How is a 401(k) Different Than a Pension Plan?

How is a 401(k) Different Than a Pension Plan?

Date: August 13, 2019,

Planning your financial future can be a complicated process, especially when you don’t necessarily understand all the ins-and-outs of the field. Most people hope to retire someday, shacking up in a place like Florida or the Bahamas in lush comfort. But to get there, a great deal of financial planning is usually necessary, especially regarding your retirement funds and your ability to live comfortably once you’ve stopped working.

With all this in mind, there are several streams of income that you may be able to draw upon when you retire. Most notably, Social Security. This government program takes a mandatory percentage of each paycheck, pooling it with millions of other contributions from other workers. Upon retirement, you will begin getting Social Security “checks” based on your earnings history.

However, Social Security is rarely enough income for a comfortable retirement on its own, and many individuals rely on other financial vehicles to help them along. Two of these,  401(k) plans and pensions, are described briefly here. The Certified Financial Planners™ at Harvest Financial Planning, LLC, can help you understand more about these two types of retirement accounts.

Understanding Pensions

Up until the 1980s, pensions were the accepted norm for employee-sponsored post-retirement savings plans. They work on a similar wavelength as Social Security, except the plans are funded and owned by the employer, who controls most aspects of the plans. So while Social Security will eventually compensate you based on your earnings — and, by proxy, the amount you have paid into the system — pension plans will pay you based on terms set by the employer.

Generally, pensions will reward company loyalty: employees who have put in enough time will qualify for the company’s pension plan and will begin receiving regular contributions to their account based on factors like their paycheck and the number of years they have worked. While many other retirement funds are funded by the employee’s contributions in some way, pensions are controlled and bankrolled by the employer.

Though these plans were widespread leading up to the 1980s, they are much less common today. Mostly, pensions are used in government positions and fields with a heavy union presence.

The Benefits of 401(k)s

The main difference between a 401(k) and a pension plan comes down to who has control over the account. A pension is funded, sponsored and controlled by the employer, while a 401(k) is an option given to employees, who can choose how much (if any) of their paycheck they would like to contribute. Not only this, but employees also have the option to invest in a wide variety of stock options through their 401(k), a choice which is often controlled by the employer when it comes to pension funds.

To make 401(k)s more attractive than individual investment or savings accounts, companies often sponsor certain benefits for those paying into the company 401(k). Most commonly, a company will offer matching contributions, which will see the company “matching” a percentage of the employee’s contributions into the system.

Like pensions, 401(k) plans will help set aside money for employees once they retire. However, the payments will correspond to their contributions — which employees determine while they are working.

Planning for Retirement?

Though retirement may seem a long way off, your retirement income depends on the decisions you make while working. This overview of the differences between two of the most common retirement plans can help you understand your options for securing a confident retirement later in life.

For more assistance with your financial planning, contact Harvest Financial Planning, LLC. Our highly experienced staff can offer a range of financial planning services and advice, helping you draft a plan to work towards your long-term financial goals.

*This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal, or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.