A pension and a 401(k) are not the same thing

A pension is a monthly payment your employer promises to give you for life after you retire, based on how long you worked there and what you earned. A 401(k) is a savings account you fund yourself during your working years, and the money in it becomes yours to withdraw whenever you want after age 59½. The employer may add money to your 401(k), but the account belongs to you from day one. With a pension, you own nothing until you retire — the employer owns and manages the money the whole time.

The biggest difference is who takes the risk. With a pension, your employer promises a specific amount every month for the rest of your life, no matter how long you live or how the stock market performs. If the pension fund runs out of money, a federal insurance program called the Pension Benefit Guaranty Corporation (PBGC) usually covers part of what you are owed. With a 401(k), you take the risk: if you invest poorly or live longer than expected and run out of money, that is your problem. The money grows or shrinks based on how you invest it.

Key Takeaways

  • A pension pays you a fixed monthly amount for life after you retire; a 401(k) is your own savings account that you control and can withdraw from.
  • Your employer funds a pension and guarantees the payment; you fund a 401(k) yourself, though your employer may contribute matching money.
  • Pensions are rare in private companies now but still common in government and union jobs; 401(k)s are the standard retirement plan for most private-sector workers.
  • With a pension, you cannot take the money early or move it if you change jobs; with a 401(k), the money is yours and moves with you.
  • A pension protects you if you live a very long time; a 401(k) puts the burden on you to save enough and invest wisely.

Who funds each plan and how

Your employer funds a pension entirely. You do not contribute money from your paycheck. The employer sets aside money each year, invests it, and uses those investments to pay pensions to retirees. The employer is legally required to put in enough money so the fund can pay what it promised. If the fund does not have enough, the employer must add more.

You fund a 401(k) by choosing how much to deduct from your paycheck each pay period — up to $23,500 per year in 2024, though that limit changes annually. Your employer may match part of what you contribute, usually 3 to 6 percent of your salary, but that is optional. The money you contribute and any employer match go into an account in your name. You decide how to invest it by choosing from a menu of mutual funds, stocks, or bonds offered by your plan.

What happens when you leave your job

If you leave a job with a pension before you reach retirement age, you usually lose the pension entirely — or you keep only a small portion if you worked there long enough. Most pensions require you to work at the same company for 5 to 10 years before you own any of it. This is called vesting. If you quit or are fired before you are vested, the employer keeps the money. If you are vested, you can leave the money there and collect a pension starting at retirement age, but it will be smaller because you did not work there until retirement.

A 401(k) is yours immediately. If you leave your job, you can take the money with you by rolling it into a new employer's 401(k) or into an Individual Retirement Account (IRA). You own it from the first day you contribute, and no employer can take it back. This makes a 401(k) much more portable if you change jobs often.

How much you receive in retirement

A pension payment is calculated by a formula that usually multiplies your years of service by a percentage of your average salary. For example, a formula might be: years worked × 1.5% × average salary over your last five years. If you worked 30 years and your average salary was $50,000, you would receive $22,500 per year for life. That amount is fixed and does not change, even if inflation makes your money worth less.

A 401(k) payment depends entirely on how much you saved and how well your investments performed. If you saved $500,000 by retirement and withdraw 4 percent per year, you get $20,000 that year — but if the stock market drops, your balance drops and so does your withdrawal. You can withdraw as much or as little as you want, or take it all at once. There is no may provide amount and no may provide it will last your whole life.

Where pensions still exist

Pensions are rare in private companies now. Most stopped offering them in the 1980s and 1990s because they are expensive and create long-term obligations. Today, pensions are common in government jobs (federal, state, and local), the military, police and fire departments, and some union jobs. If you work for a city, county, state, or federal agency, you likely have a pension. If you work for a private company, you almost certainly have a 401(k) or similar plan instead.

Some large private companies still offer pensions, but they are closing them to new employees. General Motors, Boeing, and some utilities still have pension plans, but they are freezing them — meaning current employees keep their pensions but new hires get only a 401(k). This shift happened because pensions became too expensive as people lived longer.

The trade-offs between security and control

A pension gives you security: you know exactly how much you will receive each month, and it lasts your entire life no matter how long you live. You do not have to worry about investment decisions or running out of money. The downside is you have no control. You cannot access the money before retirement, you cannot change how much you receive, and if you die before collecting much, your heirs get little or nothing.

A 401(k) gives you control: you decide how much to save, how to invest it, and when to withdraw it. You can access it early if you need to (though you pay taxes and penalties). If you die, your heirs inherit what is left. The downside is the burden falls on you. You have to save enough, invest wisely, and make the money last. If you invest poorly or live longer than expected, you could run out of money in your 80s or 90s.

Frequently Asked Questions

Can I have both a pension and a 401(k)?

Yes. Many government workers have a pension from their government job and also contribute to a 401(k) or similar plan. Some private companies that still offer pensions also let employees contribute to a 401(k). The two work independently — the pension pays a fixed amount, and the 401(k) is whatever you saved and invested.

What if my pension plan runs out of money?

The Pension Benefit Guaranty Corporation (PBGC), a federal agency, insures most private-sector pensions. If your employer's pension fund fails, the PBGC pays your pension up to a limit — $5,901 per month in 2024 for someone who retired at 65, though the limit varies by age and type of plan. Government pensions are not insured by the PBGC but are usually backed by the government agency itself.

Can I take my pension as a lump sum instead of monthly payments?

Some pensions offer a lump-sum option at retirement, but not all. If your pension offers it, you can take all the money at once instead of monthly payments. This gives you control but removes the lifetime may provide — if you spend it all, you have nothing left. Most people who take a lump sum roll it into an IRA to keep it invested.

What happens to my 401(k) if I die before retirement?

Your 401(k) goes to whoever you named as your beneficiary — usually a spouse or child. They inherit the full balance. With a pension, if you die before retirement, your beneficiary usually gets nothing unless you chose a survivor option when you retired, which reduces your monthly payment.

Can I borrow from my 401(k) but not from a pension?

Yes. Most 401(k) plans let you borrow up to half your balance, up to $50,000, and repay it over five years. You pay yourself back with interest. Pensions do not allow loans — the money is not yours until you retire, so there is nothing to borrow against.