Bill Lockyer is the former State Treasurer of California. He also served as a state senator and as the Attorney General of California
Bill Lockyer Explains What a 401(k) Plan Is
A 401(k) plan is a retirement account available to employees through their employers. When you add money to your 401(k), a portion of your salary is held back by your employer, and that money is placed in a fund that you’ll receive upon retirement. The money is “tax-deferred” meaning that it’s taken from your paycheck before taxes and won’t be taxed until you access it when you retire.
“Some employers offer what’s called a ‘401(k) match’,” explains Bill Lockyer. “That means they will match employee contributions up to a certain percentage with their own money. You should always take advantage of a match program if your employer offers it – it’s basically free money!”
Because 401(k) plans are meant for retirement, there are often heavy penalties for withdrawing the money before you’re 59 ½.
What Is A Pension Plan? Bill Lockyer Explains
A pension plan is a retirement account funded and sponsored by your employer on your behalf. It is based on a formula that includes factors like age, salary, and how long you’ve worked with the company. “For example, your pension benefit may be two percent of your average salary for the last five years you were employed times your total years of service,” explains Bill Lockyer. Over your years of employment, your employer makes contributions on your behalf and you receive regular predetermined payouts every month from the day you retire.
Bill Lockyer Discusses the Difference Between 401(k) and Pension Plans
“The major differences between 401(k)s and pension plans are who pays into them, who’s in control of the money, and the guarantee of money during retirement,” says Bill Lockyer.
- A pension plan is funded by your employer, while 401(k)s are funded by you – the employee. Remember that some employers do match employee contributions, but usually only up to around 3-6 percent of your salary.
- A 401(k) gives you control over your fund contributions – you can put as much or as little as you like into it. A pension plan is based on a formula so you can’t put in extra.
- Pension plans guarantee a monthly check during retirement – usually until your death. A 401(k) offers no such guarantee. Your monthly allowance will depend on how much you contributed and the state of the market.
Pension plans have existed for a long time, while 401(k)s are relatively new. However, there are very few companies left in America that offer pension plans. “401(k)s are much cheaper for companies,” says Bill Lockyer. “Even if they offer a match, that requires an employee to invest in their 401(k), which an alarming majority of people don’t do.” Bill Lockyer encourages readers to invest in any retirement plans available through their employers. “And if they don’t offer one, you need to be putting away at least 10 percent of your income somewhere to save for retirement. 12-15 percent is much safer.”