Pension vs 401(k): Comparing Retirement Plans

A pension is a defined benefit plan that provides retirees with a fixed income based on factors like years of service and salary. Meanwhile, a 401(k) is a defined contribution plan where individuals save and invest for retirement, often with employer matching contributions. Due to the much higher cost on employers, pensions have become significantly less common, especially for non-government employees. The 401(k), on the other hand, has become the most widely available workplace retirement plan. Understanding the differences between a pension vs. 401(k) can help you better prepare for retirement.

Whether you have a pension, 401(k) or another retirement savings vehicle, a financial advisor can help you plan and save for retirement. Connect with an advisor today.

What Is a Pension Plan?

A pension plan is a defined benefit plan in which an employer sets money aside for an employee and invests it on the employee’s behalf. When the employee retires, they receive the return from that investment as retirement income. This can be in a lump sum or through annuitized payments. These payments are guaranteed for the rest of the employee’s life and, in some cases, can continue to a surviving spouse or dependent, depending on the plan’s terms.

But pensions are far less common than they once were. For example, there were nearly 175,000 private defined benefit plans in the U.S. in 1982, according to the most recent Department of Labor data. By 2022 – the year for which the most recent data is available – the number of private defined benefit plans had dropped to less than 47,000.

How a Pension Plan Works

Your pension payment is typically calculated based on factors like your salary, the number of years you worked for your employer and any specific provisions in your employer’s plan. While some employers base your payment on a set percentage of your salary, others may use different formulas to determine the final benefit.

Employees with pensions have no control over how the funds are managed, which has its pros and cons. On the positive side, you’re relieved of the responsibility of selecting investments or rebalancing your portfolio as retirement nears. The fund’s manager handles these tasks for you.

However, entrusting your retirement savings to a fund manager comes with some risks. Although pensions are designed to provide guaranteed benefits, poor investment decisions, economic downturns or recessions could put the fund under pressure. In rare cases, companies or municipalities that sponsor pension plans may face financial trouble or bankruptcy, which can impact their ability to pay promised benefits.

Additionally, pension benefits typically require you to stay with your employer long enough to become vested. Vesting can occur either gradually or all at once, depending on the plan. Understanding your vesting schedule is crucial, as leaving a job too soon could mean forfeiting a significant portion of your benefits.

What Is a 401(k) Plan?

A 401(k) plan is the most well-known of all the defined contribution plans. Offered by many employers, 401(k) plans allow employees to contribute a portion of their paycheck to a tax-advantaged account. Contributions can be made on a pre-tax basis, reducing taxable income, or as Roth contributions using after-tax dollars, which allow for tax-free withdrawals in retirement. Employers often match a percentage of employee contributions, providing additional savings incentives.

The funds in a 401(k) are typically invested in a range of options, such as mutual funds, stocks and bonds, depending on the plan’s offerings. Employees have control over how their contributions are allocated and can adjust their investment strategy over time.

Withdrawals from a 401(k) are generally restricted until age 59 ½, with early withdrawals subject to penalties and taxes. This plan is a popular tool for building long-term retirement savings and is widely used for its flexibility and tax benefits.

Benefits of a 401(k)

Making tax-deferred contributions to a 401(k) brings two main benefits. First, contributing can reduce your taxable income, leading to a smaller tax bill. Second, you might fall into a lower tax bracket in retirement if your income decreases after you stop working. However, estimating your future income needs and predicting tax rates is challenging, so deferring taxes doesn’t necessarily guarantee greater savings.

Some 401(k) plans offer a Roth option, which gives you the ability to make after-tax contributions to your account. Since the money has already been taxed, it grows tax-free from then on and won’t be subject to income tax when you withdraw it.

Another significant advantage is that certain employers contribute to your account by matching a portion of your contributions up to a specified limit. For example, an employer may match 50% of contributions on up to 8% of your salary. If your salary is $100,000, this means that you can get as much as $4,000 in free money if you contribute at least $8,000 per year. If your employer does this, you should do whatever is necessary to meet the threshold to “max out” your employer match. Failing to do so would effectively mean you’re turning away free money.

401(k) Contribution Limits

The IRS sets an annual limit on 401(k) contributions, but often adjusts this limit on a yearly basis. In 2025, you can contribute up to $23,500 to a 401(k), plus another $7,500 if you are 50 or older.

Starting in 2025, however, people between ages 60 and 63 can save even more. Instead of the standard $7,500 catch-up contribution, people in their early-60s can contribute up to $11,250 to their 401(k)s for a total contribution of $34,750.

Pension vs. 401(k)

The fundamental difference between pensions and 401(k)s lies in their structure. A 401(k) is a defined contribution plan, meaning you control how much to contribute throughout your career and decide how to invest those funds. Upon retirement, you can withdraw money as needed, but the balance depends on your savings and investment growth.

In contrast, a pension is a defined benefit plan that guarantees a fixed income after retirement. This income is based on factors like your years of service and salary, and it continues for the rest of your life.

Here’s a look at the primary differences between these two retirement plans.

Lifetime Income vs. Retirement Savings

Pensions provide the security of lifetime income, ensuring that retirees receive the same payment every month regardless of market performance or personal spending habits. This reliability often makes pensions appealing to individuals seeking stability in their later years. With a 401(k), however, your retirement funds are finite. The total amount you can rely on depends on how much you contributed and how well your investments performed. If you spend too quickly or if the market underperforms, there is a risk of running out of money.

Control and Flexibility

One advantage of a 401(k) is the control it offers. You decide how much to contribute, where to invest, and when to withdraw funds. This flexibility can be attractive for those who prefer to manage their own finances or want access to funds for unexpected expenses. In contrast, pensions require no involvement from the employee before retirement. This hands-off approach can be ideal for individuals who prioritize simplicity or are less interested in managing investments.

Employer Offerings and Industry Trends

For most individuals, the decision between a pension and a 401(k) isn’t personal – it’s dictated by what their employer offers. Private sector companies overwhelmingly favor 401(k) plans due to their lower costs and fewer long-term liabilities. Meanwhile, public sector employers, such as government agencies, tend to provide pensions. Understanding the trends within your industry can help you anticipate what retirement benefits might be available to you.

Combining a Pension and a 401(k)

In some cases, employees may have access to both a pension and a 401(k), particularly in industries like public service or higher education. This combination allows individuals to benefit from the guaranteed income of a pension while also enjoying the flexibility and growth potential of a 401(k). For example, a 401(k) can act as a supplemental source of income, covering unexpected expenses or helping fund larger goals in retirement, such as travel or healthcare.

Having both options can also reduce the risk of outliving your savings, as the pension provides a steady baseline income while the 401(k) can be strategically managed to preserve funds for later years. If you’re fortunate enough to be offered both, consider maximizing your 401(k) contributions while also appreciating the security of your pension.

Bottom Line

Choosing between a pension and a 401(k) often depends on what your employer offers, but understanding how each plan works can help you make the most of your retirement benefits. Pensions provide the assurance of a steady income for life, while 401(k)s offer greater flexibility and control over how you save and invest. For those with access to both, combining these plans can create a balanced approach, blending the stability of guaranteed income with the potential growth and adaptability of personal savings.

Tips for a Successful Retirement

A financial advisor can be a great partner in putting together a retirement plan. If you’d rather not go it alone, talking to a financial advisor could be a big help. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
When planning for retirement, carefully consider when to claim Social Security benefits. Claiming early at age 62 reduces your monthly benefit, while delaying until age 70 can significantly increase your payouts. Analyze your financial needs, health, and life expectancy to determine the best time to start receiving benefits. For couples, coordinating the timing of claims can maximize total benefits over your lifetimes.