401(k) vs. Pension Plan: Which Is Better For You?

SHORT ANSWER: A pension plan can provide guaranteed income from the day you retire until you die. In contrast, a 401(k) plan offers more flexibility and options to contribute at higher rates and invest the funds more aggressively.

In many cases, employees don’t have an option between a 401(k) vs. pension plan. Employers often offer one or the other. But as you select where to work and how to save for retirement, you might be questioning which employer-sponsored retirement plan is best for you. Learn how these accounts compare to decide what will work best based on your circumstances.

401(k) vs. Pension Plan: An Overview

A difference between a pension and 401(k) is that a 401(k) uses cash accumulation where the employee decides what distributions to take once they become eligible for payments. A pension plan guarantees set payments until the account holder passes away. That can provide added security for you in retirement because you know you will never have to lower your distributions to stretch the funds or worry about outliving your retirement accounts.

Most private employers have done away with pension plans in favor of 401(k) plans. However, you might still find them in government jobs if you prefer their features. A Reddit thread broke down the benefits of each retirement plan nicely.

“Pension is better only if you plan to be there for a longer period or if you highly value having a pension in retirement as opposed to being subject to your own investment decisions.

“A 401(k) is better if you are inclined to manage your own money, take additional stock market risk, or think it's likely you will only be there for a short period.”

401(k) Plans

These retirement plans put the employee in charge of their retirement savings and investments. Many employers contribute to these plans via matching contributions to help the employee grow the account. Those matching contributions might not be available to the employee until they spend a certain number of years at the business.

But many employers will match 3-6% of your salary up to a certain amount annually as long as you contribute that much to the account. Individuals who participate in 401(k) plans also get tax advantages. Until age 50, an individual can contribute up to $22,500 to reduce their tax liability. After age 50, employees can make catch-up contributions of up to $7,500.

You’re in full control of your 401(k) account and how those funds are invested. When you leave your employer, those funds leave with you. You can keep them in that account or roll them over into your new employer’s 401(k) or an IRA that you manage entirely. 

You can start taking payments as early as age 59.5 without penalties. You’ll also be in charge of how much you want to withdraw from your 401(k) each month in retirement. You can take lump sums or monthly distributions as you see fit. Perhaps you want to limit distributions while you’re young and working part-time and increase them later to help stretch the funds. That can keep your funds invested and earn tax-deferred growth.

Pension Plans

You might also see a pension plan called a defined benefit plan. It is a company-funded account that saves money on your behalf and guarantees a paycheck in retirement. 

A key feature pension plans offer is that they provide payments for life once you retire. Some pension plans also allow you to take a lump sum at any point if you prefer your funds that way. 

Pension plan payouts are based on your pre-retirement earnings, how long you worked for the organization, your age and other factors the employer uses. 

You will be taxed on your pension plan distributions at your regular tax rate in retirement. Pensions offer stability for retirees who want to know they’ll have a guaranteed income source. 

However, one of the differences and drawbacks to a pension plan is that you have no control over the funds held in the account. That means that you cannot select investments and work to help the funds grow over time to help make retirement more comfortable. You’ll only get what your employer determines is your fair share.

Additionally, vesting in a pension plan can take many years. That means that if you only work at the employer for a few years and then move on, you’ll forfeit all funds. Make sure you know the requirements from your employer to vest in the account to get those guaranteed payments. Otherwise, you might leave money on the table and have lost several years of your career to save for retirement.

Pension plans also generally only pay out to the spouse in case of your untimely death, meaning you can’t use it to pass wealth to your heirs. On a Reddit thread, one person had this to say: “Most pensions offer only a spousal benefit, where when you die your spouse can get a monthly benefit for the rest of their life, but a pension rarely pays to anybody beyond you and your spouse. If there's money left because you die a little early, that's kept by the pension to pay those who lived longer than expected.”

401(k) vs. Pension Plan: Pros and Cons

Want to see how a 401(k) vs. pension plan stacks up? Here’s a look at the pros and cons of each to help you make an informed financial decision.

401(k) Plans

Pension Plans

Is it Better to Have a Pension or a 401(k)?

Many people view a pension as a better employer-sponsored retirement plan. That’s because the employee can still open an IRA and contribute funds to aid their retirement and make investment decisions while having the peace of mind that they’ll have guaranteed income from their pension plan during retirement.

However, pension plans still have their drawbacks and often have requirements that the employee stay at the company for 10 years or more to become eligible for the funds.

Ultimately, you should meet with a financial advisor to determine the best mode of planning for retirement based on what’s available to you through your employer.

How to Make Your 401(k) More Like a Pension

Many people don’t have the option to choose between a pension plan vs. 401(k). So if you like the way a pension plan works and want to make your 401(k) function more like a pension, you have an option to do so with an annuity. The SECURE Act has made it possible for people to use a portion of their retirement plan to invest in an annuity.

• Find a 401(k) provider that offers an annuity option.
• Review how your provider uses annuities to provide set funds each month in retirement to make sure this is the best option for your funds.
• Place a set amount of your 401(k) in a lifetime annuity.
• Take monthly distributions from your lifetime annuity to enjoy guaranteed retirement income much like a pension.

Before using this tactic, talk to a financial advisor. You might find that your current retirement savings are growing at better rates than the annuity rates, which could limit your retirement income. While the guarantee of set payments throughout retirement is attractive, it might not be the right move for you based on your specific circumstances.

Maximizing the Retirement Plan Your Employer Offers

While 401(k) and pension plans each have benefits, you likely can’t choose between the two. Instead, your goal should be to maximize the retirement plan that is available to you. Ensure you leave no matching funds on the table if you have a 401(k) plan and do your best to stay at your employer until your pension plan vests. Spend time learning the intricacies of your employer’s retirement plan regardless of what it offers and meet with a financial advisor when your retirement savings plan changes to ensure you’re still on track to meet your retirement goals.