Many millennials have never encountered or learned about the security offered by a pension plan but they are often referred to as something to lean on during retirement. The question is, why are pensions seemingly disappearing and what are the odds that we will experience them again in our lifetime?
Due to the higher cost to employers, pensions are becoming less and less popular, especially for non-government employees. For a variety of reasons, it’s more common that 401(k) plans are offered in the workplace. Employers will typically offer either a pension or a 401(k) - making it likely that you would have to choose one or the other. Either way, it’s helpful to know the key differences and similarities involved with these options.
What is a Pension?
A pension is often used to refer to a retirement plan option, of which there are two types: a defined contribution plan and a defined benefit plan.
1. Defined Contribution Plan
A pension in which an employee, employer or both contribute to an employee’s retirement plan is considered a defined contribution plan. This may sound familiar if you’re well-versed in 401(k) plans. These plans rely on the returns of investments that are chosen within them.
2. Defined Benefit Plan
More commonly referred to as a “pension” is a defined benefit plan. These offer automatic payouts within retirement, based on a formula that takes into account details such as your salary and years of employment.1
Pension vs. 401(k)
Considering that pensions are becoming a thing of the past, it’s important to understand why the change is occurring and what the differences between these plans may be. The most notable of which is that 401(k) plans are defined contribution plans while pensions are defined benefit plans, as noted above.
With a 401(k), you’re able to contribute a dedicated amount of money throughout your career and you can withdraw the money however you’d like within your retirement. On the other hand, a pension plan allows you to receive guaranteed payments following your retirement, up until your death.
With pension benefits, you are typically well aware of the amount you’ll continue to receive for the rest of your life. Whereas a 401(k) plan alters the amount you have in retirement, depending on how much you have contributed during your employment.
Maintaining a guarantee of lifetime income means that many prefer pension plans over 401(k) plans. Alternatively, some may prefer the increased control that coincides with a 401(k) or is employed by someone who sees pensions as too costly.
Achieving a Successful Retirement
When all is said and done, there are benefits to both pension plans and 401(k) plans. If you have a 401(k) it’s important to contribute as much as you can to prepare for your future retirement. Maxing out your employer’s match is a great way to put yourself ahead of the curve. If you’re someone who is interested in a pension plan but your employer doesn’t offer it as an option, consider helping them research the costs of such a plan and the potential benefits over alternative plan options.
Retirement preparation can be confusing and overwhelming, which is why it’s important to remain informed about your options and changes that are taking place. Talking to a financial advisor is a great way to gain more insight and understanding about the details of your finances and explore the possibilities available to you.