Difference Between 401k and Pension

401k vs Pension

People work in order to be able to provide for their own and their family’s needs. They will eventually get old, rendering them unable to work and earn a living. With this in mind, organizations and individuals prepare employees for the time that they will have to retire.

Pension plans are created to provide individuals with a source of income during the time that they are no longer able to work. Many schemes or plans are created to help them financially. One is the regular pension plan and another is the 401k account.

Pension

Pension refers to the payments that a person receives after retirement. It is a form of deferred compensation given to employees when they are no longer able to work and is paid in regular installments.

It is usually set up by employers, insurance companies, the government or trade unions and other associations. Most governments offer pension plans like the Social Security System.

Pensions usually come with insurance packages which require them to pay benefits to disabled beneficiaries or survivors. Disability pension is intended to provide for individuals who are disabled by accidents or diseases causing their inability to work.

Pension plans can either be defined benefits or defined contribution, or both. Defined benefit is based on a fixed formula that depends on the member’s salary and length of membership in the plan. Defined contribution is based on the member’s contribution and its earnings or profit. Plans that have both qualities are called hybrid plans like Cash Balance and Pension Equity Plans.

Pension plans are funded by employers by holding back a percentage of an employee’s paycheck. Investments made with the money from the contributions are handled by an investment manager. With pension plans, retirees are assured of a lifetime paycheck but when they die, the pension cannot be passed to their children.

401k

401k is a type of savings account. It is intended to help employees save for retirement and at the same time reduce their taxable income. 401k account holders are not required to pay taxes on their savings until it is withdrawn upon retirement.

401k accounts are usually funded by the employees but employers sometimes contribute a small percentage or match the contributions of the employees. They sometimes invest the contribution in the company’s stocks or in other investments. The employees have the final say though and they can choose and control their investments.

The amount that an employee receives upon retirement depends on the amount of his contribution and the return of investments made. One of the drawbacks in 401k plans is that, investing in company stocks can jeopardize the plan especially if the company suddenly becomes insolvent or files for bankruptcy.

Summary

1. Pension plans are funded by employers, while 401k plans are funded by the employee.
2. Pension plans ensures a regular paycheck to members, while 401k plans depend on the deposits made and the profits that are earned from their investment.
3. In pension plans, an investment manager controls the investments, while the employee controls the investments in 401k plans.

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