by Zac Majors
401(k) vs Pension Plans – What’s the Difference?
We recently discussed the different retirement plans employers have at their disposal for you, which included the 401(k) and other pension plans. Although both types are employer-sponsored retirement plans, it is important to note that while 401(k) is a contribution plan, pension funds are benefit plans. As an employee, it is crucial to understand the difference between the two.
Here, we’ll discuss them in detail to help you understand what type of plan your employer is offering, what you’re entitled to under each plan, and the general differences.
401(k) Plans vs Pension Plans
401(k) plans are mostly set up by your company for you and are funded by your contributions. A portion of your salary is deducted by the employer to be invested in the 401(k) account, which mostly includes investing in mutual funds via the 401(k).
It isn’t compulsory for employers to make any contribution into your 401(k), but most employers offer “matched contributions”. There is no cap on how much a 401(k) account can grow, and all growth is tax-deferred. There are no minimum or maximum benefits as they depend mostly on you, i.e., how much you invest.
Matched contributions by employers mean that they contribute into your 401(k) account for you, but mostly up to a certain limit. If employers offer employees a maximum contribution of 40% up to contributions amounting to 5% of your salary, it will mean that if you earn $10,000 per month, your contribution will be $500 (5%). Your employer will then contribute 40% of that, i.e., $200.
401(k) plans are more common in the private sector. If your employer offers this benefit, they will likely mention it in your contract, or you could simply ask your human resources department.
Pension plans are formed by employers and employees have no control over how much it is. Here, contributions will be made just by your employer.
Your employer will invest regularly into your pension fund based on a formula that may take into account your current salary, tenure, and age. Upon your retirement, you may be given choices that will pay you a designated monthly amount or you may have the choice of taking a lump sum of money out.
To see whether you have a pension, you can ask your employer. Usually employers (such as a governmental body) send out a pension statement to all pension holders once every year.
401(k) plans are more common these days, and while they put the pressure of saving on you, the employee, chances are that you’ll get more returns after retirement via the 401(k) than via a pension plan.
If you’re looking for advice with regards to your current or old 401(k) or pension plan, just let us know!