Pension Vs. 401(k): Key Differences & Similarities

September 14, 2021
  • A pension is a steady-income retirement plan that's funded in your working years by your employer. 
  • A 401(k) is a tax-advantaged plan funded with contributions from your paychecks.
  • A 401(k) plan offers more personalized retirement savings, while a pension makes guaranteed payouts.
  • Visit Insider's Investing Reference library for more stories.

With the rise of individual retirement accounts like 401(k) plans and IRAs, pension plans have fallen out of favor at most companies. But that doesn't mean they don't have anything to offer. In fact, pensions are still a great retirement savings opportunity.

But can they compete with 401(k) plans? Find out below where we cover what a pension plan is, what a 401(k) is, and the pros and cons of each so you can distinguish which one might make sense for you. 

Pension vs. 401(k): At a glance

A 401(k) and a pension are both a type of retirement plan. However, they vary greatly in how money is placed into each plan and how that money is handled. Pensions place much of the responsibility into the employer's hands, while 401(k) plans require employees to take a more active role in planning and saving for retirement while lowering the cost for the employer. 

  • A pension is an employer-funded retirement plan that your employer invests and provides monthly payouts to you in retirement.
  • A 401(k) is an employer-sponsored retirement plan that you control and contribute your money to.

What is a pension?

A pension is a retirement plan that your employer funds throughout your employment to later distribute monthly payments to you once you retire. A pension is characterized as a defined benefit plan because of the guaranteed monthly payments it provides. Nowadays, pensions aren't as widely offered by employers in the US — but they're still offered by certain government entities or larger, more established companies.

Employers set up and contribute money to pensions on behalf of employees and invest that money however they see fit. When you retire, the pension pays out a set amount each month throughout your retirement. 

Free money and guaranteed payouts sound ideal, but there are some drawbacks to pensions, too. 

One other major drawback of a pension: You cannot bring a pension with you if you switch companies. That means you'll have to stay at a company for a certain number of years to take advantage of the pension.

While pension payouts are guaranteed, it's not assured that those payments will cover all your expenses in retirement. "Pension opportunities are a good supplement, but I recommend opening another retirement account on the side before you retire," says Liz Young, the head of investment strategy at SoFi. "That gives you a better chance to meet your quality of life in retirement."

Pension funds are also not adjusted for inflation since you get the same dollar amount each month over the years. With inflation, the purchasing power of that monthly amount decreases.

What is a 401(k)?

A 401(k) plan is known as a defined contribution plan, since there is an established contribution system but no guaranteed payout amount. Many, but not all, employers offer 401(k) plans; you may have to elect to participate while others automatically enroll you. 401(k) contributions are pulled from your paycheck before taxes. Contributions are typically expressed as a percentage of your income. 

While a 401(k) places the burden of retirement savings onto an individual, there's the benefit of flexibility. For example, employees can choose how much to contribute — up to certain limits — and choose what they want to invest in from the account custodian's offerings. 

"If you're an aggressive investor, and you have a 401(k) that's properly invested and diversified that it's hopefully beating inflation, there's a bigger upside there than to a pension," says Kathleen Kenealy, Certified Financial Planner and director of financial planning at Boston Private, a Silicon Valley Bank company.

Employers may still contribute to employees' retirement savings through a 401(k) employer match. This is where they match your contribution often up to a certain amount. You can also roll over 401(k) savings from previous jobs into your current 401(k) or another retirement account. 

The financial takeaway

Although pensions are a rarity, if your employer offers a pension plan, experts suggest you take advantage of the free savings and guaranteed retirement income. You should supplement that with other retirement savings, though, like with an IRA. 

As the more popular employer-offered account nowadays, you're likely to run into a 401(k) at some point, and you'd be wise to maximize that opportunity as best as you can. Contribute as much as you can on your own and take advantage of your employer match if that's offered. Don't forget to pay attention to your investments as well, and do so over time, so that your investments and returns are optimized as much as possible.