A pension plan is a retirement account that’s sponsored and funded by your employer. It’s based on your salary, age, and the number of years you’ve worked at your company. For example, your pension benefit might be equal to one percent of your average salary for the last five years of employment, and then times your total years of service. Over the years, your employer makes contributions on your behalf and promises to make you regular, predetermined payouts every month when you retire.
Whereas a 401k plan is retirement account that’s made available to employees who wish to save for their retirement provided their employer offers a plan. It’s the employer that holds back a part of your salary tax-deferred and places it into a fund that you’ll receive when you retire.
Some employers are even willing to match the contributions made by their employees with their own money. Since 401(k) plans are meant to encourage you to save for retirement, there are heavy tax penalties imposed for early withdrawals before a certain age.
The difference between a pension plan and a 401(k) plan
- A pension plan is funded by the employer, while a 401(k) is funded by the employee.
- A 401(k) allows you control over your fund contributions, while a pension plan doesn’t.
- Pension plans guarantee a monthly cheque in retirement a 401(k) doesn’t offer guarantees.
- Pension plans have been in existence for a long time, while 401(k)’s are gaining in popularity.