1. Funding and Contributions
401(k): Funded primarily by employee contributions, with potential employer matching. Employees choose how much to contribute from their salary, and employers may match contributions up to a certain percentage.
Pension: Funded primarily by the employer, who makes contributions to a defined benefit plan on behalf of the employee. Employees typically do not contribute directly to the pension fund.
2. Type of Plan
401(k): A defined contribution plan, meaning the retirement benefits depend on the contributions made and the investment performance of the account. There is no guaranteed payout.
Pension: A defined benefit plan, meaning the retirement benefits are guaranteed based on a formula, usually considering factors such as salary history and years of service.
3. Investment Control
401(k): Employees have control over how their contributions are invested, choosing from a selection of investment options provided by the plan, such as mutual funds, stocks, and bonds.
Pension: The employer or plan administrator makes investment decisions and manages the plan's assets. Employees generally have no control over how the funds are invested.
4. Benefit Calculation
401(k): Retirement benefits depend on the total amount contributed and the performance of investments in the account. The final balance is the sum of contributions and investment returns.
Pension: Retirement benefits are calculated using a formula, often based on years of service and salary. This typically provides a fixed monthly benefit for life.
5. Risk
401(k): Investment risk is borne by the employee. The value of the account can fluctuate based on market performance, and there is no guaranteed amount at retirement.
Pension: Investment risk is borne by the employer or plan provider. Employees receive a predictable benefit regardless of market performance, as long as the plan is well-funded.
6. Withdrawal Flexibility
401(k): Allows for flexibility in how and when you withdraw funds. You can take distributions or loans, subject to plan rules and penalties for early withdrawals.
Pension: Provides a predetermined monthly income for life once you retire, with less flexibility in how benefits are accessed. Some plans may offer lump-sum options or other payout choices.
7. Vesting
401(k): Employee contributions are always fully vested. Employer matching contributions may be subject to a vesting schedule, meaning you need to stay with the company for a certain period to fully own the match.
Pension: Vesting refers to the length of service required to earn a benefit. Once vested, you are entitled to receive benefits according to the plan's formula.
8. Portability
401(k): Accounts are portable. When changing jobs, you can roll over your 401(k) into a new employer’s plan or an IRA without losing the accumulated funds.
Pension: Generally, pensions are not portable. If you leave the company before retirement, you may lose some or all of your pension benefits, depending on the plan’s rules and vesting status.
9. Longevity
401(k): The amount of retirement income depends on the account balance and how long it lasts. There is no guaranteed monthly income, and you must manage the funds to ensure they last through retirement.
Pension: Provides a guaranteed monthly income for the lifetime of the retiree, and often for their spouse as well. This guarantees a steady income stream regardless of how long you live.
10. Plan Management
401(k): Plan management is handled by the employee through the choices they make within the plan. Employees need to actively manage investments and ensure their retirement savings are on track.
Pension: Plan management is handled by the employer or a third-party administrator. Employees have little to no involvement in managing the investments or the plan's overall performance.
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