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Pension plan vs. 401(k)

One guarantees payments when you retire; the other leaves it up to how much you save and invest.

Not all that long ago, many large companies offered pension plans as part of their typical employment package. Only 13 Fortune 500 companies carry on that tradition today, shifting retirement planning responsibilities to employees through accounts like 401(k)s. While the goal is the same for pension plans and 401(k)s, you should know the key differences in how they’re managed and paid out.

How do pension plans differ from 401(k)s?

Pension plans and 401(k)s differ in many ways, including who funds and manages the account and how it’s paid out at retirement.

Pension — defined benefit plan401(k) — defined contribution plan
Payout at retirementGuaranteed lump sum or monthly paymentsWithdraw funds at age 59.5 or older
Who funds the accountEmployerEmployee with some employers matching contributions
Who manages investmentsEmployerEmployee
Payout lengthLump sum or monthly payment for life, with option for spouse to continue collecting pension after you dieLump sum or minimum total withdrawn as needed each year until balance is $0

What is a pension plan?

A pension is a defined benefit plan that’s funded by your employer and guarantees payments after you retire. How much you’re paid out at retirement comes down to a formula that considers your age, salary and years working for the employer. Payout options include a cash lump sum, a deposit into an individual retirement account (IRA) or a monthly payment for the rest of your life.

Pensions offer peace of mind that no matter how the market performs, you receive income for life. Though to earn full pension benefits, you must stay with your employer for a specified period of time. While pension plans are not as common today among the private sector, more than 5,000 public retirement pension systems are paid into by government employees.

vest

/vest/
verb
To give or bestow the right to a present or future benefit, in this case a pension.

Pros and cons of pension plans

Pros

  • Retirement security. Transparent payment amounts are guaranteed for life. And your spouse may be eligible to take over payments when you die.
  • Not subject to market fluctuations. You don’t have to worry about losing your funds if the market crashes.
  • Employer funded. Pension plan contributions are often made entirely by the employer.

Cons

  • No control of investments. You don’t get to choose where to invest your retirement funds.
  • Can’t take funds to another company. You can’t roll your pension plan to another account if you leave, giving you one more account to track.
  • Ties you to your employer until you’re fully vested. To get your maximum benefit, you’ll need to stay until you’re vested — which depends on the employer.

What is a 401(k) plan?

A 401(k) is a defined contribution retirement plan that’s funded by employees. Those who are self-employed can set up their own 401(k). The way this plan works is you choose a percentage of your salary to contribute to your 401(k) up to a maximum $19,500 in 2021. Many employers offer to match an employee’s contribution, but the amount varies by employer. Some employers, for example, may offer a dollar-for-dollar match up to 3% of your salary. If your salary is $70,000 and you contribute $2,100 — 3% of your income — your employer will match the exact amount, raising your 401(k) contributions to $4,200.

These plans offer the ability to take your accumulated balance with you through either rolling over your funds to another account or withdrawing your funds for a fee. You can also borrow from your 401(k) up to the lesser of 50% of your vested balance or $50,000. Ultimately, your payout at retirement depends on your investment choices along the way.

Finder tip: If your employer offers to match your 401(k) contribution, leverage the match by socking away the most that you’re able to maximize your retirement savings.

Pros and cons of 401(k) plans

Pros

  • Full control of your funds. You can invest your money in mutual funds, index funds, ETFs or other options.
  • Withdraw funds before retirement. You can tap into your balance early, though with limitations, fees and tax obligations, in most cases.
  • Roll over funds when changing jobs. Most 401(k)s let you take your money to a new employer 401(k) or an IRA account

Cons

  • You are responsible for contributions. Your 401(k) is funded by a percentage of your salary. (Many employers match a portion of what you save.)
  • Payout amounts can fluctuate. Your payout correlates with your investments portfolio and market performance over the years.
  • Annual contribution limits. Cotributions are limited to $19,500 in 2021. If you’re 50 or older, you can add another $6,000 in catchup contributions.

How do pension plans differ from 401(k)s?

Pension plans and 401(k)s differ in many ways, including who funds and manages the account and how it’s paid out at retirement.

Pension — defined benefit plan401(k) — defined contribution plan
Payout at retirementGuaranteed lump sum or monthly paymentsStarting at age 59.5 or older, withdraw what you’ve saved and any investment earnings
Who funds the accountEmployerEmployee with some employers matching some contributions
Who manages riskEmployerEmployee
Who manages investmentsEmployerEmployee
Payout lengthLump sum or monthly payment for life, with option for spouse to continue collecting pension after you dieLump sum or minimum total withdrawn as needed each year until balance is $0

Compare retirement accounts

Pension and 401(k) accounts aren’t the only ways to save for retirement, including individual retirement accounts (IRAs). Compare top brokers to find a retirement account that works for your financial goals.

Name Product Annual fee Available asset types
Acorns
$1 per month
ETFs
Invest your spare change. Anyone can grow wealth.
Webull
0%
Stocks, Options, ETFs
Margin financing rates start at 3.99%. No monthly subscription fees for margin.
Sofi Invest
0%
Stocks, ETFs, Cryptocurrency
A free way to invest in stocks, ETFs and crypto.
Betterment
0.25% on balances up to $99,999

0.4% on balances of $100,000+
ETFs
Betterment's automatic investment site aims to improve your returns and support good financial habits with passive investing and financial planning support.
Stash Invest
$1 per month
Stocks, ETFs
Stash is more than an investment app. You’ll have access to tools that can help you become a confident investor.
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Compare up to 4 providers

Disclaimer: The value of any investment can go up or down depending on news, trends and market conditions. We are not investment advisers, so do your own due diligence to understand the risks before you invest.

Bottom line

Pension plans and 401(k) can both help you save for retirement, but each gets you to your goals differently. Pensions are fully employer funded, while 401(k)s accumulate balances from a percentage of your paycheck, with some employers matching what you contribute. And how you’re paid out at retirement differs as well.

Learn more about the range of retirement accounts available to you, how to save enough for your goals and tips for avoiding penalties.

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