MoneyLife

Pension Plan vs 401(k): Are They the Same Thing?

By Cameron Walch
pension plan vs 401(k)

Almost all of us plan on enjoying a long and fun retirement. There are many different ways to prepare for the coveted retirement phase of life, but a lot of them are so similar, it’s hard to know the difference. For example, a pension plan vs 401(k), they seem like the same thing, but are they?

Let’s take a look at the differences between a pension plan vs 401(k) and tips on saving for retirement! 

What is a pension plan?

A pension plan is a guaranteed retirement benefit plan that is also employer-sponsored. This means that your employer promises to pay you on a biweekly or a monthly basis if you vow to stay with the company for a set amount of years. 

As an employee, you do not have control over the investment options because you do not take on any risk by accepting contributions to your pension plan. Instead, your employer takes on the risks of investing money. The employer will often give the money to a professional who will then invest it into your pension plan on their behalf. 

What is a 401(k)?

A 401(k) is a guaranteed contribution plan, meaning you contribute the money that you earn to your own 401(k) which is also known as employee contributions. Your employer might offer to match your payments, contributing money to your 401(k) in the form of employer contributions.

With a 401(k), you get to choose your investment options because you take on all of the risks. Your employer doesn’t take on any risks associated with a 401(k). Employers pay you money and then clean their hands of any responsibility. It is up to you to choose the best investment choices with the highest returns, which you can learn more about here.

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

The main difference between pensions and 401(k)s is that one is promised where the other one is not. There are pros and cons to both pensions and 401(k)s. 

The other difference is that you, the employee, must contribute money on a regular basis in order to build your 401(k) balance. Sometimes, your employer will contribute money based on how much you are actually contributing but there is no guarantee. Pension plans, on the other hand, grow without contributions from you. 

To answer the question, “Is a 401(k) a pension?” it helps to recognize that a 401(k) is a defined contribution plan whereas a pension is a defined benefit plan.

Cost

One of the many differences is the cost to the employer. Pensions ruled the retirement world before 401(k)s were invented. There was a giant shift once employers started to realize that it cost them a lot less money to provide 401(k) plans. A company’s main goal is to be profitable, so cutting pension plans and switching to 401(k)s was a great way for them to accomplish this. 

If an employee doesn’t set up 401(k) contributions, then the employer does not have to contribute any money at all. They started saving thousands of dollars a year for each employee that does not want to set up their own 401(k).

A company that offers a pension plan will immediately start building the pension plan for each new employee. They start losing within the first month of hiring each new employee due to their contributions. 

Pension survivor benefits vs beneficiary

The benefits of a pension often vary based on the terms agreed upon at the beginning of employment. But essentially, if you were to claim survivor benefits, then you will only receive a portion of the full payment. 

A beneficiary of a 401(k) would actually be able to receive all of the money that is in the account. It may not be the smartest decision to pull it out all at once due to tax complications, but every scenario is different so don’t rule it out.

As soon as you agree to one of these plans, make sure to set it up right away. You do not want to have an accident and lose all of the money you have been accumulating in your retirement account.

When to start

A pension plan is often offered to an employee once they’ve worked at a company for a certain amount of years. The longer you work there, the larger the overall payout. This is why many employees stay with companies for years and years. It pays off in the long run.

A 401(k) is all up to you. The earlier your start, the higher your balance will be. It is very important to start saving for retirement early in order for compound interest to kick in and help you accumulate even more money for your retirement years. 

Contributions

As stated earlier, there are companies that will match an employee’s contributions to their 401(k). It is normal for a company to match 100% of the first 5% that an employee contributes, which means that if an employee is going to contribute 6% of their $50,000 salary, then their employer will contribute $3,000 for that year. 

There are limitations that dictate how much you can contribute to your 401(k). As of 2021, the most you can contribute to your 401(k) is $19,500 per year.

Start investing with $5 today!

Although most of these tips we’ve shared are great strategies, they’re not your only investing options! Another excellent alternative is MoneyLion auto-investing. Make sure you are getting the most out of your investments and get started today with a MoneyLion investment account–start with as little as $5!

Sign Up
Sign Up

Discover effortless investing

We'll help grow your money using the same techniques trusted by some of the countries' wealthiest investors, even if you start with $5. Get your personalized, fully managed portfolio now.

Sign Up