Both pension plans and 401(k) plans are employer-sponsored retirement plans, but there the similarities end.

The two plans have different risk levels, investment opportunities, and employee/employer contribution levels. 

What is a pension plan?

A pension plan is typically funded by the employer, although other types of plans exist. Monthly retirement benefits are usually a percentage of your monthly salary.

What is a 401(k)?

A 401(k) is a retirement plan based on investments. The employer sets the 401(k)’s investment portfolio, and the employee decides how much to invest on a monthly basis. Contributions are usually tax deferred, so you only pay taxes when funds are withdrawn from the plan.

Why are 401(k)s replacing pension plans?

When considering a 401(k) vs. a pension, remember that while 55 percent of workers participate in workplace retirement plans, only 22 percent have pension plans.

The younger the worker, the lower the chance of having a pension plan: While 47 percent of employees age 61 to 70 have pension plans, only 14 percent of employers younger than 35 do.

Employers find 401(k)s a cheaper alternative to pension plans, in part because increased longevity makes pension plans expensive. Employer contributions are not required by 401(k) plans, which drives employer costs down even further. 

Pension plan pros

  • You have a guaranteed monthly income.
  • It may provide income for your spouse should he or she outlive you.
  • Investment risks are the employer’s concern — you don’t need to make any decisions.
  • Pension contributions are usually deducted from salaries before tax.
  • The longer you invest in a pension plan, the more you receive in retirement.

Pension plan cons

  • You don’t have access to the pension plan until age 55.
  • There’s a risk of poor returns if the plan’s stocks and shares perform poorly.
  • There is a lack of control over where contributions are invested.

401(k) pros

  • Standards for 401(k) plans are listed under the Employee Retirement Income Security Act.
  • Employers can choose to match contributions.
  • There are high contribution limits.
  • They are easily transferred to other 401(k)s if you switch jobs.

401(k) cons

  • These come with more risks than pension plans.
  • You have limited investment options compared to IRAs and mutual funds.
  • Account fees can be expensive.
  • Early withdrawal fees are high.

Pension rollover to IRA vs. 401(k) rollovers

Upon retirement, you may opt to roll your pension into a personal IRA, which gives you more control over your investments and financial choices. But consider the following.

  • Both 401(k)s and pension plans can be moved into IRAs with a direct or indirect rollover. A direct rollover transfers the funds straight from the retirement plan or 401(k) to the IRA. You never come into direct contact with the cash, so no tax events are triggered.
  • In an indirect rollover, you take possession of the funds and have 60 days to deposit the money into an IRA. Failure to do so within the 60-day time limit will result in the money being taxed.
  • One indirect pension rollover into an IRA item you won’t have when rolling over a 401(k) is this: Pension plan administrators withhold 20 percent of the account balance before issuing you the rollover check. The IRS requires 100 percent of the pension be deposited into the IRA. You must make up the 20 percent from another source to fully roll over the account.

The bottom line

Unless you work for a government agency, chances are high your company offers a 401(k) plan rather than a pension plan. If you are in the uncommon position of choosing between a pension vs. a 401(k), examine the investment opportunities and potential payout of each plan carefully, and be sure to consider other types of retirement plans.

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