A 401(k) plan and a pension plan are both tools that can provide you with a dependable income in retirement. But these employer-sponsored 𒅌retirement plans have some significant differences.

A 401(k) is a defined contribution plan, and a pension is a 澳洲幸运5官方开奖结果体彩网:defined benefit plan. These differences determine whether the employer or employee be🐟ars the investment risks. With a 401(k), the employee bears investment risk. With a pension, the risk is on their employer. In recent years, 401(k)s have replaced pensions, which have become far less common.

In this article, learn what the crucial differences💮 are between the two plan types.

Why 401(k)s Have Replaced Pensions

For much of the last 50 years, pensions have become less common and 澳洲幸运5官方开奖结果体彩网:401(k) plans have been increasingly popular. Originally, 401(k) plans were not a design of the U.S. government or the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS). They were created by benefits consultant Ted Benna. In 1979, Benna noticed that the rules established in the Revenue Act of 1978 made it possible for employers to establish simple, 澳洲幸运5官方开奖结果体彩网:tax-advantaged savings accounts for their employees.

澳洲幸运5官方开奖꧂结果体彩网:Employers found significant advantages in offering 401(k)s. With a traditional pension, a company promises to pay an employee a specified income during retirement. That’s why pension plans are known as defined contribution plans. This type of plan is federally guaranteed but still presents risks to employers, especially to small employers. Following a stock market crash, a company could potentially go bankrupt by the cost of paying employee pensions.

Despite 401(k) plans being originally designed to supplement traditional pensions, many companies have come to see them as a replacement. So, 澳洲幸运5官方开奖结果体彩网:pensions have become less common. As of March 2021, 53% of private industry workers had access to defined contribution plans, while only 3% had access to defined benefit plans, and 12% had access to both. As of 2019, 401(k) plans covered an estimated 80 million people and held $5.7 trillion in assets. About one-third of employees had no access at all to an employer-sponsored retirement plan.

401(k)s and Pensions: The Key Differences

The main differences between 401(k) plans and pensionsꦇ are who carries the investment risk and who has control over investment choices. With a pension plan, employees do not have control of investment decisions, but they also don’t assume any investment risk.

With a pension plan, contributions are made by the employer to an investment 澳洲幸运5官方开奖结果体彩网:portfolio that is managed by an investment professional. In some cases, employees may also make contributions: these can be either required or voluntary.

The plan sponsor is the one providing a monthly income to retired employees for life. However, there is a potential downside: Benefits may be reduced if the company’s 澳洲幸运5官方开奖结果体彩网:portfolio performs poorly or if the company declares bankruptcy. However, employee pensions are often protected because they are insured by the 澳洲幸运5官方开奖结果体彩网:Pension Benefit Guaranty Corp., with the employer being the one who pays regular premiums.

The main difference, in short, is that pension plans have 澳洲幸运5官方开奖结果体彩网:significantly less market risk for employees than 401(k) plans, and th🌳erefore they are generally considered a better option from their perspective. The employer carries the risk while the employee is guaranteed꧑ a set income for life. 

In contrast, with a 401(k), the employee controls the growth: if the plan is managed wisely, the benefits can be more substantial than those of a pension fund and also immediate (in contrast, with a pension, it usually takes five to seven years before the employee is vested). A 401(k) has♑ an added advantage: if the employee changes jobs, they can take it from one employer to another by rolling it over into a new 401(k)💜.

Essentially, though 401(k) plans have come to replace pensions for many workers, they are not the same. While a 401(k) theoretically offers higher growth and more flexibility, most analysts agree that this doesn’t make up for the increased market risk that it presents.

The Bottom Line

Though 401(k) plans have largely replaced pensions in today’s workplace, there are important differences betweౠen these two retirement plans. With a 401(k), the employee assumes all of the risk associated with their investments. With a pension, this risk is bor🍰ne by their employer. This typically makes pensions a better option for employees.

That said, 401(k)s can grow more quickly than traditional, conservative pension plans, and they are more flexible. By shifting risk away from employers, 401(k)s have allowed many smaller firms to offer some kind of retireme𒀰nt plan to their employees.