What are the differences, pros and cons between 401K, IRA and pension?

Employer-sponsored retirement plans like 401(k)s and pensions are becoming more common. Successful savers may utilize either method to maximize employer contributions and other retirement advantages as they prepare for retirement. So what are the distinctions between these two pension programs?

Main Points

  • Employees may save for retirement through a 401(k) plan, and their employers may also contribute to the plan.
  • Employers take on the risk of funding and guaranteeing a predetermined retirement payout for each employee under a pension plan.
  • Pensions in the private sector are becoming uncommon due to the rise of 401(k) plans.
  • With the rise of 401(k) plans, workers are now responsible for their own retirement planning and investment, bearing all associated risks.
  • Investors seeking a lifetime income stream would do better with a pension plan, while those seeking more financial autonomy in retirement might do better with a 401(k).

Comparison between 401(k) and Pension Plans

In contrast to a pension, which is a defined-benefit plan, a 401(k) is a defined-contribution plan. There are two main types of retirement plans: defined-contribution plans, which enable both workers and employers to make contributions and investments toward retirement, and defined-benefit plans, which guarantee a certain income stream once the participant reaches retirement age.

These key distinctions define who is responsible for the investment risks, the company or the individual. Since pensions are becoming less popular, 401(k)s are being asked to fill in the gap, despite their initial intent to complement existing pension plans rather than replace them.

Sixty-six percent of private sector employees in the United States had access to defined contribution plans in March 2022, while only fifteen percent had access to defined benefit plans.

Municipal and state government workers are at another end of the spectrum. By March 2022, defined benefit plans were available to 86 percent of state and local government employees. On the other hand, just 39% of respondents said they had access to defined contribution plans.