a 401(k), while pensions are completely controlled by your employer. This provides 401(k) account holders the opportunity to choose how their funds are invested.

  • Length of Benefits: 401(k) plans only last as long as the money in the account lasts. Unfortunately, it is not uncommon for individuals to fail to save enough for retirement. Pensions, on the other hand, are guaranteed for the rest of someone’s life.

Can You Have Both A Pension And A 401(k)?

You can have both a pension and a 401(k) if you have worked for an employer that provides each of these retirement accounts. For example, you could work at a private company that offers a 401(k) after one year of employment. Let’s say you work at the company for a year and open the 401(k). You then decide to leave your job for a government position. In this position you are offered a pension after working for 40 years — at this point, you would be eligible for a pension while still having your previous 401(k) account available.

Opening more than one retirement account is generally thought to be a beneficial strategy. Although, it can be difficult to obtain both a pension and a 401(k) because they are both employer-sponsored. If you have a pension or 401(k) and are interested in bolstering your retirement savings, consider looking into an IRA as another option. You can combine as many retirement saving strategies as you want, just make sure to choose the right options for your needs.

pension plan vs 401k

Is A 401k Or A Pension Plan Better?

Deciding whether a pension or 401(k) plan is better will depend on what your goals are for both your career and retirement. Most workers do not have a choice in the retirement plan their employer provides, however, this information can be useful if you are deciding between job offers or perhaps starting a business yourself. Here are a few things to consider as you weigh the benefits of a pension vs 401(k):

  • Pensions Risk Being Underfunded: Employers control how much to add to a pension fund, which in some cases can lead to pensions being underfunded. This risk is especially high during periods of economic downturn, as most pensions are provided by governmental agencies. With a 401(k) the responsibility to plan ahead is entirely in your hands.

  • 401(k)s Require Investment Choices: When you open a 401(k), you will be directly responsible for how that money is invested. Employers will typically appoint a financial advisor to help guide your investment decisions, and you will be allowed to grow your retirement in mutual funds, index funds, and more. This allows you to increase your retirement savings, but it also puts you in charge of the risk management associated with those investment choices.

  • Pensions Stay At The Company: Pensions can be a great way to guarantee retirement income, but that comes with a tradeoff. You have to work at an organization for a minimum number of years to be eligible for a pension. If you leave the position early, those benefits do not transfer to your new role. As “job hopping” becomes increasingly common, 401(k)s are thought to be a better alternative as these accounts can move with an employee.

  • 401(k) Plans Protect Against Company Failure: When it comes to private companies, 401(k) plans are generally safer in the event a company goes out of business. This is because employers do not have any control over 401(k) plans, and you would be able to keep your account if the company ceased business operations. If a company providing pensions were to go bankrupt, all of the employees would unfortunately lose their retirement benefits. At this point, they would have to go through the Pension Benefit Guaranty Corporation (PBGC) to determine eligibility for benefits.

Summary

Pensions were once thought to be the most beneficial and widespread form of retirement plan; however, 401(k) plans have emerged as a less costly alternative for employers. When looking at a pension vs 401(k) there are various pros and cons available for employees to consider. Many individuals prefer the level of control that a 401(k) offers, while others seek the dependability of a pension. The key is to choose a retirement account (or two) that caters to your financial wants and needs. By taking the time to research the various options available, you are one step closer to preparing for a secure financial future.

Now that you have learned about a pension vs 401(k) which is better in your opinion? Share your thoughts in the comments below.


Do you want to be able to retire financially comfortable?

Our new online real estate class can help you learn how to invest in rental properties that can help increase your monthly cash flow. Expert investor Than Merrill shares the core real estate investment principles that work best in today's real estate market.

Register for our FREE 1-Day Real Estate Webinar and get started educating yourself on how to invest in today’s rental real estate market!

Real Estate Financing
Real Estate Financing
Real Estate Financing
Real Estate Financing
Real Estate Financing
Real Estate Financing