For today’s workers, retirement provision is very different from that for their parents and grandparents.
Social security benefits are likely to cover only a fraction of retirement needs and, unlike in previous decades, it is left to the individual to make up for this shortage.
This change is due to a shift in the type of retirement provision currently being offered in most workplaces. Your grandparents may have retired with pension benefits. You are more likely to rely on a nest egg that you built in a 401 (k).
The two plans actually have little in common. In this article, we’ll explain the differences between a pension and 401 (k), and how those differences now affect your planning.
How the plans differ
A generation ago, millions of Americans worked in pensionable jobs. Many people stayed with the same company for decades – even throughout their careers – receiving benefits under a retirement plan that paid them a fixed amount for life after they retired. Today many government agencies still offer traditional pensions, but they are rare in the private sector.
If you work for a private company, you are more likely to be offered a 401 (k) plan that you and / or your employer will contribute to input tax.
The main difference between the plans is who bears the investment risk.
In a pension, the entire risk lies with the employer. As a defined benefit plan, an annuity pays retirees a fixed amount for life. If the plan’s investments don’t perform well enough to meet those commitments, the company must make up the difference. And if the company goes under, your benefits are insured – and therefore guaranteed – with the Pension Benefit Guarantee Corporation.
In a 401 (k) defined contribution plan, the amount you will get in retirement is not guaranteed. It depends on how much money you are investing and how good those investments are. That means that all of the risk is yours.
In 1998, 59% of Fortune 500 companies offered their employees a pension fund. in 2019, Only 14% of these companies still offered such a plan.
Why such a dramatic change? They are expensive for employers. Pension plans are usually fully employer-funded, but not always. And the benefits are based on years of service, so companies with many high-paid, long-term employees ultimately commit to long-term funding for the plan.
Payouts for retirement plans
In retirement, employees on a pension plan receive a fixed payment each month. The benefits are lifelong so there is no risk of running out of money.
Some retirement plans offer a spouse survival option that typically pays the retired worker a lower monthly amount, but with a guarantee that the spouse will continue to receive payments after they die.
The amount a retiree receives each month is calculated based on the number of years the employee has worked for a company and their salary. In order to receive the full pension benefit, an employee must have worked for a company for a certain number of years.
What is important for someone considering a pensionable job? First, government salaries tend to be lower than those in the private sector. So you could be anchored in a job that pays less – but in exchange for old-age insurance; H. The income for life.
Introduction to 401 (k) plans
As retirement plans have grown in popularity over the past few decades, 401 (k) plans have skyrocketed. They allow employees and Employers to invest funds in the employee’s retirement.
Contribution to a 401 (k)
For 2020 and 2021, employees can defer up to $ 19,500 of their pre-tax salary. Employees aged 50 or older can wager an additional $ 6,500. In addition to employee contributions, many employers offer a match.
Many employers pay 100% of the employee contribution up to 3% of the salary. So if you were making $ 40,000 a year and contributing 3%, you would put in $ 1,200 and your employer would bring in another $ 1,200.
Most people cannot afford to contribute the maximum amount to their 401 (k). However, you should try to do enough to get your employer’s match. Otherwise, you will lack the free money.
Most employer-sponsored 401 (k) packages include access to online tools that will help you determine how to invest. Target Funds let you set and forget about it based on your risk tolerance, age, and other factors.
Taxes and 401 (k) s
Similar to IRAs, 401 (k) offers two tax options: a traditional 401 (k) and a Roth 401 (k).
When you contribute to a traditional 401 (k), the money becomes “tax-deferred”. That is, if you add $ 10,000 to your 401 (k) in 2020, you won’t pay any income tax on that $ 10,000 now. However, you will pay tax on this money when you withdraw it in retirement.
With Roth 401 (k) plansYou now pay tax on the money you contribute, but it is tax free if you take it out when you retire.
Both types of 401 (k) have a 10% penalty if you withdraw early (before turning 59 ½).
The key to success: Unlike retirement plans, there is no guarantee of the money in your 401 (k). If the market is arming right before takeoff, you may not have time to make up for the losses. But historically the market is increasing. As you work and make more money in your career, there is a large pot of cash that can come with you when you leave your job.
Pension plan vs. 401 (k)
Here are the key strengths and weaknesses of retirement plans and 401 (k) s:
Guaranteed income: retirement plans
A retirement plan guarantees you an income for life. You know exactly how much you are going to have each month. Talk about peace of mind in retirement.
Required Term of Office: 401 (k) s
Gone are the days when employees chose a company and stayed for 40 years. Today’s workers prefer to change jobs more frequently during their careers. Switching jobs is easier when you have a 401 (k).
Low stress: retirement plans
Retirement plan investments are determined and managed by professionals – you have no say. And because the plan guarantees the benefits, the money is usually invested very conservatively. A 401 (k) is much more exposed to fluctuations in the stock market.
Investment flexibility: 401 (k) s
With that risk comes an opportunity. A 401 (k) gives you more investment flexibility and allows you to invest your money in less risky assets as you near retirement.
Timothy Moore is an editorial and graphic design researcher and freelance writer. He has been working in this field since 2012 with publications such as The Penny Hoarder, Debt.com, Ladders, WDW Magazine, Glassdoor and The News Wheel. He lives in Ohio with his fiancé.
This article originally appeared on www.thepennyhoarder.com