Pension vs. 401k: 5 Ways they are Different
How can you plan for retirement if you don’t understand your retirement plan at work?
As pension plans have been shut down over the last few decades 401ks have taken their place as one of the most popular workplace retirement programs. What are five main differences between these plans?
- A pension plan is a defined benefit plan and a 401k plan is a defined contribution plan. A defined benefit plan is funded by the employer and guarantees a specific retirement benefit for each employee (e.g. ABC’s pension plan will pay you 50% of your salary per year in retirement if you work at ABC company for 30 years). A defined contribution plan has a stated amount that is invested in the plan each year (e.g. employee contributes 6% of their pay and the employer matches the employee 50%, so the employee’s overall contribution is 9% of compensation)
- In a pension plan, the employer takes on the risk of investing. Employees can see a projection of their pension amount, but they do not see their actual account or the performance of the funds. No matter how the pension dollars are invested, the employer needs to fulfill the obligation they have to pay the pension benefit. In a 401k plan, the employee has an account and assumes the investment risk. Employees choose how their money is invested and can watch their nest egg grow or shrink based on the market environment.
- The 401k is portable. If you leave an employer, you can leave the 401k where it is (if permitted), take the 401k with you to your new job, roll it into an IRA as it is your money, or cash it out. If you have a pension and leave that company, you have to leave the pension behind. I have clients who left pension plans in their 30s and at 65 learned that they had accumulated a small pension that they could take.
- A pension plan is harder to track than a 401k. Most pension plans will issue annual statements as to what the employees guaranteed benefit is. For most 401ks, you can logon to your account and see the value every day. This makes it easy to track as you work through the years and through different careers.
- When companies that have pension plans declare bankruptcy, you may not get what was promised to you. You could get nothing or a reduced pension benefit. The 401k money is yours to keep and as long as you have the account it cannot be taken away from you due to the bankruptcy of a company.
It is important to consider what is in store for your in retirement. Check with your company to see what types of retirement programs they have and what is available for you.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.