By Donald Albach
Choosing the right financial plan to reach a comfortable retirement can be challenging since there are a multitude of options to choose from. Since all retirement plans have their own features and benefits, it’s not always easy to know which one is which. Two popular options are pension plans and 401(k)s, but what sets them apart? In this article, we’ll share the key differences between these two plans to help you find the best fit for your specific needs.
What Is a 401(k)?
A 401(k), or defined-contribution plan, is a common retirement plan offered by employers. With a 401(k), you elect to contribute part of your salary into a retirement account. You can choose from a range of investments, such as index funds, mutual funds, and target-date funds. Although you have the ability to change your investments, they are limited to the investments your employer offers. You can contribute up to $22,500 (as of 2023) each year, and if you are age 50 or older, you get an additional $7,500 catch-up contribution. Your employer may also choose to match your contributions up to a certain amount. The total limit for employee and employer contributions is $66,000.
There are two types of 401(k) plans: a traditional 401(k) and a Roth 401(k). In a traditional 401(k), your contribution is taken from your salary pre-tax. Your traditional 401(k) grows tax-deferred, and you only pay taxes when you withdraw from the account in retirement. Because these contributions are tax-deferred, contributing to a traditional 401(k) means you lower your taxable income at the time you contribute.
A Roth 401(k) is funded with money after you’ve already paid taxes on it. The money in your Roth 401(k) grows tax-free in your account, and since you’ve already paid taxes on your contributions, when you withdraw funds, you withdraw them tax-free. Thus, the key difference between the two comes down to when you pay taxes. If your employer offers both, you need to decide whether it makes sense for you to pay taxes now or when you retire. 401(k) plans are also generally subject to required minimum distributions, meaning you’ll need to begin withdrawing from your plan when you reach age 73.
If you are a current federal employee, you can contribute to the Thrift Savings Plan (TSP), which is similar in structure to a private-sector 401(k) plan. Eligible employees receive a matching contribution equal to a maximum of 5% of their gross pay. The matching contribution includes an automatic 1% match (which does not require the employee to make a contribution). Like a 401(k) or IRA, the matching contribution provides additional income, and TSP can be set up with “traditional” (pre-tax) or Roth (after-tax) contributions, and you can also make a combination of both traditional and Roth contributions.
What Is a Pension Plan?
A pension plan, or a defined-benefit plan, is an employer-sponsored plan that guarantees an amount of income in retirement. The amount you receive in retirement is determined by a few factors, such as your length of employment, your salary, your age at retirement, and any other specifications set by the employer.
Your employer is responsible for contributing to the plan and all the investment risk is on them as well. However, you may need to work several years at the organization before you’re eligible for a pension plan. Additionally, with a pension plan you have no control over how it’s invested. Depending on the plan, you may be allowed to contribute part of your salary as well. You are also guaranteed regular payments for the rest of your life, though the plan might offer you the choice of a lump-sum payment.
Which Plan Is Better: 401(k) or Pension Plan?
Both plans have their advantages and disadvantages. Pension plans have been around longer, however, 401(k) plans are much more common today. In fact, as of March 2021, 52% of employees had access to a defined-contribution plan such as a 401(k), while only 3% had access to only a pension plan (12% had access to both). If you have a 401(k), it’s up to you to save for your retirement. You have more control but more responsibility as well. With a pension plan, your employer is responsible for funding the plan. If you like knowing you’ll have a guaranteed income in retirement and prefer not having to contribute any of your own money, a pension plan will be more attractive to you. If you’d rather have more control over how much you put toward retirement, a 401(k) may be a better fit.
Let Us Guide Your Success
Preparing for retirement and making the right decisions can seem overwhelming, but you don’t have to face it alone. Finding the right financial advisor can make all the difference in your retirement journey.
At Millstone Financial Group, we strive to simplify the complexities of retirement planning, creating personalized strategies that suit your unique goals and objectives. Don’t settle for a one-size-fits-all approach—let us help you design a plan for a fulfilling retirement. Schedule a complimentary consultation by calling (732) 385-8544 or emailing [email protected] to get started today.
About Don
Donald Albach is President and Co-Founder of Millstone Financial Group, an independent financial advisory firm helping pre-retirees and retirees pursue their retirement goals. Don has over 26 years of experience in the financial industry and focuses on retirement planning, designing retirement income planning strategies to guide his clients toward financial independence. Don graduated from Norwich University, the nation’s oldest private military college, and has worked his entire career in the financial services industry, including First Boston, MetLife, and C&A Financial Group. He co-founded Millstone Financial Group in 2012 with Michael Russo. Don and Mike met each other while working at MetLife, and in 2003 both he and Mike were recruited to work at C&A Financial Group, where they spent the next 10 years. It was at C&A Financial Group where they decided they needed to start their own company that strictly focused on retirement income planning. They both had a desire to help people navigate the complexities of retirement and created Millstone Financial to do just that.
Don currently lives in Monroe Township, NJ, with his wife, Tina, to whom he has been married since 1992. They have three children together: Paige, Donny, and Ally. Don’s two passions are sailing and watching college football, and he also enjoys cooking Sunday dinner for his family. To learn more about Don, connect with him on LinkedIn.
Advisory services are offered through Millstone Financial Group Limited Liability Company, a Registered Investment Advisor in the State of New Jersey. Insurance products and services are offered through Millstone Financial Group Limited Liability Company. Millstone Financial Group Limited Liability Company is not affiliated with or endorsed by the Social Security Administration or any government agency.
All material discussed is for informational purposes only. Opinions expressed are solely those of Millstone Financial Group Limited Liability Company and staff. All topics covered are believed to be from reliable sources; however, Millstone Financial Group Limited Liability Company makes no representations as to its accuracy or completeness. Investing involves risk including the loss of principle.
This article shall in no way be construed as a solicitation to sell securities or investment advisory services to residents of any state other than New Jersey, or where otherwise permitted. All information and ideas should be discussed in detail with your individual adviser prior to implementation.
This material is intended to provide general financial education and is not written or intended as tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.
