What's the difference between a 401(k) and a pension plan?

Pensions, 401(k)
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The single greatest difference between the two plans is the source of contributions:

  • A 401(k) is largely funded by the employee.
  • Pension plans are largely funded by the employer.

Many employees do offer a matching contribution, while some offer a profit sharing contribution to a 401(k); additionally, some pension plans include employee contributions, as do many union labor or government based pension plans.

Other differences include:

  • Maximum employer annual contribution/deduction:
    • Pension plan: determined by actuary
    • 401(k) plan: 25% of covered payroll excluding deferral, if plan specifies

 

  • Employer contributions required?
    • Pension plan: Yes
    • 401(k) plan: No

 

  • Employer Contributions discretionary?
    • Pension plan: No
    • 401(k) plan: Yes, top-heavy minimum employer contribution may be required.

 

  • Voluntary employer matching contributions allowed?
    • Pension plan: N/A
    • 401(k) plan: Yes

 

  • Maximum participant benefits:
    • Pension plan: Lesser of 100% of compensation or $215,000 annually.
    • 401(k) plan: N/A

 

  • Maximum participant allocations:
    • Pension plan: N/A
    • 401(k) plan: Lesser of 100% of compensation or $54,000.

 

  • Catch-up provisions for those age 50 and older:
    • Pension plan: N/A
    • 401(k) plan: $6,000

 

  • Investments self-directed by participant or can be invested at participant discretion?
    • Pension plan: N/A
    • 401(k) plan: Yes

 

  • Retirement benefits specified in plan?
    • Pension plan: Yes
    • 401(k) plan: N/A

 

  • Investment return affects retirement benefits?
    • Pension plan: No
    • 401(k) plan: Yes

 

  • Benefits guaranteed at retirement?
    • Pension plan: Yes
    • 401(k) plan: No 

 

Best of luck!

Jack Brkich III, CFP.

October 2014
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