What are the differences, pros and cons between 401K, IRA and pension?

Employer-sponsored retirement plans like 401(k)s and pensions are becoming more and more common. There are many differences between the three main options: 401(k), IRA and pensions. So what are the distinctions between these pension programmes?

401(k)

Named after a section of the US Internal Revenue Code, a 401(k) is a retirement savings and investing plan offered by many American employers. Contributions are automatically taken out of a worker’s paycheck and invested in funds selected by the employee from a list given to them by the plan administrator. The funds are withdrawn from the pre-tax amount of a paycheck and the employee gets a tax break upfront.

These contributions, along with any earnings, grow tax-deferred until the employee reaches retirement age.

. Withdrawing funds before the age of 59½ may result in penalties. Once an employee reaches retirement, they gain access to the funds and have the freedom to choose how they want to manage and utilize their savings.

Roth IRA

A Roth IRA is a personal retirement account that individuals can open on their own to save for the future. Contributions to a Roth IRA are made by the individual on an after-tax basis, meaning they do not provide an immediate reduction in taxable income. However, the major benefit of a Roth IRA is that both contributions and any earnings grow tax-free. This means that when the individual reaches retirement age and starts withdrawing funds, they are not subject to additional taxes.

While early withdrawals before the age of 59½ may be subject to penalties, Roth IRAs offer flexibility in that the contributions, but not the earnings, can be withdrawn penalty-free at any time.

Compared to pensions, both investment plans give employees the chance to make riskier investments to potentially increase their retirement pot.

Pension

A pension is an employer-sponsored retirement plan that aims to provide a guaranteed income stream during retirement. Unlike 401(k) plans or IRAs, pensions are funded by the employer, although employees may also contribute.

Contributions to a pension are made on a pre-tax basis, reducing taxable income for the employee. This is taken out of monthly income to the employee. Upon retirement, participants receive periodic payments from the pension, providing a reliable income source throughout their retirement years.

Pensions are becoming less common in the private sector, with defined-contribution plans like 401(k)s gaining popularity. However, in the public sector, such as municipal and state government jobs, pensions remain more prevalent due to better contributions providing a secure retirement income.