Retirement nest eggs come in many types, each with its advantages and disadvantages. Finding what retirement options work best for your unique circumstances means balancing risks over rewards and maximizing employer contributions. Both pensions and 401(k) investments are qualified, which means they offer protection of investments and tax benefits by meeting Employee Retirement Income Security Act (ERISA) guidelines. Assets in both types of accounts are protected from company creditors.
Pensions require businesses to take on the risk of investing, while a 401(k) transfers that burden to employees, who must choose their investments from defined options provided by their employer. Here’s how pensions and 401(k) plans weigh in on a balanced retirement nest egg, as well as their pros and cons.
What Is a Pension?
Pensions have a defined benefit structure where employers bear the risk of investing money over the years and paying out a pre-determined monthly benefit to retirees. Pensions are becoming less common but are still offered by some private sector businesses and many government employers.
Vesting schedules determine when employees become eligible for pension payments. Employers, and sometimes the employee, contribute to investments in the pension plan. Pension payouts are based on wages, contributions, and the number of years of service.
Pensions provide periodic payments, typically for the life of the employee. Some pensions may offer benefits to surviving spouses. Payments can be adjusted along with the cost of living, similar to how Social Security payments are adjusted compared to inflation.
Since pensions are funded mainly by the employer, their portability is limited if employment is terminated. While some government jobs allow pensions to transfer, they often remain with the employer until the employee reaches retirement age. Employers may offer buyouts in the form of lump-sum distributions that can be rolled into an IRA.
Performance can be poor with any investment; companies can go bankrupt or face challenges that cause benefit reductions. The Pension Benefit Guaranty Corporation insures most private pension funds.
What Is a 401(k) Plan?
401(k) plans are considered a defined contribution investment, with employees bearing the risk of choosing their investments. Such plans are becoming more popular, with employer matches of a percentage of employee contributions typically part of the plan. Employees are charged with investing and saving for retirement.
Vesting schedules for 401(k) plans list when employees become partial and full owners of their employer’s matching contributions toward their plans. Participants can take loans against their holdings in most plans. For those who change jobs, funds can be rolled over into the new employer’s plan, kept with the old employer under some circumstances, or rolled into an IRA.
Most 401(k) contributions are pretax funds that can grow or decline in value without limitations either way. Investments are typically placed in a variety of mutual funds. Investments currently are capped at $19,500, or $26,000 for those who are 50 or older. Employers commonly match individual contributions up to a certain amount each year.
What Plan Works Best for You?
Each employee has a unique set of circumstances that help determine the best course of action. Having sufficient money for a secure retirement requires diversified investments in a variety of account types. Both pensions and 401(k) plans are protected and offer tax benefits since they are qualified plans.
Defined benefit plans like pensions place the investment risk on the employer, which agrees to pay a certain amount to retirees based on salary, years of service, and contributions. Employees don’t have control over their investments. The ability for the account to grow is limited, as future contributions are already defined; on the other side, employees are protected from downturns in the market or employer bankruptcies. Pensions typically pay out for the lifetime of the employee, but some plans may include surviving spouses.
Pensions don’t offer easy portability if people change jobs, which is common these days. Employees often don’t stay at their jobs for the career-long spans they did years ago. The pension stays with the former employer until the ex-employee reaches retirement age. The ex-employee also could be offered a buyout.
Defined contribution plans like the 401(k) give employees flexibility in deciding how much and where they place their investments. Growth is unlimited, but so are potential losses depending on the funds chosen. Employees bear the risk of investing, but they can also reap rewards and tax benefits. Unlike pensions, 401(k) accounts can run out of money, so employees should be mindful of future financial needs.
401(k) plans offer easy portability into a new employer’s plan or one of numerous IRA options. The plans commonly allow low-interest loans that aren’t reported to credit reporting agencies; 401(k) loans often must be paid within a couple of months of terminating employment, though. Under some circumstances, a 401(k) loan may be rolled into a new employer’s plan.
What If My Employer Doesn’t Offer a Qualified Retirement Plan?
Some employers don’t offer qualified plans like pensions or 401(k) plans. Executives may be offered nonqualified benefits, while independent contractors and small business owners may fund their own plans. Nonqualified retirement plans that don’t meet ERISA guidelines aim to attract and retain top talent. Nonqualified plans aren’t protected like qualified plans. They can include special benefits like deferred compensation plans, executive bonuses, and whole life insurance policies that offer a tax benefit for high-income individuals.
People with or without an old 401(k) or similar account can roll it into an IRA, another example of a nonqualified plan. Investors can start their own IRA or tax-deferred Roth IRA at any time, following IRS regulations. IRAs can contain a combination of stocks, bonds, and other assets, with withdrawals starting as early as age 59½. Roth IRAs can offer increased liquidity since their funds are invested after income taxes are taken out.
Weighing Retirement Plan Options
Retirement planning can be very complex, with ever-changing regulations and tax implications. Investors face possible highs and lows in future market performance, making monitoring investments and realigning funds essential as retirement approaches or job situations change.
Contact 3D Partners Wealth Advisors Today!
For expert assistance in maximizing the benefits of your retirement investments, contact 3D Partners Wealth Advisors. Our team can help you with long-term financial planning, maximizing your ability to benefit by strategically measuring tax impacts and potential risks and rewards.