401(k) vs. Pension Plan: An Overview

401(k)s and pensions share several similarities: to start, they're both employer-sponsored retirement plans that promise 澳洲幸运5官方开奖结果体彩网:tax advantages as well as future financial security. Both are methods of funding employees' retirement costs with real taꦜx savings for participants. The main differences:

• A pension guarantees the retiree a set payment for life.
• A 401(k) and similar plans, like the 403(b), accumulate cash until the employee retires and takes responsibility for managing the account.

In the U.S., pensions are still available for many public and government jobs, but have largely disappeared from the private sector, where they've been replaced by 401(k)s.

Defined Contribution Plan🌊 vs. Defined 🐽Benefit Plan

A 401(k) is classified as a 澳洲幸运5官方开奖结果体彩网:defined contribution plan while a pension is a 澳洲幸运5官方开奖结果体彩网:defined benefit plan.

A defined contribution plan allows employees and employ𒈔ers (if they choose) to contribute funds regularly to a long-term account. The employee chooses how to invest the money from a selection provided by the employer. Both the employer and the employee get tax breaks on their contributions. When the employee retires, the total amount in the account is theirs.

A defined benefit plan also grows over the years with contributions from the employer and employee. The employer generally pools all contributions to be professionally invested and managed. After reti🔴ring, the employee will receive a set payment from this fund for life. The payment is based on factors such as length of service and final salary.

Who Bears the Risk?

A crucial difference between a 401(k) and a pension plan is in who bears꧟ the risk.

A 401(k) is turned over to the retiring employee, who takes on the rights and responsibilities of managing the balance of the account. If the retiree spends all the money, or if the investments lose value, it's that person's problem alone.

A pension is paid out from a fund retained by the employer. If all of its retirees live to age 120, or the fund experiences investment losses, it's the company's problem.

Who Has a Pension?

The 401(k) was originally intended to be a supplement for traditional pensions, rather than as a replacement. It's rare to have both today. Pensions are disappearing from the private sector.

As of March 2023, about 67% of private sector workers in the U.S. had defined contribution plans, while only 15% reported access to defined benefit plans. This is in stark contrast to state and local government workers. Also as of March 2023, 86% of state and local government workers reported having access to defined benefit plans while only 39% had defined contribution plans.

401(k) Plans

A 澳洲幸运5官方开奖结果体彩网:401(k) plan is funded primarily through regular employee contributions via paycheck deductions, up to an annual limit set by the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS). Those who choose a 澳洲幸运5官方开奖结果体彩网:traditional 401(k) plan get an immediate tax break, as their contributions are deducted from their gross income for the year. Those who choose 澳洲幸运5官方开奖结果体彩网:a Roth plan get no immediate deduction but will enjoy a tax break down the road when they wiᩚᩚᩚᩚ𓄧ᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚthdraw the money.

Contributed money can be placed into various investments chosen by the employer. These are typically 澳洲幸运5官方开奖结果体彩网:mutual funds although stocks, bonds, and 澳洲幸运5官方开奖结果体彩网:annuities may also be available. Any investment growth in a 401(k) occurs tax-deferred until you make a withdrawal.

Many employers offer 澳洲幸运5官方开奖结果体彩网:matching contributions with theౠir 401(k) plans, meaning they contribute additional money to an employee account up to a certain level.

For exa♋mple, your employer may offer a 50% match of your contributions to your 401(k), up to 6% of your salary. If you earn $100,000 and contribute $6,000 (6%) to your 401(k), your employer would contribute $3,000.

Unlike pensions, 401(k)s place the investment and 澳洲幸运5官方开奖结果体彩网:longevity risk oඣn individual employees, requiring them to choose their own investments with no guaranteed minimum or maximum benefits.

Employees assume the risk of outliving their savings o💫r experiencing losses in a market downturn.

Pension Plans

Employees do not make any investment decisions about a pension plan, and they do not assume the investment risk.

Instead, contributions by the employer are paid into a fund that is managed by an investment professional. In some cases, employees may also make contributions, which may be required or voluntary. Still, the primary so🐈urce of the money is typically the employer.

The employer promises to provide a certain monthly income to each retired employee for life. This amount is usually determined by the number of years an employee has worked, a final average salary based on the last three to five years of the employee’s service, and a percentage multiplier, typically 2%.

The pension must be vested, meaning that the employee is eligible to receive the full amount only after staying on the job for a 🌺number of years, often five to seven.

The main tax advantage is that you will not pay 澳洲幸运5官方开奖结果体彩网:capital gains taxes on any portion of your pension, although you will owe 澳洲幸运5官方开奖结果体彩网:income taxes.

The guaranteed income comes with a caveat: If the company’s portfolio performs poorly or the company declares 澳洲幸运5官方开奖结果体彩网:bankruptcy or faces other problems, benefits may be reduced. However, almost all private pensions are insured by the 澳洲幸运5官方开奖结果体ꦏ彩网:Pension ꦉBenefit Guaranty Corporation. Employers paying regular premiums, which protects their employees' pensions.

Ultimately, pension plans present individual employees w෴ith significantly less market risk than 401(k) plans.

Pension vs. 401(k): Which Is Better?

There are pros and cons to both𒁃 plans, but pensions are generally considered better than 401(k💝)s because they guarantee an income for life.

A 401(k) can be more aggressively managed by the individual, which could create more growth🌟 than is likely from a pension fund. Then aꦏgain, investment losses are also possible.

The earnings on employee contributions to a 401(k) are yours immediately, while a pension usually takes five to seven years to vest. (Many 401(k)s have a vesting schedule for employer-contributeꦬd funds.)

Also, a 401(k) is portable. You can take the account from one employer to another by rolling it over into a new 401(k) at your new job. You can also roll it over into an 澳洲幸运5官方开奖结果体彩网:individual retirement accounꦚt (IRA).

A pension stays with the employer who provides it, even if you switch jobs. You must keep track of it, and when you are ready to retire, you have to apply to begin receiving your payments.

The Bottom Line

If you're working in the private sector, your employer is much more likely to offer a 401(k) than a pension in its benefits package. With a 401(k), you can make your own decisions on investing and watch your retirement fund grow. However, you lack the guaranteed income in retirement that a pension would provide.

If you work in the public sector or for a company that offers a pension plan, you have the advantage of a guaranteed monthly income in retirement, with the inves🦂tment and longevity risk plܫaced on the plan provider.