A 401(k) plan and pension are two types of retirement plans offered by employers. The biggest difference between the two is that a pension is a defined-benefit plan and a 401(k) is a defined-contribution plan. Can you have a pension and still contribute to a 401(k) plan? Is a pension better than a 401(k)?
What's the difference between 401(k) and pension?
A pension and 401(k) plan are both retirement plans sponsored by employers. A 401(k) plan is mostly funded by employee contributions through pre-tax paycheck deductions. Contributed funds can be put in various investments, usually mutual funds, based on the options made available through the plan. Any investment growth in a 401(k) plan is tax-free and there isn’t any limit on the growth of an individual account. A 401(k) plan puts the longevity and investment risk on individual employees. They are required to select their own investments with no assured maximum or minimum benefits.
Most employers offer matching contributions with their 401(k) plans. For example, your employer offers a 50 percent match of your individual contributions to your 401(k) plan up to 8 percent of your salary. You earn $50,000 and contribute $4,000 (8 percent) to your 401(k) plan, so your employer contributes an additional $2,000. However, there’s a cap on how much you can contribute to a 401(k) plan per year. For 2020 and 2021, the most an employee can contribute to a 401(k) plan is $19,500 or $26,000 if they are 50 or older.
In a pension plan, employees don’t control the investment decisions and they don’t assume the investment risk. In a pension plan, contributions are made—either by the employee or the employer, usually both—to an investment portfolio, which is managed by an investment professional. In return, the sponsor assures some monthly income to retired employees for life depending on the number of years spent working for the company and the amount contributed.
The assured income in the pension plan comes with a condition. The retirement benefits might be reduced if the company declares bankruptcy or faces other problems.
Can you have 401(k) and pension?
A good retirement plan is to contribute to different retirement investments. You can have a pension plan and still contribute to a 401(k) plan to take charge of your retirement. A pension plan provides a fixed monthly benefit upon retirement for the rest of your life. A 401(k) plan also provides income in retirement. However, the amount in a 401(k) plan is based on how much you contribute and how well the investments performed.
Does 401(k) count as retirement benefits?
A 401(k) plan is an employer-sponsored retirement savings plan that's eligible for special tax benefits under IRS guidelines. You can invest part of your monthly salary up to an annual limit. The employer might or might not match a certain part of your contribution. The funds would be invested for your retirement—ideally in your choice of a variety of mutual funds. However, you can’t usually withdraw any of the funds without paying a tax penalty until you turn 59 and a half.