Employee Pension and 401k Plans

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Saving for retirement is a priority for many workers who currently earn a salary but will need another source of income after voluntarily leaving the workforce. The number of options for retirement saving makes the process a complicated one, but employee pensions and 401k savings plans are among the most common and useful options.

Function

  • Both an employee pension and a 401k account provide a steady monthly income during retirement. A pension is based on your employment record with a particular company. Some small businesses don't offer pension plans, and workers who move from one company to another often may not qualify for a pension. A 401k plan is a tax-deferred savings account that allows workers to contribute a portion of each paycheck before taxes are deducted. Employers have the option to match employee contributions and deduct their contributions from taxable business income. A 401k account remains active even if a worker leaves the company that sponsors it.

Differences

  • Even though employers administer both pension plans and 401k accounts, the two have significant differences. In the case of a pension, workers make no contributions on their own. Instead the company sets its own pension policy and offers it as a benefit to attract skilled workers and reward loyalty to the company. Workers fund their own 401k accounts, at least in part. When a worker moves to a new company, she may give up her pension with the former employer but can take her 401k account with her, rolling it into a new 401k through the new employer if she chooses. The funds in a 401k account can be invested by the fund manager across the economy to increase an account holder's benefits during retirement.

Value

  • The value of a pension depends on the company's policy as well as the worker's length of service and earnings. Pension benefits usually are computed as a percentage of a worker's average salary. Workers with a longer tenure stand to earn a benefit closer to their original salary, while those who retire early receive a lower percentage. Pensions reward loyalty, but also pay more to workers who earned more. A 401k's value depends on how much the worker contributes, how much the employer contributes and how well the funds in the account are managed. Both workers and employers must comply with tax laws that limit the maximum annual contribution to a 401k. A 401k has the added value of lowering a contributing worker's tax burden, instead taxing the funds when they're withdrawn and the retiree is in a lower tax bracket.

Alternatives

  • While some workers rely primarily on pensions and 401k accounts to fund retirement, there are other options as well. Social Security benefits come from the federal government and pay a monthly amount based on how much a worker contributed in Social Security taxes over a lifetime of employment. IRAs, or individual retirement accounts, are an alternative to 401k plans that don't require an employer to act as a sponsor. Workers also can invest in personal holdings, such as stocks and bonds, with the intention of selling the investments to fund a retirement.

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