Retirement Planning

What's the Difference Between a Pension and a 401(k)?

Pension plans, which are funded by your employer, are increasingly being replaced by 401(k) plans, which are employee-funded. Learn how these plans work and what they mean for your retirement.

Understanding the Difference Between a Pension Plan and a 401(k) Plan

There are many different financial plans that can help you save for a comfortable retirement. However, since all retirement plans have their own features and benefits, it's not always easy to know which one to select. That's why it's best to compare as many of the different plans as possible in order to make the right choice for you.

In this article, we're going to focus on what pensions and 401(k)s are, as well as the key differences between the two.

What is a pension plan?

A pension plan (also referred to as a defined benefit plan) is a retirement account that is sponsored and funded by your employer. It's based on a formula that includes factors such as your salary, age, and the number of years you have worked at your company. For example, your pension benefit might be equal to one percent of your average salary for the last five years of employment, and then times your total years of service.1 Over the years, your employer makes contributions on your behalf and promises to make you regular, predetermined payouts every month when you retire.

What is a 401(k) plan?

A 401k plan is retirement account that's made available to employees who wish to save for their retirement (provided their employer offers a plan). In this case, it's the employer that holds back a part of your salary (tax-deferred) and places it into a fund that you'll receive when you retire. Some employers are even willing to match the contributions made by their employees with their own money. Since 401(k) plans are meant to encourage you to save for retirement, there are heavy tax penalties imposed for early withdrawals (before age 59½).

What's the difference between a pension plan and a 401(k) plan?

  • A pension plan is funded by the employer, while a 401(k) is funded by the employee. (Some employers will match a portion of your 401(k) contributions.)

  • A 401(k) allows you control over your fund contributions, a pension plan does not.

  • Pension plans guarantee a monthly check in retirement a 401(k) does not offer guarantees.

Pension plans have been in existence for a long time, while 401(k)s are gaining in popularity. In fact, the 401(k) will most likely be replacing pension plans all together in the near future.2 However, there are still employers who offer both a pension plan and a 401(k) plan - if you're lucky enough to be in that fortunate situation.

1. http://www.dol.gov/ebsa/faqs/faq_consumer_pension.html
2. http://www.ssa.gov/policy/docs/ssb/v69n3/v69n3p1.html

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All Learning Center articles are general summaries that can be used when considering your financial future at various life stages. The information presented is for educational purposes and is meant to supplement other information specific to your situation. It is not intended as investment advice and does not necessarily represent the opinion of Protective Life or its subsidiaries.

Learning Center articles may describe services and financial products not offered by Protective Life or its subsidiaries. Descriptions of financial products contained in Learning Center articles are not intended to represent those offered by Protective Life or its subsidiaries.

Neither Protective Life nor its representatives offer legal or tax advice. We encourage you to consult with your financial adviser and legal or tax adviser regarding your individual situations before making investment, social security, retirement planning, and tax‐related decisions. For information about Protective Life and its products and services, visit www.protective.com.

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Retirement Plan

Retirement planning can be complex. For this reason, it's important to take the time to learn about the different types of retirement plans and their benefits. In this article, we'll take a closer look at the difference between a pension plan and a 401(k) retirement plan. For more information, visit the Protective learning center.

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