Saving for retirement takes commitment and determination, but you have many tools at your disposal to help you along the way. Tax-favored accounts like IRAs and pension plans play a vital role in the retirement planning of millions of Americans, but you have to understand the ins and outs of these retirement accounts in order to make the most of them. Below, we'll go through some of the differences between IRAs and pension plan accounts.
The big difference: employer controlThe biggest distinction between IRAs and pension plans is in who controls the retirement account. With an IRA, you're in complete control, with the right to contribute as much as you want up to the maximum allowed by law and to pick whatever investments you wish for your account. The timing of contributions and investments is up to you as well.
Pension plans, on the other hand, are largely under the control of your employer. Defined benefit plans offer monthly payments to you in retirement based on your salary and years of service, and it's entirely up to your employer to figure out how to save and invest in order to come up with the monthly payments it will make after you retire.
Defined contribution plans like 401(k)s do offer some elements of employee control, including the size of your contributions and the way that you invest them. However, the employer is responsible for choosing an appropriate menu of investment options for its employees, limiting you to the investments that your employer chooses. In some ways, 401(k)s are the worst of both worlds, as you're ultimately responsible for making sure that the amount you save and the way you invest provides enough return to sustain your retirement needs, yet you still have to deal with employer control.
Getting free moneyThe other big difference between IRAs and pension plans is that many employers make contributions of their own to pension plans for the benefit of their employees, whereas IRA money almost always goes unmatched by your employer. Some employers make profit-sharing contributions regardless of whether an employee participates in a 401(k), whereas others offer matching contributions that require employees to make their own contributions in order to qualify.
Some other differences are also important. For instance, the minimum age for penalty-free withdrawals from a 401(k) is 55 rather than 59 1/2 for IRAs, and the exemptions from the 10% penalty for early withdrawals are slightly different. Protection from creditors is more absolute in pension plans than with IRAs, although both benefit from substantial protective provisions.
Overall, the differences between IRAs and pension plans make both options useful parts of an overall retirement planning strategy. By taking the best of both, you can maximize your opportunities in saving toward your retirement.
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